Accounting and Tax Considerations for Using Cryptocurrency

Accounting and Tax Considerations for Using Cryptocurrency

If your business sells products or services, and you’re accepting (or considering receiving) cryptocurrency as payment, you need to be aware of some tax implications that affect how you report your earnings. The Internal Revenue Service has started cracking down on businesses and individuals who don’t accurately report their virtual currency transactions and warning investors that they may owe capital gains taxes on cryptocurrency income.

While this relatively new form of online currency (first issued in 2009 by Bitcoin) was created to provide a decentralized, peer-to-peer digital cash system, it has also spawned a new trading market. As a result, the IRS is treating cryptocurrency assets as property rather than currency (at least for now). That means you could owe taxes at capital gains rates like those for stocks if you’ve received or shared payments in this format.

What Is Cryptocurrency?

Cryptocurrency is an internet-based medium of exchange that uses strong cryptography to secure financial transactions and distribute virtual currency on a peer-to-peer basis. It is decentralized, meaning there is no central bank or hub where the currency is created, and it’s purely digital, meaning it has no physical representation.

Cryptocurrencies leverage blockchain technology, a type of distributed electronic ledger that serves as a very secure public financial transaction database, which confirms authenticity using private keys. Bitcoin was the first cryptocurrency but is now one of more than 2,000 other cryptocurrencies that are traded in online markets.

Most (but not all) cryptocurrencies have a finite supply because their source codes are designed to limit the number of units that can ever exist. As a result, such currencies tend to rise in value as the supplies become more limited, similar to gold and other precious metals, rather than decline in value the way government-issued (fiat) currencies, which can have unlimited supplies, can become deflated over time.

Using Cryptocurrencies

Why would a business want to use (or invest in) cryptocurrencies? The primary reason is typically to avoid transaction fees on international purchases (or payments). Transferring assets easily across borders was a principal reason the cryptocurrency Bitcoin was invented.

But cryptocurrencies are also being used to hide assets (from a spouse or government, for example) or to purchase goods or services that might not be completely legal. However, many legitimate businesses, such as WordPress, Microsoft, Expedia and Overstock, also accept payment in Bitcoin.

Hiding assets and illegal purchasing could be among the reasons the U.S. government and IRS are taking a stronger stance toward them. At least two bills were introduced in 2019 to the House of Representatives to regulate cryptocurrency: the U.S. Virtual Currency Market and Regulatory Competitiveness Act and the Virtual Currency Consumer Protection Act.

In addition, cryptocurrencies have become an investment vehicle in their own right. When the one-year value for a single Bitcoin unit went from $750 to $20,000 between December 2016 and 2017, the investment bandwagon took off. Yet, the inevitable happened, and just a year later the cryptocurrency market took a huge dip. As an investment scheme, cryptocurrencies are fraught with complications and risks (not the least of which is fraud), in spite of the fact that transactions made using cryptocurrencies are generally secure.

Stay Clear of Tax Problems

If you accept cryptocurrency payments, keeping accurate records of any virtual transactions is important, but so is understanding what to report on your taxes Consider this list of common mistakes accountants see clients making when using cryptocurrencies:

  • Not disclosing assets and transactions for tax reporting
  • Submitting missing or inaccurate data
  • Miscalculating capital gains for profits and losses
  • Using manual tracking of data or account information

The valuations and tracking of cryptocurrency gains and losses can be challenging, especially in regard to assets that have a token created but haven’t yet been exchanged. New laws may help remove some of the ambiguity and simplify legal issues for merchants and small businesses accepting this form of payment. In the meantime, get help from a tax professional to avoid making mistakes.

“Virtual currencies, perhaps most notably Bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us.” – Thomas Carper, US-Senator

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