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Cryptocurrency holders have more than price volatility to fear this year. The tax authorities want to know about your business activity.
Bitcoin hit new highs over the weekend, reaching $ 42,000 on January 8. However, its value fell in value on Monday amid a massive sell-off in cryptocurrencies, and bitcoin’s value is now hovering around $ 33,000.
Whether you interpret the price drop as a buying opportunity or a wake-up call, you will need to share the information with the IRS.
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The transactions in which you participate this year will be reportable when you submit your 2021 tax returns next spring.
This tax season, the IRS asks a “yes or no” question on the front page of the 2020 federal income tax return: “At any time in 2020, have you received, sold, sent, traded or otherwise acquired any interest? financial in a virtual currency? “
“If you particularly use bitcoin, not only is every transaction potentially an income or a deduction, but when you use it to pay for goods, you might have a gain to report on that bitcoin,” said E. Martin Davidoff, associate. -charge in the national practice of tax controversy of Prager Metis.
Buying and selling cryptocurrency isn’t the only action that creates a reporting requirement.
You will also need to check the “yes” box on your tax return if you happen to pocket free crypto or receive your holdings in exchange for goods or services.
Exchanging your bitcoin for other goods is also a reportable transaction.
This is where things can get complicated, as users can use multiple exchanges or platforms for their crypto trading activity.
Some exchanges will only provide you with a Form 1099-K for tax time. It contains details of your activity if you have had gross payments greater than $ 20,000 or if you have completed more than 200 transactions.
This means that the responsibility for accurate record keeping, reporting and paying taxes really rests with the investor.
“You have to keep track of every transaction you’ve made, of every sale,” Davidoff said.
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In general, the IRS considers virtual currency to be property. This means that if you sell your holdings, you have either accrued a capital gain or a loss.
During this time, wages paid to you in cryptocurrency will be reported to you on a Form W-2, which your employer must send you by the end of this month. Federal income tax and FICA taxes would apply to the payment, as they do for salaries paid in dollars.
The cryptocurrency you mine should also be included in your taxable income. In this case, you must include the fair market value on the day you received it.
Failure to report income can result in penalties and interest – and in the most extreme cases, jail and fines up to $ 250,000.
Indeed, in 2019, the IRS sent letters to thousands of taxpayers with virtual currency transactions, advising them to reimburse taxes and submit amended returns.
In addition to tracking your transactions, tax practitioners recommend keeping detailed records of your base or initial investment in the asset.
Also important is the length of time you held the asset before making a transaction with it.
If the holding period exceeds one year, you are subject to favorable long-term capital gains treatment when you sell your virtual currency. In this case, the capital gain tax can be 0%, 15% or 20%.
However, if you sell your virtual currency within a year of purchasing it, regular tax rates take effect. These rates can reach 37%.
You have to follow your base even if you are using your bitcoin to buy things from a merchant, so be careful how you trade.
“If you have to choose between using your US currency versus crypto, at least with cash, you don’t have to go basic,” Davidoff said. “It’s a huge headache.”