The IRS is now taking tax debt deriving from cryptocurrency gains very seriously, as evidenced in IRS document 2019-132.
The time has come when accountants need to counsel their clients with cryptocurrency interests to come forward with their gains given the fact that the tax collection efforts of the IRS will only continue to ramp up in this area.
At this point, the best counsel you can give is to disclose everything which has been accumulated thus far. Another thing you can do is provide a clear explanation of the central takeaway from IRS Notice 2014-21. As we’ll discuss below, IRS Notice 2014-21 was designed to quell some of the uncertainty regarding the taxation of cryptocurrency.
In this document, the IRS describes the basic tax principles which apply to cryptocurrency and discusses how taxpayers can use these principles to effectively plan for their cryptocurrency tax bill. Let’s first discuss the latest tax collection efforts by the IRS with regard to virtual currency and then go into the crux of the Notice.
IRS is Cracking Down on Virtual Currency Tax Debtors
The IRS is currently in the process of sending out over 10,000 letters to individuals suspected of having cryptocurrency-based tax debt. In its 2019-132 document, the IRS indicated that it would be sending these letters in three variations through the month of August.
Individuals would receive Letter 6173, Letter 6174, or Letter 6174-A. Each of these letters has a unique purpose. Recipients of one of these letters should file amended or delinquent tax returns and, depending on the circumstances, get in touch with a qualified tax attorney The IRS has made clear the fact that it will pursue criminal charges in cases involving cryptocurrency tax fraud or tax evasion.
Bottom line: those who have gains deriving from cryptocurrency mining or sales shouldn’t expect to be treated gently.
The Main Takeaway from IRS Notice 2014-21
Though many would (understandably) suppose that the taxation of cryptocurrency would be overly complex, the truth is that cryptocurrency taxation is reasonably straightforward. Of course, not all bugs have been worked out and those who have cryptocurrency gains may have to perform a bit more legwork when compared with other taxpayers but, on the whole, the typical cryptocurrency return won’t be impossibly difficult.
The primary takeaway from Notice 2014-21 is that virtual currency is treated as intangible personal property by the IRS. This essentially puts virtual currency in the same category as other, non-virtual intangible property, such as stocks, bonds, patents, copyrights and so forth.
Notice 2014-21 discusses the tax principles which follow given this classification for virtual currency. If virtual currency is held for investment purposes, then the gain which follows a sale will be taxed at the applicable capital gain tax rate. If, on the other hand, the virtual currency is sold in the ordinary course of business (i.e. a commercial exchange), then the seller will be taxed at the applicable ordinary income tax rate.
Those who “mine” virtual currency as their primary trade or business will be subject to income taxation, and also will be subject to the self-employment tax. If an employer pays its employees using virtual currency for wages, this payment would be subject to the normal withholding and reporting requirements for employment tax purposes.
Likewise, if an independent contractor receives more than $600 of virtual currency (as determined by fair market value at the time of receipt), then that would be a reportable event and require a Form 1099. Notice 2014-21 references several key IRS documents which are recommended for consultation purposes in connection with virtual currency taxation (i.e. basis of assets, taxable and nontaxable income, etc.).
Accountants should consult these materials as necessary when determining the tax liability from cryptocurrency gains in any given case. Again, not all bugs are fixed and since virtual currency can be spent directly in place of U.S. dollars in many venues, this raises issues for tax liability computation in certain contexts.
But, the tax situation for many virtual currency holders will be clarified a great deal through the information contained in Notice 2014-21. In other words, the principles laid out in Notice 2014-21 will suffice in many, but not all, cases involving cryptocurrency gains. For now, accountants can solidify their client base and go a long way toward assisting their clients by relaying the core message of Notice 2014-21.
Jorgen Rex Olson is a graduate of Washington State (B.A., cum laude, 2008) and the Indiana University (McKinney) School of Law (J.D., 2012). He writes for Mackay, Caswell & Callahan, P.C., one of the leading tax law firms in New York State.