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Why Small Businesses Should be Careful about Crypto Taxes

October 16, 2019
Small Business

Over the years, the IRS has cracked down on people who have falsified or altogether failed to report their cryptocurrency transactions. Just a couple of months ago, IRS circulated more than 10,000 letters to taxpayers about the reporting mechanism of virtual currencies.

It is true – calculating and reporting as per rules can get tricky when it comes to capital assets, stocks, or even real estate. However, with the increasing usage of the digital currency, it was only a matter of time the IRS released a comprehensive guideline for the taxpayers to report and pay correct taxes.

It is imperative to understand that this is the first IRS revenue ruling about cryptocurrency since 2014. Here’s a complete guide as to what small and medium-sized businesses should know about the perks and dangers of crypto taxes.

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What Does the New IRS Revenue Ruling State?

As per the new revenue ruling, taxpayers need to answer whether or not their income comes from a hard fork of a cryptocurrency. Furthermore, the guideline highlights the procedure when taxpayers receive additional units of a new cryptocurrency.

In essence, the ruling answers some of the most common questions when it comes to the tax treatment of cryptocurrency. Airdrops and hard forks, for instance, is a transactional process where digital currencies are divided from traditional currencies. 

The goal of a taxpayer is to find whether or not the airdrop or cryptocurrency hard forks affects their total income. A general example is when Bitcoin holders receive cash rather than units.

Cryptocurrency Tax History

Apart from the 2014 cryptocurrency guideline, the Internal Revenue Service (IRS) has provided multiple short instructions in the past to deal with the crypto taxes. Remember, virtual currency is treated as a capital asset that can be converted into tangible cash. It practically means the traditional rules of the capital gains and losses will apply to your cryptocurrency.

The IRS’ concerns regarding the tax implementation of cryptocurrency are, in fact, quite genuine. In 2016, for example, just 802 taxpayers managed to file tax returns. However, the total number of taxpayers who could’ve filed income electronically was 132 million.

IRS’ New Cryptocurrency Reporting Rules

Naturally, to counteract against such a disheartening figure, the government continues to seek a compliance mechanism that could help taxpayers understand the crypto taxes. Concurrently, the IRS hasn’t backed down to warn taxpayers about the intentional or unintentional criminal negligence associated with the crypto taxes.

Small businesses that refuse to view crypto taxes, for instance, will inevitably have to pay penalties, late taxes, interest, and even face criminal prosecution. Though the IRS letters and ruling are warning signs, the federal authority insists that it's educational information.

The point is to notify taxpayers about the tax obligations or revert past errors associated with the cryptocurrency taxes. The dilemma of taxpayers skyrockets when it comes to different versions of guidelines from the IRS. Unlike the new ruling that acknowledges noncompliance tax standards, the old guideline merely used to attach the entire cryptocurrency activity of the taxpayer. 

The compliance campaign by the IRS intends to resolve the crypto tax issues. In fact, it requires an immediate response than some of the contemporary tax problems. Furthermore, the IRS has indicated to initiate more than fifty (50) campaigns to educate taxpayers regarding the right usage of tools and recourses for crypto taxes. 

Figure Out the Basics of Crypto Taxes

When it comes to crypto taxes, you may have to dig deeper to understand how your income, goods, or services are treated. In hindsight, taxpayers should take into account that cryptocurrency transactions may render capital gain or a loss.

Calculate Capital Gains

The underlying purpose of calculating capital gains or losses is to determine if your total cost has increased or decreased since the time you acquired cryptocurrency in a taxable event.

Now, the cost you pay for your cryptocurrency is called the cost basis that can be adjusted over an extended period. Whether you use cryptocurrency as an investment or to purchase another item, you will have to calculate the cost with additional investment and purchased items.  

What Qualified as a Taxable Event?

In simple terms, a taxable event refers to a disposition of an asset or direct business sales. The same rules, however, don’t apply cryptocurrency because the taxable event could occur anytime the digital currency is used or traded to buy goods or services.

That said, taxpayers are often bewildered when it comes to reporting the virtual currency that doesn't require third-party. That's because there's no Form 1099-B at the end of the year nor a comprehensive summary that you can use to file your taxes normally.

In addition, cryptocurrency withdrawal or exchange is not easy to track. If you operate as a small business, cashing out a cryptocurrency such as Bitcoin out of an exchange is considered a sale. If you are, on the other hand, forced to withdraw, you may have to apply the same steps as there’s no official regulated guideline on it.  

Cryptocurrency’s Trade and Commission Fees

The commission is treated in the same traditional manner for cryptocurrency taxes. Just remember, the calculation should include your total purchase price and other related costs.

Conversely, fees have been deducted from Schedule A for each item. But the new tax reform law has discarded such deductions until 2025. However, if your business has made sizable investments, you can deduct the related fees from entity tax form or Schedule C.

Remember the Holding Period

The total amount of time you’ve owned or had access to the cryptocurrency would classify as the holding period. Interestingly, the timeframe should be between acquisition data and a taxable event.

What happens when you hold a cryptocurrency asset for more than a year and prior to a taxable event? As per new IRS guidelines, it’ll be viewed as long-term gain or loss. And if you hold a cryptocurrency for less than a year, it will be viewed as short-term gain or loss. 

Taxes on Your Capital Gains

Your crypto capital taxes can result in favor of your business. You should focus on the short-term capital gains as the IRS uses ordinary rules to tax your income. But your long-term capital gains mainly range from 0% to 20% that may or may not turn out to be beneficial for your business. 

Don’t Wait Until Cash Out

Cash-out is arguably the most common problem when it comes to crypto taxes. And that's because taxpayers will prepare for a taxable event without conducting formal cash out. Primarily, that's one of the reasons why the cryptocurrency is treated as a sale to purchase goods or services. The confusion turns into a reality for businesses when they can't decide if the purchase of a unique item can be treated as a sale. 

Realized Gains and Losses: When Can You Claim Cash?

When your total realized losses are more than your total realized gain, your business has a capital loss that will be used for tax reasons. Typically, you can claim capital losses of more than $3,000. However, the total amount of losses can compensate for your annual taxable income. If your loss exceeds the stated limit, you can move the loss to upcoming years with minimal restrictions.

Also, the rise and devaluation of cryptocurrency generate additional problems for taxpayers. Traditionally, you care about the beginning and end of the year when it comes to preparing and filing taxes — cryptocurrency functions in a continuous momentum that requires calculation throughout the year.

For example, when the rate of Bitcoin plummets in the market, it wouldn’t render a realized gain or loss for your taxes. Instead, it’s about the possession of the asset that you can trade, sell, or dispose of before a taxable event.

Report Your Gains or Losses

Taxpayers are required to report realized gains or losses on Schedule D form. Thereafter, you can transfer the accumulated information to a federal Form 1040.  It is important to remember that the changing value of your cryptocurrency doesn’t affect the filing. Therefore, you will still have to file a Schedule D. However, you won’t have to report if there’s no disposition of sale.

What are Current Crypto Tax Expectations?

Although there’s bound to be additional guidance on the crypto taxes in the foreseeable future, taxpayers should be cautious to have direct business investments and purchase records that involve a cryptocurrency.

Sure, the demand of cryptocurrency is higher than ever. But that doesn’t change the fact that small businesses are often caught in the federal tax requirement of digital currencies such as Bitcoin and Ethereum. 

But once taxpayers treat cryptocurrency for tax purposes, it can be treated as a valuable asset to gain capital and thrive as a business. Unfortunately, there may be more parameters attached to the digital currency than the traditional ones.

Conclusion

It is baffling when you realize that there are a handful of tax specialists and accountants who understand complex tax mechanism of cryptocurrencies. However, few tax experts that have helped businesses to create opportunities and resolve cryptocurrency issues are known to have programming or software engineering background. The fact remains, cryptocurrency is the way of the future. Hence, it’s wise to deduce that the IRS will devise bold new laws to help taxpayers usher in this new digital age.


Tatiana Bashlova

Tatiana is the Junior Vice President at Halon. She has experience in operations, payroll, legal, human resources, and finance in various industries. In her spare time she enjoys reading about new laws, hiking, and fishing. .

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