Bitcoin

<div class="Section1"><br /> <br /> As with any other type of transaction, there are advantages and disadvantages to using bitcoin or other virtual currency as a method of payment. With bitcoin, transaction costs for transferring the virtual currency can be lower than costs charged by a financial institution or credit card company. Further, bitcoin can be transferred internationally with few complications, and without many of the fees that can apply when converting currency.<br /> <br /> Bitcoin or other virtual currencies can also be useful in developing countries that lack a secure banking system or stable currency. As discussed below, bitcoin can be volatile, but it is also possible that the virtual currency will be less volatile than the currencies existing in many developing nations.<br /> <br /> Despite this, individuals should be aware of this volatility issue. Unlike United States currency deposits, bitcoin and other virtual currency value is not protected by federal deposit insurance. Bitcoin and other virtual currencies are also not universally accepted—many retailers do not accept bitcoin as valid payment. Although regulation is evolving rapidly, bitcoin is currently not strictly regulated, meaning that it may be difficult to challenge suspected fraudulent transactions and security may become an issue. This lack of consumer protection has made it difficult for bitcoin and other virtual currencies to enter the mainstream as a mode of payment.<br /> <br /> </div>

<div class="Section1"><br /> <br /> The IRS now asks about cryptocurrency transactions on taxpayers&rsquo; Form&nbsp;1040 federal income tax returns.&nbsp;The IRS&rsquo;s question asks the taxpayer if they received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency&nbsp;at any time during the tax year.&nbsp; Every taxpayer must answer either &ldquo;yes&rdquo; or &ldquo;no.&rdquo;&nbsp; Taxpayers must check "yes" if they (1) received digital assets as payment for property or services provided, (2) received digital assets resulting from a reward or an award, (3) received new digital assets resulting from mining, staking and similar activities, (4) received digital assets resulting from a hard fork (which is defined as a branching of a cryptocurrency's blockchain to split a single cryptocurrency asset into two), (5) disposed of digital assets in exchange for property or services, (6) disposed of a digital asset in exchange for another digital asset, (7) sold a digital asset, or (8) otherwise disposed of any financial interest in a digital asset.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> The IRS also released guidance clarifying that taxpayers who purchased cryptocurrency with &ldquo;real&rdquo; currency are not required to answer the question with a &ldquo;yes&rdquo; if they had no other cryptocurrency transactions during the tax year because a taxpayer who merely owns cryptocurrency is not taxed on any gains or losses until they sell or otherwise exchange the cryptocurrency. In other words, there has been no realization event that would trigger tax liability.<br /> <br /> <b>Planning Point:</b><span style="font-weight: 400;"> In a recent case, a taxpayer pled guilty to two counts of filing false individual income tax returns for falsely answering &ldquo;no&rdquo; to the Form 1040 digital asset questions in 2021 and 2022.&nbsp; He both falsely answered the basic question and failed to report millions of dollars in digital artwork transactions.&nbsp; The case shows that the IRS Criminal Investigation division continues to carefully monitor transactions involving digital currency and assets.<a href="#_ftn2" name="_ftnref2">²</a></span><br /> <br /> Dispositions of bitcoin as property must be reported to the IRS in the same manner as any other intangible property transactions, meaning that the taxpayer will be required to complete and file Schedule D and Form&nbsp;8949, or Form&nbsp;4797, to report the transaction in accordance with the instructions to those forms.&nbsp;The reporting requirements do not vary because the property transferred is bitcoin.<a href="#_ftn2" name="_ftnref2">³</a> Each bitcoin trade should be reported separately.<br /> <br /> The IRS released regulations<a href="#_ftn3" name="_ftnref3">⁴</a> that require brokers to report sales and exchanges of cryptocurrency and digital assets to the IRS. Information reporting under IRC Section 6045 would be extended to cover brokers who act as agents, principals or middlemen in selling digital assets to others. The regulations are broad and cover transactions where cryptocurrency is sold for cash, broker&rsquo;s services or any property that is subject to reporting by brokers. Brokers who handle payments of cryptocurrency via payment card and third-party network transactions would also be subject to reporting under IRC Section 6050W. Under Section 6045, the definition of &ldquo;broker&rdquo; includes digital asset trading platforms, digital asset payment processors, digital hosted wallet providers, and parties who regularly offer to redeem digital assets that were created or issued by that person. Brokers will be required to report sales and exchanges of cryptocurrency on new Form 1099-DA for 2025 transactions beginning January 1, 2026. Depending on the facts, brokers may also be required to provide basis information with respect to gain or loss for sales that take place on or after January 1, 2027 (to allow individuals access to information necessary to report such gain or loss on their federal tax returns).<br /> <br /> <span style="font-weight: 400;">In Notice 2025-33, the IRS extended transition relief from backup withholding tax liability and penalties for brokers that do not withhold and pay the backup withholding tax for digital asset sales or exchange transactions that occur in 2026.&nbsp; Brokers will not be required to backup withhold for digital asset sales or exchange transactions occurring in 2027 for customers, or payees. Brokers will be required to submit the payee&rsquo;s name and tax identification number to the IRS (via their TIN matching program) and receive an IRS response confirming that the name and TIN match IRS records.&nbsp; The notice also provides relief for failure to withhold and pay the backup withholding tax due, if the failure is due to a decrease in the value of withheld digital assets in a sale of digital assets in return for different digital assets in 2027, assuming that the broker immediately liquidates the withheld digital assets for cash.</span><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong>&nbsp;Taxpayers who trade in various types of cryptocurrencies should be reminded that each trade is a taxable event. Further, IRS guidance has confirmed that pre-2018 exchanges of bitcoin, ether, and litecoin do not qualify for Section&nbsp;1031 exchange treatment under pre-2018 law (post-tax reform, Section&nbsp;1031 is limited only to exchanges of real property).&nbsp;The IRS&rsquo;s rationale is that these were not exchanges of like-kind property and so were taxable even prior to tax reform.&nbsp;The IRS found that bitcoin and ether each played special roles in cryptocurrency trading because if taxpayers wanted to trade in other types of virtual currency, they had to first exchange the other currency into or from bitcoin or ether.&nbsp;Therefore, exchanges between Litecoin and bitcoin/ether did not qualify as &ldquo;like kind.&rdquo;&nbsp;Further, the IRS identified differences in design, intended use and actual use of bitcoin and ether.&nbsp;While this guidance currently only extends to exchanges involving bitcoin, ether, and litecoin, it is possible that the IRS could extend the rationale to other types of cryptocurrencies.<br /> <br /> For many taxpayers, the pre-2018 three-year statute of limitations may have expired if the return was filed on time.&nbsp;However, a special six-year limitation period applies if taxpayers fail to report more than 25&nbsp;percent of their income, meaning that taxpayers with substantial cryptocurrency gains in earlier years may remain exposed to tax liability, interest, and penalties.<a href="#_ftn4" name="_ftnref4">⁵</a><br /> <br /> <hr><br /> <br /> As discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7725">7725</a>, employers that pay employees in bitcoin are required to report those payments as taxable compensation on Form W-2, and employers that pay independent contractors in bitcoin are required to report those payments on Form&nbsp;1099-MISC.<br /> <br /> While the treatment of bitcoin or other virtual currencies for U.S. taxpayers with foreign accounts who are required to file FinCen Form&nbsp;114, Report of Foreign Bank and Financial Account, is unclear following guidance allowing its exclusion in 2013 only, these individuals should include bitcoin unless they have a clear reason to exclude it.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IR-2024-18.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; <span style="font-weight: 400;">U.S. v. Waylon Wilcox, 1:25-cr-00096 (M.D. Pa. 2025).</span><br /> <br /> <a href="#_ftnref2" name="_ftn2">3</a>.&nbsp; Notice 2014-21, 2014-16 IRB 938.<br /> <br /> <a href="#_ftnref3" name="_ftn3">4</a>.&nbsp; RIN 1545-BP71.<br /> <br /> <a href="#_ftnref4" name="_ftn4">5</a>.&nbsp; GCM 202124008.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Bitcoin is a type of cryptocurrency<a href="#_ftn1" name="_ftnref1">¹</a> (or virtual currency) that has an equivalent value in real currency (and can often act as a substitute for real currency) so that it is often referred to as a “convertible virtual currency.” It can be digitally traded between users or converted into other types of currencies (including U.S. dollars).<br /> <p style="padding-left: 40px;">Cryptocurrencies are not “legal tender” of public debt in virtually all jurisdictions worldwide, specifically including the U.S. However, in late 2018, a web-based cryptocurrency tax payment portal, using third-party vendor BitPay (who converts Bitcoins to U.S. dollars), was set up by the Ohio State Treasurer to facilitate the payment of corporate taxes to the State of Ohio.<a href="#_ftn2" name="_ftnref2">²</a> Less than 10 months later in late 2019, a new Ohio State Treasurer halted the initiative and closed down the website portal, explaining that the prior Treasurer had not followed the proper Ohio processes to acquire the third-party vendor, lack of use of the process by taxpayers, and absence of an opinion from the Ohio Attorney General that such a procedure was proper.<a href="#_ftn3" name="_ftnref3">³</a></p><br /> <p style="padding-left: 40px;">Cryptocurrency regulation has varied across worldwide jurisdictions, ranging from none to extensive. U.S. regulation has stepped up significantly, since then-SEC Chairman Jay Clayton’s “Statement on Cryptocurrencies and “Initial Coin Offerings” (ICOs) on December 11, 2017. In fact, to better clarify the regulatory agencies to be charged with the statutory authority for the regulation of digital assets (cryptocurrency), a bill, the “Crypto-Currency Act of 2020,” was introduced in March, 2020.<a href="#_ftn4" name="_ftnref4">⁴</a> The bill did not gain much traction in light of the pandemic and presidential election. Since then, the U.S. House of Representatives has passed a bill to create a crypto task force on digital assets.</p><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  See generally for background information on bitcoins and other cryptocurrencies, www.wikipedia.org/wiki/Bitcoin.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  See https://thenextweb.com/news/ohio-suspends-bitcoin-tax-payment-system-no-one-cares-ohiocrypto#:~:text=Ohio%2C%20the%20first%20US%20state,longer%20pay%20in%20digital%20assets.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  See, e.g., https://apnews.com/article/dc71a9967b134858bb9aef69249d4eb5.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.  See HR 6154, introduced March 9, 2020 (Rep Paul Gosar).<br /> <br /> </div>

<div class="Section1"><br /> <br /> If a taxpayer receives bitcoin as compensation for services provided as either an employee or an independent contractor, the value of that bitcoin is treated as either wages or self-employment income, depending upon the circumstances. The fair market value on the date of receipt will be subject to withholding (including FICA and FUTA taxes) and treated as any other compensation received by an employee (and must be reported on Form W-2). Payments can become subject to backup withholding in the same manner as when payment is made in U.S. dollars.<a href="#_ftn1" name="_ftnref1">¹</a> In keeping with this position, the IRS Counsel indicated in a late 2020 internal Tax Advice Memorandum that cryptocurrency paid for providing micro-services, like completing an online survey, processing data or reviewing images, is taxable ordinary income to the recipient, and may even be subject to self-employment taxes, depending on the circumstances.<a href="#_ftn2" name="_ftnref2">²</a> Every taxable event involving a taxpayer’s cryptocurrency holdings must be reported on IRS Form 8949, Cryptocurrency Tax Form.<br /> <br /> Similarly, the fair market value of any bitcoin received by an independent contractor will be subject to self-employment tax. The fair market value must be measured in U.S. dollars on the date of receipt.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> If an employer makes a payment in bitcoin to an independent contractor that exceeds $600 in value (on a combined annual basis), the employer is required to report the payment to the IRS on Form 1099-MISC in the same manner as if the payment were actually made in “real” currency. Bitcoin transactions must be included when an independent contractor calculates estimated tax payments.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Notice 2014-21, 2014-16 IRB 938. See also, IRS Publication 1281, “Backup Withholding for Missing and Incorrect Name/TINs.”<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  See TAM 202035011 (Aug. 28, 2020).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  Notice 2014-21, 2014-16 IRB 938.<br /> <br /> </div>

<div class="Section1"><br /> <br /> For purposes of determining the value of bitcoin received that must be included in gross income, the fair market value is determined as of the date the bitcoin is received by the taxpayer. As in other property transactions, this fair market value forms the “basis” of the bitcoin as of that date.<a href="#_ftn1" name="_ftnref1">¹</a> The taxpayer must determine the value of the bitcoin in U.S. dollars. This means that the basis of bitcoin will typically be its acquisition cost. In the case of a gift or inheritance of bitcoin, the basis of the bitcoin in the hands of the donor will presumably apply (this issue has not yet<a href="#_ftn2" name="_ftnref2">²</a> been formally addressed in official guidance).<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> As of early 2022, proposals would require taxpayers to report cryptocurrency transactions with a fair market value of $10,000 or more. Beginning January 1, 2024, these cryptocurrency transactions were to trigger Form 8300 filing requirement if the fair market value of the transaction is $10,000 or more.  The IRS has since delayed this reporting requirement.<a href="#_ftn2" name="_ftnref2">³</a><br /> <br /> </div><br /> <div class="Section1"><br /> <br /> <hr /><br /> <br /> In some cases, virtual currency such as bitcoin will be listed on an exchange, in which case the exchange rate listed on that exchange must be used to convert the value into U.S. dollars (or some other “real” legal tender currency that can be converted to U.S. dollars).<br /> <br /> Late in 2019, the IRS released a set of FAQ answering questions about the tax treatment of bitcoin and other virtual currency. One issue that commonly arose was determining how exchanges of virtual currency for other virtual currency or property were taxed. The FAQ provide that when virtual currency is exchanged for other virtual currency, the taxpayer’s gain or loss is the difference between the fair market value of the currency received and the adjusted basis of the property disposed of. If the property exchanged is a capital asset, capital gain or loss tax treatment will apply. If the property exchanged is not a capital asset, ordinary income tax treatment will apply.<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong>  The IRS Office of Chief Counsel (OCC) released a Chief Counsel Advice (CCA) document advising that a charitable contribution deduction for a donation of digital assets without a qualified appraisal should be denied because the value of those assets exceeded $5,000. The taxpayer in this case donated cryptocurrency valued at $10,000. The $10,000 value was based on the value listed on the cryptocurrency exchange where the assets were purchased as of the date the donation was made. The taxpayer did partially complete Form 8283, Noncash Charitable Contributions, but did not obtain a qualified appraisal. The IRS did not agree with the taxpayer's rationale that she did not need an appraisal because the value of the digital assets was published and readily available. Under IRC Section 170(f)(11)(C), an appraisal is generally not required when the property has readily available value (including cash, publicly traded securities, etc.). The OCC noted that while cryptocurrency exchanges may publish valuation information, these assets do not meet the definition of a security. The IRS further found that a reasonable cause exception would not apply because the taxpayer did not attempt to obtain an appraisal as required in Form 8283.  However, the OCC also noted that the CCA should not be cited as precedent.<a href="#_ftn3" name="_ftnref3">⁴</a><br /> <br /> <hr /><br /> <br /> When a taxpayer receives virtual currency through an exchange, the fair market value is the amount recorded by that exchange in U.S. dollars. If virtual currency is received in a peer-to-peer transaction, fair market value is determined as of the date and time the transaction is recorded on the distributed ledger. The IRS notes that it will accept as evidence of fair market value certain values determined by a cryptocurrency or blockchain explorer that analyzes worldwide virtual currency values. If the taxpayer does not use an explorer value, the taxpayer is responsible for establishing that the value used is an accurate reflection of the virtual currency’s value.<a href="#_ftn4" name="_ftnref4">⁵</a><br /> <p style="text-align: center;"><strong>Loss Deductions</strong></p><br /> In 2023, the IRS Office of Chief Counsel addressed a situation where a taxpayer attempted to take a Section 165 loss deduction with respect to worthless or abandoned cryptocurrency on their 2022 federal income tax return.<a href="#_ftn5" name="_ftnref5">⁶</a> In the end, the IRS noted that the taxpayer would still have not had a deductible loss because miscellaneous itemized deductions subject to the 2% floor are suspended through 2025. However, the IRS also addressed the issues as they would have applied had the deduction not been suspended to offer insight to taxpayers going forward.<br /> <br /> The IRS denied the individual’s Section 165 loss deduction claim, finding that the cryptocurrency investment was neither worthless nor abandoned for purposes of the IRC. The taxpayer purchased cryptocurrency units for $1 in 2022 and the unit value fell to less than 1 cent by year-end. The assets continued to be traded on at least one cryptocurrency exchange (and the taxpayer maintained control over the digital assets, as evidenced by the fact that the taxpayer was free to sell or exchange the assets). The taxpayer attempted a Section 165 deduction on their 2022 return.<br /> <br /> The IRS initially determined that the asset did not rise to the level of a “security” for 165(g) purposes. The court then found that a mere fluctuation in value could not give rise to a loss deduction. Such a loss must be evidenced by a permanent closing, such as abandonment, sale or exchange. Here, the units still had some value and could possibly increase in value in the future. Further, the taxpayer showed no affirmative step to abandon the property because they maintained dominion and control over the assets.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Notice 2014-21, 2014-16 IRB 938.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  As of the date of the last review of this publication in 2024, advisors should check for any updates as guidance is coming more rapidly now as cryptocurrencies have gained more popularity.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  Notice 2024-4.<br /> <br /> <a href="#_ftnref3" name="_ftn3">4</a>.  CCA 202302012.<br /> <br /> <a href="#_ftnref4" name="_ftn4">5</a>.  <em>See</em> FAQ on Virtual Currency Transactions, available at https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions.<br /> <br /> <a href="#_ftnref5" name="_ftn5">6</a>.  CCA 202302011.<br /> <br /> </div>

<div class="Section1"><br /> <br /> It is important that individuals or entities that use bitcoin or other virtual currencies maintain complete and accurate records of all bitcoin transactions to ensure that income and loss is properly accounted for.&nbsp;These records should include the dates that the bitcoin is acquired and disposed of, especially if the taxpayer wishes to use identification accounting.&nbsp;Taxes on bitcoin transactions must be paid in U.S. dollars, not bitcoin, so it is important that the taxpayer have a system in place to convert bitcoin into dollars.&nbsp;The IRS has now specified that absent the ability to use identification accounting, the taxpayer must use the &ldquo;First-in First-Out&rdquo; (FIFO) method (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>) to account for bitcoin transactions.&nbsp;These records can be extremely important to establishing a taxpayer&rsquo;s basis in the bitcoin for income tax purposes.<br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Advisors should be aware that the value of bitcoin and other cryptocurrencies can fluctuate like any other investment, and at times can be very volatile. Presently, advisers should probably consider a cryptocurrency investment to be a highly speculative investment.&nbsp;They may also wish to advise clients who already own such currencies to consider converting bitcoin to dollars on a fairly regular basis if they are not interested or able to take the risks associated with cryptocurrency price volatility. As discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7726">7726</a>, most traditional consumer protection systems do not apply to bitcoin transactions, increasing the risk of fraud associated with these transactions, and regulators in the United States and worldwide are taking note. Advisors should proceed very cautiously in recommending investing in such virtual currencies.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <hr><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; The SEC and state securities regulators in the US.., and many foreign securities regulators are warning investors about cryptocurrencies, especially ICOs - Initial Coin Offers - (so-called initial coin offers in new virtual currencies). In January&nbsp;2018, the State of&nbsp;Texas (TSSB) took action against US_-Tec Limited (BitConnect) under&nbsp;Texas Blue Sky laws with an emergency cease-and desist order and later an action for a fraudulent securities issuance in connections with a first so-called ICO in the U.S. Other states are taking similar steps toward regulation of virtual currencies and ICOs.&nbsp;Treating the cryptocurrency as a &ldquo;security&rdquo; covered by the jurisdiction&rsquo;s securities laws (federal and state) seems to be the clear directions of the date of this publication.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> In many cases, taxpayers own multiple pieces, or units, of the same type of virtual currency that were acquired at different times and at different costs. When a taxpayer does not dispose of all units of the type of virtual currency, the 2019 FAQ&nbsp;on virtual currency transactions provides that taxpayers are entitled to choose which specific pieces of virtual currency will be deemed part of the transaction.<br /> <br /> This election can be made either by (1) documenting the specific currency unit&rsquo;s unique digital identifier such as a private key, public key, and address, or (2) by records showing the transaction information for all units of a specific virtual currency, such as bitcoin, held in a single account, wallet, or address.<br /> <br /> The information provided must generally include:<br /> <p style="padding-left: 40px;">(1)&nbsp; the date and time each unit was acquired,</p><br /> <p style="padding-left: 40px;">(2)&nbsp; basis and the fair market value of each unit at the time it was acquired,</p><br /> <p style="padding-left: 40px;">(3)&nbsp; the date and time each unit was sold, exchanged, or otherwise disposed of, and</p><br /> <p style="padding-left: 40px;">(4)&nbsp; the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.</p><br /> For taxpayers unable to specifically identify pieces of virtual currency involved in a transaction, a first-in, first-out (FIFO) accounting method must be used (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7722">7722</a>).<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; See FAQ&nbsp;on Virtual Currency&nbsp;Transactions, available at https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions.<br /> <br /> </div></div><br />