Pay Me In Bitcoin

 

He plays right guard for the Carolina Panthers and had a great quote about cryptocurrency:

         "Pay me in Bitcoin.”

We are talking about Russell Okung.

I believe he earned about $13 million for the 2020/2021 season, so he can move a lot of Bitcoin.

And Bitcoin had quite the run in 2020, moving from approximately $7,200 in January to $30,000 by year-end. The payment platform company Square added Bitcoin as an investment, and PayPal started a new service allowing its users to buy, hold and sell Bitcoin through their PayPal account.

Then there is, as always, the near inexplicable behavior of some people. In October, John McAfee (yes, John of McAfee computer security products) was arraigned for tax fraud. He was charged with, among other things, not reporting income for his work promoting cryptocurrencies.

The IRS is paying more attention.

We have existing guidance that the IRS views cryptos – which include Bitcoin and Ethereum – as property and not currency. While this might sound like an arcane topic for a business school seminar, it does have day-day-day consequences. If you buy something for $11 and pay with a $20 bill, there is likely no tax consequence.  A crypto is not currency, however. Pay for that $11 purchase using your Bitcoin and the IRS sees the trading of property.

What does that mean?

Taxwise you sold crypto for $11. You next have to determine your cost (that is, “basis”) in the crypto. If less than $11, you have a capital gain. If more than $11, you have a capital loss. The gain or loss could be long-term if you held the crypto for more than one year; otherwise, it would be a short-term gain or loss.

Assume that you have frequent transactions in crypto. How are you to determine your basis and holding period every time you pay with crypto?

You had better buy software to do this, or use a wallet that tracks it for you. Otherwise you could have a tax mess on your hands at the end of the year.

You can, by the way, also have ordinary taxable income (rather than capital gain) from cryptos. How? Say that you do consulting work for someone and they pay you in crypto.  You have gig income; gig income is ordinary income; that crypto is ordinary income to you.

By the way, mining Bitcoin is also ordinary income.

The IRS had a question about cryptos on a schedule in prior years, but for 2020 it is moving the following question to the top of Form 1040 page 1:

At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

The IRS moved the question to make it prominent, of course, but there is another reason. Remember that you are signing that tax return “to the best of your knowledge and belief” and “under penalties of perjury.” The IRS is raising the stakes for not reporting.

Expect more computer matching. Expect more notices.   

Even Treasury is upping its game.

There is a form that one files with the Treasury if one owns or has authority over $10,000 or more in a foreign bank or other financial account. We tax veterans remember it as the FBAR (Foreign Bank and Financial Accounts) report, but the name has since been revised to FinCen 114 (Financial Crimes Enforcement Network). Here is Treasury telling us that we will soon be reporting cryptos on their form:

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.

This area is moving in one direction – more reporting. There is currently some inconsistency in how cryptocurrency exchanges report to the IRS (Form 1099-B versus 1099-K versus 1099-MISC). I expect the IRS to lean harder – and soon - on standardizing this reporting. This genie is out of the bottle.

The IRS Cryptocurrency Letter

Do you Bitcoin?

The issue actually involves all cryptocurrencies, which would include Ethereum, Dash and so forth.

A couple of years ago the IRS won a case against Coinbase, one of the largest Bitcoin exchanges. The IRS wasn’t going after Coinbase per se; rather, the IRS wanted something Coinbase had: information. The IRS won, although Coinbase also scored a small victory.

·       The IRS got names, addresses, social security numbers, birthdates, and account activity.

·       Coinbase however provided this information only for customers with cryptocurrency sales totaling at least $20,000 for years 2013 to 2015.

What happens next?

You got it: the IRS started sending out letters late last month- approximately 10,000 of them. 

Why is the IRS chasing this?

The IRS considers cryptocurrencies to be property, not money. In general, when you sell property at a gain, the IRS wants its cut. Sell it at a loss and the IRS becomes more discerning. Is the property held for profit or gain or is it personal? If profit or gain, the IRS will allow a loss. If personal, then tough luck; the IRS will not allow the loss.

The IRS believes there is unreported income here.

Yep, probably is.

The tax issue is easier to understand if you bought, held and then sold the crypto like you would a stock or mutual fund. One buy, one sell. You made a profit or you didn’t.

It gets more complicated if you used the crypto as money. Say, for example, that you took your car to a garage and paid with crypto. The following weekend you drove the car to an out-of-town baseball game, paying for the tickets, hotel and dinner with crypto. Is there a tax issue?

The tax issue is that you have four possible tax events:

(1)  The garage

(2)  The tickets

(3)  The hotel

(4)  The dinner

I suspect that are many who would be surprised that the IRS sees four possible triggers there. After all, you used crypto as money ….

Yes, you did, but the IRS says crypto is not money.

And it raises another tax issue. Let’s use the tickets, hotel and dinner for our example.

Let’s say that you bought cryptos at several points in time. You used an older holding for the tickets. 

You had a gain on that trade.

You used a newer holding for the hotel and dinner.

You had losses on those trades.

Can you offset the gains and losses?

Remember: the IRS always participates in your gains, but it participates in your losses only if the transaction was for profit or gain and was not personal.

One could argue that the hotel and dinner are about as personal as you can get.

What if you get one of these letters?

I have two answers, depending on how much money we are talking about.

·       If we are talking normal-folk money, then contact your tax preparer. There will probably be an amended return. I might ask for penalty abatement on the grounds that this is a nascent area of tax law, especially if we are talking about our tickets, hotel and dinner scenario.

·       If crazy money, talk first to an attorney. Not because you are expecting jail; no, because you want the most robust confidentiality standard available. That standard is with an attorney. The attorney will hire the tax preparer, thereby extending his/her confidentiality to the preparer.

If the IRS follows the same game plan as they did with overseas bank accounts, anticipate that they are looking for strong cases involving big fish with millions of dollars left unreported.

In other words, tax fraud.

You and I are not talking fraud. We are talking about paying Starbucks with crypto and forgetting to include it on your tax return.

Just don’t blow off the letter.

Bitcoin and Fred

I am going to dedicate this post to Fred.

Fred likes to talk about Bitcoin. He is a believer. He may as well be on the payroll.

I do not want to talk about blockchain or cryptocurrencies or any of that.

Let’s talk about the taxation of the thing, in case Fred has gotten to you.

As I write this Bitcoin is selling for around $15 grand.

On January 1, 2017 – less than a year ago – it sold for around $1 grand.

COMMENT: There is a reason why we are still working, folks.

There are even Bitcoin ATMs. I understand there around 70 or so locations around Miami alone. You can tap into one if you are going to the Orange Bowl at the end of this month.

Mind you, if you withdraw dollars-for-Bitcoins you probably have a tax consequence.

You see, the IRS has said (in 2014) that Bitcoin is not a currency. Given this thing’s propensity to swing hundreds if not thousands of dollars of day, it makes sense that it is not a currency. Currencies are supposed to have some stable value, at least until politicians run them into the ground.

No, Bitcoins are property, like stocks or a mutual fund. Like a stock or mutual fund, you have a tax consequence on the sale.

Let’s use the following numbers for the sake of discussion:

          Bought on 1/1/17                    $1,000

          Cashed-in on 12/31/17           $16,500

Let’s say you cash-in a Bitcoin while you are at the Orange Bowl. What have you got?

Way I see it, you have ...

    $16,500 (proceeds) - $1,000 (cost) = $15,500 gain

You are supposed to report $15,500 as income on your tax return.

What type of income is it?

I see a buy. I see a sell. I would argue this is capital gain. It would be short-term, as you did not own it for a year.

Let’s throw a curve ball.

Let’s say that you did some work for somebody in 2016. The paid you with that Bitcoin on January 1, 2017 – the one worth $1,000 at the time.

What are your tax consequences now?

You got paid with a Bitcoin worth $1,000. You have $1,000 of ordinary income. If you got paid for work, it is also subject to self-employment tax.

Then you sell it.

I see the following …

   $1,000 (ordinary) + $15,500 (capital gain) = $16,500   

This is what happens when Bitcoin is considered “property” rather than “currency.” It would be the same as you writing checks on your Fidelity or Vanguard mutual fund. Every time you do you are selling some of your mutual fund. And it all gets reported to the IRS at year-end.

Except that most of Bitcoin does not get reported to the IRS at year-end. Not yet, at least. In fact, in 2015 only 802 people reported Bitcoin on their tax return. You know that doesn’t make sense.

Which is why the IRS served a “John Doe” summons on Coinbase in November, 2016. Coinbase is an exchange for virtual currencies like Bitcoin and Ethereum. A “John Doe” summons substitutes a group or class or people for a specific person. It could be as easy as “anyone who sold more than $600 of Bitcoin between 2013 and 2015.”

Coinbase fought back, of course, but in the end the two wound up compromising. Coinbase will not provide 100% of its account data, but the IRS is getting information on over 14,000 account holders and almost 9 million transactions.

Bitcoin and other virtual currencies have become the new overseas bank accounts. It is time to come clean on this stuff, folks.

And yes, I believe there will be IRS reporting – akin to what the stock brokerages do – in the near-enough future. The government is flipping the sofa cushions for every nickel it can find. Until they get us to a 100% tax rate, they are going to keep looking for new sofas.

Someone – probably Fred - was telling me about a Bitcoin credit card.

That is a tax nightmare

Why?

Say that you bust to Starbucks in the morning. You put your coffee on the card. You stop for fuel – on the card. You go to lunch – on the card. You stop at the dry cleaners and Krogers on the way home – both on the card.

You have 5 “sales” that day. Each one has a cost, and who knows how we are going to come up with that number. Say that you do something comparable almost every work day. I will probably “fee discourage” you from using me as your tax advisor.

BTW, a similar thing can occur if you accept Bitcoin as payment for your services. Say that you are an independent contractor and two or three of your clients pay you in Bitcoin. You are going to have to price the Bitcoin every time you get paid with one, as your “proceeds” are its value on the day you receive it.

That is an accounting hassle.

Can you think of a nightmare scenario?

I  can.

What if you get paid with Bitcoin next year when it is worth $20,000. You hold onto it. Let’s say Bitcoin drops to $9,000 by December 31, 2018. You bring me the info for your taxes. How much do you have to report as income from that Bitcoin?

You have to report $20,000.

But it is only worth $9,000 now!

Yep. That is how it works since Bitcoin is not considered a currency.

What can I do to get my taxes down? Should I sell it?

Now you have a different problem. If that thing is a capital asset – and we said earlier that it was – you will have a capital loss upon sale. You will report a $11,000 capital loss on your return.

And unless you have capital gains to absorb those losses, you continue to have tax problems. Capital losses are allowed to offset only $3,000 of your “other” (read: Bitcoin) income on your tax return. You get no bang on the remaining $8,000 ($11,000 - $3,000), at least until the following year when you can use another $3,000. 

Don’t forget that you are also paying self-employment taxes on that $20,000 and not on $9,000.

This is ridiculous. If I were you, I would fire me as your tax advisor.

I do not accept Bitcoin for my fees, but I am waiting for someone to bring it up. I might do it for an isolated transaction or two. 

But no way am I using a Bitcoin credit card.