If you’re one of the increasing numbers of small businesses accepting or using cryptocurrency for payments, it’s crucial you understand the tax implications that affect your small business. Failing to report cryptocurrency transactions properly when filing your taxes could prove to be very expensive.
Generally the IRS calls cryptocurrency and other digital currencies “virtual currency” and warns in this notice about crypto and taxes that the “sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability.”
Cryptocurrency is treated as property for federal tax purposes. What does that mean for your small business? And more importantly, can you write crypto off as a business expense?
Keeping good records of your crypto transactions is your first order of business. The IRS says that a taxpayer who receives virtual currency as payment for goods or services must include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received when computing gross income. (Publication 551, Basis of Assets goes into more detail.)
You’re going to need to either work with your accounting professional to set up a system to keep these records, or use a crypto tracking software or crypto tax software to help you do that. (Gilded, for example, is a service that can sync crypto to certain accounting software programs. TaxBit and Cointelli are other services that can be used for crypto tax tracking.)
As Enrolled Agent Dave Duval points out, “Businesses that utilize bitcoin or other virtual currency are required to keep detailed records of the fair market value in U.S. dollars as they receive each unit of cryptocurrency. They also need to set-up and maintain an inventory valuation method, such as FIFO, LIFO, or another alternative valuation method for when the cryptocurrency is either traded for U.S. dollars or used to pay for expenses associated with their business.”
Can Crypto Losses Be Used As A Tax Write Off?
Anyone who has invested in crypto knows it is very volatile. In 2022, many crypto investors saw the value of their crypto assets decline a lot. Those that decided to sell may have a loss.
As the IRS explains, “when you sell virtual currency, you must recognize any capital gain or loss on the sale, subject to any limitations on the deductibility of capital losses.” You may also incur a capital loss when you exchange virtual currency for services or other property.
For small business owners, it’s important to keep in mind that crypto received as payment for goods or services will generally be treated as income. If the business holds the crypto and it increases or decreases in value and is sold or exchanged for other property, there may be a gain or loss.
Your loss (or gain) will be the difference between your adjusted basis in the virtual currency and the amount you received in exchange for the virtual currency, reported in US dollars. Your cost basis may be reduced by fees, commissions or other acquisition costs, and there may be other adjustments as described in IRS Publication 551, Basis of Assets.
Because cryptocurrency is considered property, it is generally subject to capital gains. Short-term capital gains tax rates apply to those assets held for one year or less before they were sold or exchanged. (The clock starts ticking the day after you acquired it, and ends the day you sold or exchanged it.)
If you held the crypto for more than one year and then exchanged or sold it, long-term capital gains apply.
When crypto prices drop, investors may be able to sell or exchange it as a loss, and use that loss to offset other stock or crypto gains. If overall losses are larger than gains, some may be used to offset current losses and up to $3000 of ordinary income. If losses are large enough, they may be carried forward to future years. This is referred to as “tax-loss harvesting.”
With crypto, unlike stocks, there is currently no wash sale rule that prohibits the seller of crypto from immediately turning around and buying more of it, though that could change.
Can Paying Taxes On Crypto Gains Be Avoided?
If you’re trying to use crypto in your business as a way to hide income and avoid taxes, you’re taking a lot of risk. The IRS is increasingly scrutinizing these transactions and has been gradually adding new tax filing requirements to make sure taxes are paid.
That said, there may be ways to lower your tax liability on crypto gains.
That said, there may be legitimate ways to reduce or avoid taxes on crypto gains. One way is to simply hold the crypto. Until you sell or exchange it, you likely do not have a taxable event. (Crypto received for goods or services in your business is still taxable as business income when received, of course. And as mentioned later, mining or receiving crypto from staking or an airdrop can be taxable when received.)
If you sell it and have other capital losses— say other crypto holdings or stocks that you sold at a loss— those may be used to offset the capital gains.
You may be able to give it to a family member. Up to $15,000 can be given a year without paying gift taxes.) They will have to pay taxes on it when they sell it.
You could also make a gift of crypto to a qualified charity to avoid taxes, and you may even get a tax deduction. There are caveats, though, so consult with a tax professional.
Finally, you could hold it and let your heirs inherit it after your death. Under current tax law they will receive it on a “stepped up” basis, which means they are taxed on any increase in the gain after you die.
A CPA or investment professional can help you understand options for reducing your tax burden.
How Do I Claim Crypto On My Taxes?
Businesses and business owners that receive crypto for the payment of goods or services need to treat it as other taxable income and report it as income received by the business based on the FMV the date it was received.
(Note we’re talking about federal income tax returns here; you’ll also need to comply with state tax requirements for you and your business.)
Many small business owners, especially the self-employed, use Schedule C to report business income and expenses. They attach it to their personal 1040 tax return. Your business may use other tax forms depending on your business entity and the form you elect. For example, a S Corporation will file a 1120 S tax return.
Gains or losses will be reported on Schedule D and Form 8949, Sales and other Dispositions of Capital Assets.
In addition, if your business makes a payment of $600 or more in a taxable year to an independent contractor for the performance of services, you’re required to report that payment to the IRS and to the payee on Form 1099- MISC, Miscellaneous Income, or the newer form for independent contractors, 1099-NEC. If you pay the contractor in crypto and the payment meets this threshold, you’ll need to file that form using the FMV of the virtual currency in U.S. Dollars as of the date of payment.
If you are self-employed and receive crypto as payment for your services, you’ll need to report it as income. If the amount you receive from one business is $600 or more in the tax year, you should get a 1099 with the value of that income. Otherwise, you’ll use the FMV of the crypto you received in USD as of the date of payment.
If you are mining crypto, your mining activity may count as a trade or business, and your net earnings are subject to self-employment tax. Generally, when you successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt must be included in your gross income. However, you may be able to deduct certain business expenses that would affect your net earnings.
If you are investing in crypto personally and have income to report, you’ll include it with your Form 1040. Gains or losses will go on Schedule D and Form 8949, as mentioned above.
A few other scenarios to keep in mind:
If you receive crypto as an airdrop you’ll need to report it as ordinary income based on the FMV. (Air drops are rewards of crypto, usually as new tokens.) Similarly, a hard fork that includes an air drop will be taxable.
Staking that results in awards of more crypto should also be reported as ordinary income based on the FMV when the crypto is received.
If you hold onto crypto you receive these ways, and later sell or exchange it, you may also have a gain or loss at that time.
A few credit cards offer crypto in lieu of cash back. Crypto credit card rewards are not specifically addressed in the IRS Faqs about crypto. Generally, credit card rewards aren’t taxable because they are considered a rebate. It’s not completely clear if that is the case with crypto credit card rewards, so you may want to ask your tax advisor. (It would still be wise to keep track of these transactions as they will typically result in a gain or loss if the crypto is later sold or exchanged.)
Is Transferring Between Crypto Wallets Taxable?
It should not be. The IRS says that as long as you transfer virtual currency from a wallet, address, or account belonging to you, to another wallet, address, or account that also belongs to you, then the transfer is not a taxable event.
Note, though, that exchanging one type of crypto for another may be a taxable transaction.
But keep records of all transactions, including these. A cryptocurrency exchange or platform may send an information return reporting this activity, and you’ll need to be able to demonstrate that it’s not taxable.
Do Any Countries Not Tax Crypto Currency?
If your goal is to move to another country to avoid taxes on crypto, you’re likely out of luck. The US taxes its citizens on worldwide income, regardless of where they live. So while some countries such as Germany or Switzerland don’t tax crypto, moving there is not going to save you money if you’re a US citizen.
How Does The IRS Know If You Have Cryptocurrency?
Generally speaking you’re supposed to voluntarily track and report your taxable income, even if the IRS isn’t notified by a third party. Anonymity is one of the benefits of crypto, and initially it wasn’t clear how or whether it would be taxed.
But gradually the IRS has added guidance around these issues. In recent years, the IRS added an explicit question about virtual currencies to Form 1040 to help encourage that reporting. .
More recently, cryptocurrency exchanges and platforms have been providing information to the IRS. Transactions that meet certain thresholds must be reported to the IRS using forms 1099-B or 1099-K. You should get a copy of that form, but even if you don’t, that doesn’t mean the IRS does not have information about your crypto transactions or that you don’t have to report them.
The IRS has also been issuing subpoenas to some exchanges in an effort to get them to report information. Finally, data analytics tools like Chainalysis are being used by government agencies and other organizations to help uncover illicit activity.
Having your business audited by the IRS for unreported crypto income could result in taxes and penalties, as well as a tax lien that hurts your business credit and make it harder to get small business loans in the future. Many business owners won’t want to take that risk.
This article was originally written on October 7, 2022.