Cryptocurrency and Federal Taxes: What are Your Obligations to the IRS?

The Internal Revenue Service (IRS) is cracking down on individuals who fail to report cryptocurrency transactions and who fail to pay income taxes triggered by these transactions. In late 2019, the IRS issued updated guidance on the federal tax treatment of cryptocurrency (or “virtual currency”); and, at the same time, it warned that it is, “actively addressing potential non-compliance in this area through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.” If you are concerned that you may be behind on your federal tax obligations, you should speak with a New Jersey tax attorney promptly.

Understanding the Federal Tax Treatment of Cryptocurrency

Despite its unique aspects, the IRS considers cryptocurrency to be on par with all other forms of property for federal income tax purposes. In its Frequently Asked Questions on Virtual Currency Transactions, the IRS states, “[v]irtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency.”

That said, reporting income on cryptocurrency transactions does present a number of unique challenges, and the IRS offers some guidance for addressing these challenges as well. For example, its Frequently Asked Questions also address matters such as:

• Determining the fair market value of cryptocurrency for purposes of determining income tax liability  
• Determining basis in cryptocurrency either purchased or received in exchange for goods or services
• Calculating gain or loss on the sale or other disposition of cryptocurrency
• Calculating income when a customer pays for a product or service with cryptocurrency
• Determining whether gain or loss is short-term or capital
• Determining when gain or loss from cryptocurrency transactions is realized for federal income tax purposes

However, as you might expect, the IRS’s Frequently Asked Questions only provide general (and often very short) answers, and they do not address the specific issues that many taxpayers will confront when attempting to prepare compliant returns. The IRS has released additional documents that address issues such as the tax implications of cryptocurrency mining and “hard fork” events, but these too only serve as starting points for individuals seeking to understand their federal tax obligations.

The IRS is Aggressively Targeting Cryptocurrency Tax Noncompliance

Despite the novelty of cryptocurrency and the constant evolution of the cryptocurrency market, the IRS is nonetheless aggressively targeting individuals who are suspected of violating the law. In 2019, it sent “educational letters” to more than 10,000 individuals who, “may have reported transactions involving virtual currency incorrectly or not at all.” Cryptocurrency holders can expect the IRS to maintain its enforcement efforts in 2020; and, for those who are non-compliant, the consequences have the potential to be severe.

Do You Have Questions about Your Cryptocurrency Tax Obligations? A New Jersey Tax Attorney Can Help

If you have questions about your federal income tax obligations related to cryptocurrency, if you have received a letter from the IRS, or if you are facing a federal tax audit, our New Jersey tax attorneys can help you avoid unnecessary tax, interest and penalties. To request a confidential consultation with New Jersey tax attorney Kevin E. Thorn, Managing Partner, Thorn Law Group, call 201-355-8202 or contact us online today.