The Tax Cuts and Jobs Act is the biggest federal tax law change in over 30 years. This is a significant change affecting qualified business income from a partnership, S corporation, LLC, or sole proprietorship. Note: Except where noted, the change is effective for tax years 2018–2025.
The Tax Cuts and Jobs Act, a $1.5 trillion tax cut package, was signed into law on December 22, 2017. The centerpiece of the legislation is a permanent reduction of the corporate income tax rate. The corporate rate change and some of the other major provisions that affect businesses and business income are summarized below. Provisions take effect in tax year 2018 unless otherwise stated.
Cryptocurrencies can be used entirely within a virtual economy or can be used instead of a government-issued currency to purchase goods and services in the real economy (GAO Report: Virtual Economies and Currencies —Additional IRS Guidance Could Reduce Tax Compliance Risks (GAO-13-516), (June 18, 2013)). Cryptocurrency, also known as virtual currency, is a digital representation of value that functions as a medium of exchange, a unit of account, or a store of value, but is not backed by a government-issued legal tender. A few examples of popular cryptocurrencies are Bitcoin, Ethereum, and Litecoin.
Since virtual currencies don’t have the status of legal tender, the Internal Revenue Service has said it will treat virtual currency as property rather than currency, since it is not regulated by any central banking system (IRS Notice 2014-21). This means that the sale or exchange of a virtual currency that has gained value since they were acquired could trigger a tax liability.
Through certain exchanges, virtual currencies can be digitally traded between users and purchased or exchanged for U.S. dollars, other foreign currencies, or other crypto-currencies. Accordingly, taxpayers can have gain or loss on the exchange of virtual property. The tax treatment of that gain or loss, well, depends on a number of factors. Many of these factors have not been completely defined, as the AICPA points out in its comment letter to the IRS (AICPA Comments on Notice 201421, June 10, 2016).
Generally, convertible virtual currency (e.g., Bitcoin), which has an equivalent value in or acts as a substitute for real currency, is treated as property for federal tax purposes. Transactions using convertible virtual currency are subject to the general tax principles that apply to property transactions. A taxpayer who receives convertible virtual currency as payment for goods or services must include in gross income the currency's fair market value, measured in U.S. dollars, as of the date it was received. If a taxpayer successfully "mines" convertible virtual currency (e.g., uses computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger), the currency's fair market value is includible in gross income as of the date of receipt (IRS Notice 2014-21) (U.S. Master Tax Guide® (2018), 785, Taxation of Miscellaneous or Other Income).
Selling or Exchanging Virtual Currency
Generally, stocks and virtual currencies are taxed the same when held as capital assets by the taxpayer, according to the IRS Notice. The character of gain or loss from an exchange of virtual currency for property depends on whether the virtual currency is a capital asset in the taxpayer’s hands. Thus, if virtual currency is a capital asset in the taxpayer’s hands, the taxpayer realizes capital gain or loss from the exchange of virtual currency for property. If the virtual currency is not a capital asset in the taxpayer’s hands, the taxpayer realizes ordinary gain or loss.
Taxpayers who exchange virtual currency for other property will have gain or loss on the transaction. Like other exchanges of property, the amount of gain or loss is based on the difference between the fair market value of the property received and the adjusted basis of the property given up. Thus, a taxpayer has taxable gain if the fair market value of the property received in exchange for the virtual currency exceeds the taxpayer’s adjusted basis for the virtual currency. A taxpayer has a loss if the fair market value of the property received in exchange for the virtual currency is less than the taxpayer’s adjusted basis for the virtual currency.
Taxpayers who engage in a like-kind exchange of property held for investment or for productive use in a trade or business may defer gain on the transaction. However, like-kind exchanges cannot be used for certain types of property including stocks, bonds, and foreign currencies. It is not clear if cryptocurrency can be disposed of in a like-kind exchange; and, if it can be, what would qualify as like-kind property. The AICPA has requested that the IRS clarify "if there are particular factors that distinguish one virtual currency as likekind to another virtual currency for section 1031 purposes" (AICPA Comments on Notice 201421, June 10, 2016).
Receiving Virtual Currency for Earned Income
Taxpayers have gross income if they receive virtual currency as payment for providing goods or services.
Employers and employees. Individuals who receive virtual currency, such as bitcoin, from their employer as payment for services must include the fair market value of the virtual currency in income. Employers that pay their employees’ wages in virtual currency must withhold tax on the wages. The fair market value of the virtual currency paid is subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) tax and Federal Unemployment Tax Act (FUTA) tax. Employers must report such amounts on Form W-2, Wage and Tax Statement.
Independent contractors. An individual who receives virtual currency for performing services as an independent contractor has self-employment income equal to the fair market value of the virtual currency measured in U.S. dollars on the date of receipt.
Miners of virtual currency. Individuals will have gross income if they receive virtual currency for successfully mining virtual currency. An example of mining is using computer resources to validate bitcoin transactions and maintain the public bitcoin transaction ledger. When a “miner” successfully mines virtual currency, the miner has gross income equal to the fair market value of the virtual currency on the date of receipt of the currency.
An individual who mines virtual currency as a trade or business and not as an employee is subject to self- employment tax on the income derived from the mining activities. Self-employment tax is applied to the individual’s net earnings from self-employment from the mining activity, which is the gross income derived from the trade or business of mining less allowable deductions.
Gifts or Inheritance
The current IRS guidance on virtual currency transactions does not address the tax treatment of gifts and inheritances involving virtual currency. Since the IRS’s stated taxing principle is to treat virtual currency as property, gifts or inheritances of virtual currency should be treated as gifts or inheritances of other kinds of property.
Regarding Fair Market Value
Fair market value of virtual currency. In order to calculate gross income, gain or loss, or basis for virtual currency transactions, taxpayers must determine the fair market value of the virtual currency. Since virtual currency transactions are reported in U.S. dollars for tax purposes, taxpayers must determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt of the virtual currency.
The fair market value for popular virtual currencies, such as bitcoin, ethereum or litecoin, can easily be determined. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value is determined by converting the virtual currency into U.S. dollars at the exchange rate in a reasonable manner that is consistently applied. If the virtual currency is converted into a different real currency, then that amount must be converted into U.S dollars. Virtual currency converters are widely available on the internet.
Although the fair market value of virtual currency can easily be determined if it is listed on an exchange, the IRS has not provided any guidance on determining the fair market value of the hundreds of virtual currencies that are not listed on an exchange.
Taxpayer’s are responsible for maintaining adequate records and documentation to substantiate the accuracy and completeness of their tax return. Also, it’s possible that each virtual currency transaction is reportable in some form on a taxpayer’s tax return. Support of a tax professional who is familiar with the virtual currency environment is recommended to assist with reporting requirements. We are excepting a limited number of new clients this tax season. Contact our office today to schedule a consultation.
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act, a sweeping $1.5 trillion tax-cut package that fundamentally changes the individual and business tax landscape. While many of the provisions in the new legislation are permanent, others (including most of the tax cuts that apply to individuals) will expire in eight years. Some of the major changes included in the legislation that affect individuals are summarized below; unless otherwise noted, the provisions are effective for tax years 2018 through 2025.