Cryptocurrency

It is very important to keep accurate and complete tax records. This is especially true if you own, invest in or use virtual, digital or crypto-currencies like bitcoin and ethereum.

The IRS treats cryptocurrencies as property, rather than currency. This means that anytime you use digital currency to buy goods or services, or you convert digital currency into a legal currency like dollars or yen, you may have gain or loss that must be included in your income.

To figure your gain or loss, you’ll have to show your basis in the currency. Basis is usually how much you paid for the currency. If you received the currency as payment for goods or services, your basis is generally the fair market value of the currency when you received it. This is probably also the case if the currency was a gift or inheritance.

Your gain or loss is the difference between your basis and the fair market value of the currency when you spend or convert it. If that fair market value is more than your basis, you have gain; it it’s less, you have loss. You must also determine whether you gain or loss is capital or ordinary. This depends on why you acquired the currency and how long you held it.

Virtual currency can also affect employment income and taxes. Employees and independent contractors who are paid with virtual currency have income equal to the fair market value of the currency when it is received. If you “mine” the currency, you also have income equal to the fair market value of the currency when you receive it. If the mining activity is your trade or business, you’ll owe self-employment tax on the income. If you use virtual currency to pay employees or independent contractors, you may have to file information returns.

As you can see, using and owning cryptocurrency can complicate your tax situation. And several other rules are still unsettled, so proper planning now may be key to avoiding additional taxes and penalties in the future.