Market Extra: Uncle Sam is coming after your bitcoin gains
A judge’s ruling in favor of the U.S. Internal Revenue Service in its suit against Coinbase, a cryptocurrency exchange, once again proves that death and taxes are about the only certain things in life.
A federal court on Wednesday ordered Coinbase to report all transactions worth $ 20,000 or more between 2013 and 2015. The IRS took Coinbase to court when the latter refused to turn over the information voluntarily when requested.
Bitcoin prices BTCUSD, +0.88% rose from about $ 1,000 in January to above $ 11,000 on Tuesday, appreciating more than 10-fold. On Thursday, bitcoin fell to trade at $ 9,730.
Some analysts say that it is this massive appreciation in price that prompted the IRS to look into taxing gains from bitcoin trading.
The IRS alleged that bitcoin traders are not disclosing gains from trading in the cryptocurrency. According to the court documents, the IRS said that only a tiny fraction of hundreds of thousands of Coinbase users, or about 900, reported gains or losses from bitcoin trades, prompting the agency to request user data.
Read: Outage on bitcoin exchange hits prices
The judgment says that Coinbase must turn over information, such as taxpayer IDs, names, birth dates, addresses and transactions of the customers that fall within the IRS’s search parameters.
Coinbase fought this issue on the grounds that it violates financial privacy of its customers and claimed partial victory, in a blog post, saying that only about 14,000 users, a small percentage of its customer base, will be impacted by the order.
“Coinbase started this process more than 12 months ago, and while today’s result is not the complete victory we hoped for, it does represent a substantial and unprecedented victory for the industry and the hundreds of thousands of customers that would have been unfairly targeted if it weren’t for our action,” the company said.
But if an exchange doesn’t report transactions to the IRS, the onus falls on taxpayers. According to a November survey by LendEDU, a marketplace of private loans, more than a third of respondents are not planning to report their transactions to the IRS. That number appears too small compared with the numbers reported by the IRS itself in court documents.
The role of reporting gains on traditional securities, such as stocks or exchange-traded funds falls on brokerage firms or asset managers and not exchanges where these securities are traded.
Unlike a traditional securities exchange, such as New York Stock Exchange or Nasdaq, however, Coinbase also doubles as a brokerage firm, storing digital currency and allowing users trade on margin through its subsidiary GDAX.
“It took the IRS until 2014 to issue rules about cryptocurrencies and how to view them for tax purposes. It is only a matter of time before firms like Coinbase and other exchanges are required to issue tax documents for their users,” said Robert Graham, partner at Friedman LLP, an accountancy and advisory firm.
“Investors who have gains from bitcoins have to keep detailed records, so they can calculate their short-term and long-term returns. This ruling is a sign that as the industry is maturing and regulators are evolving. As institutional investors get involved with digital currencies, government agencies will tighten control over the industry,” Graham said.
The IRS treats virtual currencies as property for U.S. federal tax purposes, which means that general rules for property transactions apply.
According to IRS rules, “a taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.”
In other words, if you got paid in bitcoins, you should report it as income using the fair market value on the day you were paid.
If a taxpayer realized a gain or loss after selling or exchanging bitcoins held as an asset, then it is treated as capital gain or loss on property if held for longer than 12 months. Short-term gains are taxed as ordinary income.
“Once we got the ruling from the IRS about treating bitcoin as property, there is no ambiguity about reporting it. Knowingly withholding gains is fraudulent and can cause penalties,” Graham said.