What Is Cryptocurrency Tax Law?

If you have received correspondence from the IRS citing underreported cryptocurrency income and are confused about tax law in this area, the experienced tax attorneys at Wiggam Law can evaluate your situation for proper tax treatment and represent you in discussions with the IRS. 

For the past several years, the IRS has been cracking down on cryptocurrency transactions and demanding payment for what it sees as unpaid taxes on allegedly underreported virtual currency income. But until recently, the agency has not specifically asked taxpayers about their virtual currency dealings. As a result, many taxpayers have been confused about cryptocurrency tax law and particularly what to report on their tax return. 

What is Cryptocurrency? 

The IRS defines virtual currency as a digital representation of value, and cryptocurrency as a type of virtual currency. Cryptocurrency uses cryptography to authenticate and secure transactions, which are digitally recorded on a distributed ledger. 

The agency considers cryptocurrency and all other types of virtual currency to be property, like stocks, bonds, and other investments. Any cryptocurrency transaction therefore has a tax consequence and may result in a tax liability, whether it’s the sale or exchange of cryptocurrency or the use of it to purchase goods and services. While virtual currency can be used to purchase items, it does not have legal tender status in the United States. 

What is Cryptocurrency Tax Law? 

In 2014, the IRS issued Notice 2014-21 IRS Virtual Currency Guidance, which is still considered the main tax law on cryptocurrency and other types of virtual currency. This is the document that designated virtual currency as property rather than as currency or legal tender. If a taxpayer uses cryptocurrency to pay for goods or services, they must recognize a gain or loss. The gain or loss is calculated as the difference between the fair market value in U.S. dollars of the virtual currency on the date it was received by the taxpayer and the fair market value of the item or service on the date purchased. 

As with stocks and bonds, gain or loss on cryptocurrency is classified as short or long term. If you hold cryptocurrency for one year or less before selling or exchanging it, then you must recognize a short-term gain or loss and pay any taxes due at the applicable short-term rate. If you hold the cryptocurrency for more than one year, a sale or exchange results in a long-term gain or loss.

If you are paid in cryptocurrency by an employer, the fair market value of the cryptocurrency is subject to federal income tax withholding as well as Social Security and Medicare taxes. The employer must report the fair market value on your W-2. Likewise, if you are an independent contractor who is paid in virtual currency, you should receive a Form 1099-MISC with the fair market value of the cryptocurrency noted as income. 

What Do I Have to Report on Form 1040? 

Beginning with tax year 2020, the IRS began requiring taxpayers to answer a question related to virtual currency on their Form 1040. The 2020 form asked taxpayers whether at any time during the year they had received, sold, sent, exchanged, or otherwise acquired a financial interest in any virtual currency. The language was a bit confusing for taxpayers, so the IRS is expected to tweak it for 2021. The draft 2021 Form 1040 more simply asks taxpayers whether they received, sold, exchanged, or otherwise disposed of any financial interest in virtual currency. 

What is the IRS Crackdown on Cryptocurrency? 

For years now the IRS has been working to collect unpaid taxes on cryptocurrency transactions. In 2019, the agency announced it was using data analytics to identify taxpayers who failed to report cryptocurrency income. In the same year, it sent letters to 10,000 taxpayers with virtual currency transactions, advising them they may have failed to report income. 

The agency has also been going through the courts to require virtual currency dealers to release information on clients with significant virtual currency transactions. The IRS’s criminal investigation unit has a special section dubbed Operation Hidden Treasure that is dedicated to virtual currency. 

If you have been contacted by the IRS about unreported cryptocurrency income and unpaid taxes, it’s best to speak with an experienced tax attorney about all your options. At Wiggam Law, our team of experienced tax lawyers can help you evaluate your choices and represent you. Give us a call today at (404) 233-9800 to get started.