The U.S. Taxation of Cryptocurrency (2024): A Crypto Tax Guide

A New Crypto Taxes Guide for 2023: What You Should Know

New Crypto Taxes Guide

Cryptocurrency tax enforcement has become a key compliance priority for the IRS. While the tax rules continue to evolve, the past few years have proven that the Internal Revenue Service seeks to aggressively seek enforcement. In 2019, the IRS issued a revenue ruling (RR 2019-24) on the treatment of crypto. Despite the revenue ruling, many questions remain unanswered about how crypto income and reporting are treated — especially if it involves overseas and international cryptocurrency. Moreover, the  2020 1040 tax return and subsequent returns have included  a direct question regarding virtual currency (aka crypto or Bitcoin) on the very first page of the tax return. That should give you a clear indication of how cryptocurrency has become a key enforcement priority for the US government.

An Introduction to Taxation of Cryptocurrency

Let’s work through some of the most commonly asked questions regarding virtual currency (noting, the rules are still evolving and you should always be sure to check any recent updates):

Is Crypto Treated as Currency or Property?

This is probably the most commonly asked Cryptocurrency Tax FAQ. Cryptocurrency is considered property, not currency, for US tax purposes. Therefore, the taxation of cryptocurrency exchanges will be treated differently than if it was currency.

Tax Treatment of Property vs Currency?

Here is a simple example of the difference between property versus currency for tax treatment:

If Peter goes to the store with $100 and purchases something for $95, the transaction is relatively simple. Peter gives the clerk $100 and receives the product as well as $5 back. The product is worth $95 and that will be the adjusted basis (aka the original cost) for the product. Instead, if Peter has crypto worth $10,000 that he exchanges for a new crypto valued at $10,500, then Peter has a $500 gain. In other words, Peter exchanged an asset that was worth $10,000 and received another asset worth $10,500. That new asset in Peter’s hand is worth $10,500. Presuming it was an arms-length transaction, the general rule would be Peter has a $500 gain that he would need to report on his tax return for the current year. When Peter goes to sell or transfer the new asset, it will be worth $10,500. As you can imagine, when a person has hundreds, thousands, or even millions of crypto exchanges in a single year — the tax ramifications can be daunting.

What is the Crypto Question on the new 1040?

As we mentioned at the beginning of this article, the draft version of the new 1040 asks the following question (on the first page of the 1040):

• • • Digital Assets At any time during 2023, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)? (See instructions.)

Is Crypto Reported on the Tax Return?

Yes. If your cryptocurrency was sold or exchanged, it is generally reported on Schedule D while incorporating form 8949 to identify each transaction.  If instead the crypto was received for employment purposes, then it would be reported as income.  In other words, the crypto is reported based on the category of income represented by the crypto transaction.

Do I Report Each Crypto Sale or Exchange Transaction?

Yes. Technically each transaction involving cryptocurrency (unless it was only purchased and not sold or otherwise exchanged) is reportable on the tax return.  For example, if Melissa purchased cryptocurrency for $25,000 but did NOT sell or exchange that cryptocurrency  — the mere purchase of the crypto is not in and of itself a reportable transaction.

How do I Report Each Sales Transaction?

Each sale/exchange transaction is reported on Form 8949, which is a form that accompanies Schedule D.

What if I Exchange Crypto for Crypto?

When a person exchanges cryptocurrency for different cryptocurrencies, this is an exchange of assets between two parties and it is reportable on Schedule D. 

What if I Exchange Crypto for Other Property?

It is still reportable. When a person exchanges cryptocurrency for other property, that too may result in a capital gain or loss which is reportable on Schedule D as well.

What if I Exchange Crypto for Services?

When a person receives cryptocurrency for services, it is reportable as well — but it would not usually be reported on Schedule D; rather, it is booked as regular income.  For example, Denise’s employer pays Denise in cryptocurrency for the work she performed. Denise reports that cryptocurrency as income and pays all necessary employment and related taxes. Likewise, the value or adjusted basis of the cryptocurrency in Denise’s hand will be the value she reported as income.  So, if Denise was paid $100,000 in cryptocurrency for the work she performed and the next year, she sells that cryptocurrency for $110,000 — she would have a $10,000 gain.

What About Cryptocurrency Investments?

Cryptocurrency investments can get very complicated.  The baseline perspective is this: if your cryptocurrency is bundled in a fund or other investment and it generates income — it may be taxable.  Generally, earned investment income to U.S. persons is taxable when it accrues, but there are some exceptions depending on whether the taxpayer has the opportunity to select a cash vs reinvestment dividend.

What if the Crypto Generates Income?

If cryptocurrency is in an account or other exchange that generates any type of income, then the income may be taxable. Drop-ins are generally taxable and will usually have a zero basis since they were “dropped into” the account and not purchased or exchanged.

FinCEN 114 for Virtual Currency

When virtual currency is being held in a foreign financial account or something similar and there is no other currency (such as euros) held within the account, then the account is generally not reportable. It is important to note, that if there is any currency held within the account outside of virtual currency, then the account may become reportable.

As provided by the IRS in pub 5569:

• • • “Example:

      • A foreign account holding virtual currency is not reportable on the FBAR (unless it’s a reportable account under 31 C.F.R. 1010.350 because it holds reportable assets besides virtual currency). These funds aren’t reportable at this time, per FBAR regulations issued by FinCEN February 24, 2011, but FinCEN Notice 2020-2 indicates FinCEN’s intention to propose amending the regulations to include virtual currency as a type of reportable account under 31 CFR 1010.350.”

Hybrid Foreign Accounts and FBAR

When an account is only virtual currency, then it does not have to be reported for FBAR at this time — but the same rule does not apply if it is a hybrid account in which it holds reportable assets in addition to virtual currency. For example, if a taxpayer exchanges their foreign virtual currency for pounds or euros within that account, then it may be considered a hybrid account that requires reporting.

FATCA (Form 8938)

FATCA is different than FBAR and can include additional foreign assets that are not reportable for FBAR. For example, a foreign asset that would be reported for FATCA purposes on Form 8938 is an overseas stock certificate — but this same stock certificate would not usually be subject to FBAR reporting unless it was held within an account. The question then becomes whether foreign virtual currency/virtual currency is considered an asset that is reportable on Form 8938. Since virtual currency is considered an asset — and there is no absolute exclusion from having to report virtual currency for FATCA purposes — chances are virtual currency would be a reportable asset on Form 8938.

PFIC (Form 8621)

PFIC refers to Passive Foreign Investment Companies. Many US taxpayers may find themselves subject to the PFIC rules simply because they own foreign mutual funds or other pooled funds. In the past few years, multiple crypto investment funds have been launched both in the US and abroad. And, if a crypto fund qualifies as a PFIC, then Form 8621 would be required (unless an exception, exclusion or limitation applies).

Notice 2020-2

Notice 2020-2 reflects the fact that FinCEN intends to amend regulations requiring virtual currency to be identified as a reportable account for FBAR purposes – and chances the IRS will extend the reporting rule to FATCA/Form 8938 as well.

• • • Currently, the Report of Foreign Bank and Financial Accounts (FBAR) regulations do not define a foreign account holding virtual currency as a type of reportable account. (See 31 CFR 1010.350(c)). For that reason, at this time, a foreign account holding virtual currency is not reportable on the FBAR (unless it is a reportable account under 31 C.F.R. 1010.350 because it holds reportable assets besides virtual currency). However, FinCEN intends to propose to amend the regulations implementing the Bank Secrecy Act (BSA) regarding reports of foreign financial accounts (FBAR) to include virtual currency as a type of reportable account under 31 CFR 1010.350.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to streamlined procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead of the Streamlined Procedures. But, if a willful Taxpayer submits an intentionally false narrative under the streamlined procedures (and gets caught), they may become subject to significant fines and penalties. 

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