Tag Archives: Bitcoin

How To Report Bitcoin Cash And Avoid IRS Trouble

August 2, 2017 | By: Robert A. Green, CPA


Read it on Forbes.

In light of the Aug. 1 split of Bitcoin into two separate cryptocurrencies, Bitcoin and Bitcoin Cash, many questions remain. While the IRS has issued guidance on cryptocurrency — labeling it an “intangible asset” for investors subject to capital gains and loss treatment using the realization method — it has not issued guidance on cryptocurrency split or “fork” transactions. There are thousands of cryptocurrencies, and many formed in this type of division in the blockchain.

Tax reporting for the receipt of Bitcoin Cash
The initial market price of Bitcoin Cash was $266 per unit, which was 9.5% of the comparable Bitcoin unit price at that time of $2,801. Bitcoin holders were distributed one unit of Bitcoin Cash for each unit of Bitcoin, a separate financial instrument with a liquid market value. In the eyes of the IRS, that’s taxable income. (An alternative name for Bitcoin Cash is BCash.)

Bitcoin holders should report the receipt of Bitcoin Cash on their 2017 income tax returns. It does not qualify as dividend income on Schedule B since a cryptocurrency is not a security. It’s also not considered interest income on a debt instrument or bank deposit. I suggest reporting the value received as “Other Income” on line 21 of Form 1040 —a catchall category for income that does not fit into a standard category.

Some taxpayers might choose to use Form 8949 (Sales and Other Dispositions of Capital Assets) instead. The taxpayer reports the $266 value of Bitcoin Cash as proceeds and 9.5% of Bitcoin cost basis as Bitcoin Cash cost basis. The initial value of Bitcoin Cash was 9.5% of the Bitcoin price at that time. This alternative treatment reduces taxable income by the cost basis amount. Another benefit is capital gains use up capital loss carryovers. I question whether this method would pass muster with the IRS — Bitcoin did not decline in value by a material amount after the split, and that undermines the use of this treatment.

Constructive receipt of income
Some Bitcoin holders mishandled or skipped arranging access to Bitcoin Cash, or their exchange does not support Bitcoin Cash, making retrieval difficult or impossible after Aug. 1, 2017. These taxpayers may believe they don’t have to report the Bitcoin Cash as taxable income since they don’t currently have access to it. While that seems reasonable, the IRS could apply the constructive receipt of income doctrine to argue the Bitcoin holder had access to Bitcoin Cash but turned his or her back on receiving it. Kelly Phillips Erb of Forbes goes into more detail in her article, Bitcoin Shift Could Cause Tax Headaches For Some Users).

Tax reporting for the sale of Bitcoin Cash
If you sold your Bitcoin Cash, you need to use capital gains treatment on Form 8949. For proceeds, enter the selling price. For cost basis, enter the $266 Bitcoin Cash value received per unit as you previously reported it as Other Income on line 21 of your 2017 Form 1040. The holding period for these units of Bitcoin Cash started on Aug. 1, 2017.

A cryptocurrency split is not a tax-free exchange
Taxpayers may feel a cryptocurrency split such as Bitcoin Cash qualifies as a tax-free exchange. I don’t think it does because cryptocurrencies are not securities, where tax-free splits are possible.

“Receipt of new Bitcoin Cash assets is a taxable event,” said tax attorney Roger D. Lorence. “Corporate taxation concepts on distributions to shareholders, dividends, spinoffs, split-offs, corporate reorganization nonrecognition events under Section 368 and allied rules, are all not applicable, as cryptocurrency is not a security. The new Bitcoin Cash assets are substantially different economically from the old Bitcoin assets.”

Lorence said the Supreme Court decision in Cottage Savings supports the view that the two classes of Bitcoin assets are not identical and therefore the transfer of the assets is considered a new class for which no nonrecognition provision of the code applies.

The IRS goes after cryptocurrency investors
Many cryptocurrency investors made a fortune the past several years selling high-flying Bitcoin and other cryptocurrencies for cash. Unfortunately, far too many of them did not report this taxable income to the IRS. Some cryptocurrency investors used Section 1031 like-kind exchange tax law to defer taxation, but that may be inappropriate (stay tuned for a blog post on that soon). Some cryptocurrency exchanges issued Form 1099-K, Payment Card and Third Party Network Transactions. The IRS feels they are insufficiently informed, so they are taking action.

Bitcoin rose in price from $13 in 2009 to more than $3,000 on June 11, 2017, and on Aug. 1, 2017, its market cap was $44 billion. Ethereum had a market cap of $21 billion. Bitcoin Cash skyrocketed overnight to a market cap of $12 billion on Aug. 2, 2017. The IRS figures hundreds of thousands of American residents did not report income from sales or exchanges of cryptocurrency and they might be able to collect several billion dollars in back taxes, penalties, and interest.

The IRS recently summoned Coinbase, one of the largest cryptocurrency exchanges, to turn over its customer lists. It later agreed to narrow the scope of the list to people with cryptocurrency transactions worth over $20,000 without a Form 1099-K. (Read IRS Blinks in Bitcoin Probe, Exempts Coinbase Transactions Under $20,000.)

Tax treatment for sales of cryptocurrencies
The IRS was slow to issue guidance for cryptocurrencies. It finally declared cryptocurrencies an “intangible asset,” not a sovereign currency, and sales and exchanges are subject to capital gain or loss treatment for investors and traders, using the realization method. (Read If You Traded Bitcoin, You Should Report Capital Gains To The IRS.)

There is tax controversy brewing with cryptocurrency investors, which means tax exams will escalate. Don’t be greedy: Pay your capital gains taxes on windfall income and amend tax returns to report capital gains before the IRS catches up with you.

Darren Neuschwander CPA, Adam Manning CPA and tax attorneys Roger D. Lorence and Mark M. Feldman contributed to this blog post.

If You Want To Trade Bitcoins, First Learn CFTC Rules

February 16, 2017 | By: Robert A. Green, CPA

The CFTC requires counterparties, including brokers and exchanges, doing business with American retail customers to register if they offer “leveraged” or “financed” financial products, including derivatives. The CFTC brought an enforcement action against unregistered Bitfinex of Hong Kong because they offered leveraged cryptocurrency contracts to American retail customers. Several other unregistered offshore exchanges offer leveraged cryptocurrency contracts to American retail customers. Many Americans trade cryptocurrency on exchanges that do not provide leveraged contracts, and that seems okay.

Bitcoin is the most famous cryptocurrency, and there’s been significant price volatility the past few years. That’s attracted American retail traders to Bitcoin exchanges offering leveraged trading and derivative products based on Bitcoin price movements.

In this post, I discuss CFTC regulation for Bitcoin counterparties (exchanges and brokers), and in my related post, I cover tax treatment for trading Bitcoin. (See If You Traded Bitcoin, You Should Report Capital Gains To The IRS.)

Is Bitcoin trading legal for American retail customers?
Some American retail customers trade leveraged or financed cryptocurrency contracts with counterparties that are not registered with the Commodity Futures Trading Commission (CFTC) or another U.S. regulator to allow cryptocurrency trading by American retail customers. I asked the CFTC and National Futures Association (NFA) if that is legal, and both said CFTC regulations for American retail customers apply to counterparties, not American retail customers. Does that imply that leveraged Bitcoin and cryptocurrency trading may be legal for American retail customers, and illegal for counterparties? Perhaps, yes, but I am not sure. It’s risky for American retail customers to trade leveraged Bitcoin contracts or another leveraged cryptocurrency because the CFTC may take enforcement action against their counterparties as it did against Bitfinex (see below). Maintain control of Bitcoin wallets to avoid some counterparty risk with regulators.

CFTC regulations
The Commodity Futures Trading Commission (CFTC) requires counterparties, including brokers and exchanges, to register with the CFTC if they offer leveraged or margined financial products to American retail traders. That includes some Bitcoin exchanges and Bitcoin derivative products.

If a forex dealer wants to do business with American retail traders on leveraged forex contracts off-exchange, the CFTC requires the forex dealer register with the CFTC, SEC or bank regulator. There is CFTC-registered Retail Foreign Exchange Dealers (RFED), and CFTC-registered Futures Commission Merchant (FCM) Forex Dealer Members.

The CFTC considers Bitcoin a “currency,” but not a “foreign currency.” The CFTC says Bitcoin is not forex, so it doesn’t fall under the forex regulations. The CFTC also refers to Bitcoin as a “commodity.”

The North American Derivatives Exchange, Inc. (Nadex), a U.S.-based CFTC-regulated exchange, offered leveraged Bitcoin binary contracts until it discontinued that product at the end of 2016. On Dec. 16, 2016, Nadex filed a Self-Certification to Delist Bitcoin.

Bitcoin exchanges offering leverage try to escape CFTC jurisdiction
Bitcoin exchanges have sought exemption from CFTC jurisdiction in claiming traders are “making and taking delivery” of each trade on their “exchange,” by transferring the title into Bitcoin wallets. The CFTC does not regulate private transactions in commodities, or forward contracts when made for delivery within 28 days. For example, a farmer may sell wheat to a cereal manufacturer for immediate delivery, or with a forward contract. A warehouse receipt is evidence of delivery.

CFTC jurisdiction applies to counterparties offering futures, options, derivatives, and financed (or leveraged) retail transactions for future delivery. In the CFTC enforcement case cited below, the CFTC explained how leveraged trades in the spot Bitcoin market with an American retail customer fell under CFTC jurisdiction as a financed retail transaction. The CFTC also disagreed that Bitfinex made full delivery of Bitcoin to traders.

Two CFTC enforcement cases against Bitcoin exchanges
Bitfinex in June 2016, and Coinflip in September 2015. Read CFTC vs. BFXNA INC. d/b/a BITFINEX and CFTC Bitfinex Enforcement Action, an analysis by law firm Clifford Chance. Here are some excerpts from the Clifford Chance client briefing:

  • “The Order expands the CFTC’s regulation of bitcoin and other cryptocurrencies into spot markets under certain conditions.”
  • “The result is that spot trades qualifying as financed retail transactions will be regulated as if they were futures trades.”
  • “The Exception does not apply since the bitcoins were not actually delivered. In finding lack of actual delivery, the CFTC looked to the fact that at all times Bitfinex held the private keys needed to access the wallet where bitcoins were held.”

On-exchange vs. off-exchange
On-exchange means a CFTC-registered U.S. futures, options or derivatives exchange like the CME, CBOE, ICE, NYMEX and NADEX.

On-exchange also includes foreign futures and options exchanges, providing the CFTC issued a “Part 30 Letter” granting the foreign exchange permission to solicit accounts with American retail customers. The exchange must demonstrate similar rules as in the U.S. including posting prices, setting margin requirements, meeting capital adequacy, and more. (See a list of CFTC Part 30 Letters on the CFTC website.)

The CFTC’s mission is to protect American retail customers
The CFTC prefers leveraged trading transactions for American retail traders conducted on-exchange, so the exchange may act as the counterparty to both buyer and seller, who otherwise do not know each other. With off-exchange forex, the CFTC-registered RFED and Forex Firms are the counterparties.

Consider the infamous failure of the largest (at the time) Bitcoin exchange, Mt. Gox, which filed for bankruptcy protection in Japan in 2014. The CFTC is trying to protect American retail customers from these types of losses.

Exemptions for ECP and ECE
Eligible Contract Participants (ECP) who meet certain high net worth requirements are “institutional” and exempt from CFTC regulations for American retail customers. ECP can trade off-exchange leveraged financial products, including Bitcoin derivatives. Eligible Commercial Entities (ECE) are exempt, too. (For a definition of ECP, click here and for ECE, click here.)

Republicans are interested in scaling back Dodd-Frank regulations
President Trump, his administration officials, and the GOP leaders in Congress have indicated they want to scale back elements of the Dodd-Frank Act. It’s conceivable they could reduce some of the CFTC limitations on American retail customers trading leveraged financial products off-exchange.

Tax reporting
Whether it’s legal or not under CFTC regulations, the IRS requires American resident taxpayers to report Bitcoin trading income and losses worldwide on U.S. resident tax returns. It doesn’t matter whether or not you repatriate funds back to the U.S. (See my blog post: If You Traded Bitcoin, You Should Report Capital Gains To The IRS.)

Bitcoin is not reported on 2013 FBARs

June 6, 2014 | By: Robert A. Green, CPA

Bitcoin investors store bitcoin on foreign exchanges in countries like Estonia, Russia and elsewhere. Do they have to file bitcoin holdings outside the U.S. on 2013 FBARs due June 30? The IRS just said no.

The following are excerpts from Thomson Reuters/Tax & Accounting’s “IRS official: taxpayers don’t have to report virtual currency on 2013 FBARs”:

“During a recent webinar, an IRS official stated that for purposes of the current filing season, taxpayers aren’t required to report virtual currencies on a Report of Foreign Bank and Financial Accounts (FBAR) with the U.S. Treasury. However, although this previously disputed matter is settled for the present, he stated that this position may well be subject to change.”

“Virtual currency isn’t subject to FBAR reporting … for now. During a recent IRS webinar titled “Reporting of Foreign Financial Accounts on the Electronic FBAR,” Rod Lundquist, Senior Program Analyst in IRS’s Small Business/Self Employed (SB/SE) division, stated that for purposes of the current filing season (i.e., for 2013 FBARs due later this month), taxpayers aren’t required to report Bitcoin on an FBAR. However, he cautioned that IRS is continuing to analyze virtual currency and that this policy could very well change going forward.

The issue of whether Bitcoin is subject to FBAR reporting has been widely debated among the financial and tax online community. One view is that, unless a taxpayer can prove that their bitcoins are within the U.S. (a potentially tricky proposition), then their owner would be required to file an FBAR if his holdings exceed $10,000. However, others question whether a Bitcoin account is truly a “financial account” with a “financial institution” for purposes of the FBAR rules-and, despite the IRS official’s recent pronouncement, these questions are still unanswered.”

Can business traders apply Section 475 elections to bitcoin trades?

May 21, 2014 | By: Robert A. Green, CPA

At the May 9 American Bar Association (ABA) meeting, tax attorneys asked the IRS about bitcoin. According to Tax Analysts coverage of the meeting, Jo Lynn Ricks of Deloitte Tax LLP said the IRS guidance didn’t answer the question of whether a virtual currency could be a commodity, adding that if it is a commodity, dealers and traders could elect mark-to-market treatment under section 475(e) and (f).

“If you have something that trades through a futures contract, then it could be a commodity through the [Commodity Exchange Act],” she said. Bitcoin futures are traded on an exchange called ICBIT, creating the potential for virtual currencies to meet that broader definition of commodity, according to Ricks.

In its guidance, the IRS labels bitcoin an “intangible asset,” but it doesn’t go as far as labeling bitcoin a commodity. The sale of an intangible asset, commodity or security brings capital gains or loss treatment. The sale of a commodity futures contract traded on a U.S. commodities or futures exchange means lower 60/40 tax rates under Section 1256.

Business traders electing Section 475 have ordinary gain or business loss treatment on Form 4797 Part II. We generally recommend business traders elect Section 475 on securities only, so they can retain lower 60/40 tax capital gains tax rates on futures (considered “commodities” in Section 475). Our tax attorney Mark Feldman suggests that to deal with bitcoins, the election language be changed so that it applies “for securities and for those commodities which are not eligible for Section 1256 treatment.”

IRS Guidance On Bitcoin Transactions

March 25, 2014 | By: Robert A. Green, CPA

The IRS just issued bitcoin guidance stating that it is considered property, not a currency.

That’s good news for taxpayers with huge gains on using, investing or trading bitcoin, since it receives capital gains treatment and if they held it over one year, the lower long-term capital gains tax rate applies.

Conversely, it’s bad news for those with large losses, with the recent price of bitcoin dropping significantly. According to the IRS guidance, bitcoin does not receive Section 988 ordinary loss treatment, which is unlimited; instead, it’s capital-loss treatment is limited to $3,000 per year.

The IRS guidance stresses a point — widely overlooked by many taxpayers — that using bitcoin to purchase an item or service triggers capital gain or loss recognition reflecting appreciation or depreciation of bitcoin. Compare the market price on the date bitcoin is used to make a purchase vs. the market price on the date you acquired that bitcoin, and the difference is a capital gain or loss on property. Few people or companies have filed Form 1099s on these transactions, as may be required, and taxpayers will have to scurry around to figure their cost basis and sales proceeds on each purchase where they used bitcoin as a digital currency. See the example of buying a cup of coffee with bitcoin in the Bloomberg article Bitcoin Is Property Not Currency in Tax System, IRS Says. The WSJ articles IRS Says Bitcoin Is Property, Not Currency and Q&A: The New IRS Rules on Bitcoin are good too.

Having to report a capital gain or loss on each purchase using bitcoin will have a chilling effect on bitcoin reaching its goal to be a widely used digital currency. Who wants to spend 30 minutes or more figuring out their capital gain or loss for a simple $3 cup of coffee? And who wants to risk getting audited by the IRS over bitcoin tax reporting to boot?

See the IRS Notice 201421 which includes many good FAQs that may strike a cord with taxpayers.

Bitcoin is a hot commodity, but how is it taxed?

December 3, 2013 | By: Robert A. Green, CPA

Buttressed by an Internet craze, the price of bitcoin has skyrocketed this past year from $17 to over $1,200. Pundits expect significant price volatility in 2014 as well.

While the Federal Reserve gave tacit approval, stating “virtual currencies like bitcoin have legitimate uses and should not be banned,” the IRS has not yet issued tax guidance. Despite the lack of guidance, income from bitcoin transactions must be reported.

What’s the bitcoin tax treatment for traders?
There are two possibilities how bitcoin should be treated for tax purposes: either it is an (1) intangible asset, or (2) a foreign currency. The problem with saying that it’s a currency is that it is not issued by a government, and traditionally currencies are legal tender issued by governments. In California Bankers Assn v. Shultz, the Supreme Court stated (in a non-tax context): “‘Currency’ is defined in the Secretary’s regulations as the “coin and currency of the United States or of any other country, which circulate in and are customarily used and accepted as money in the country in which issued.” The IRS has not said its opinion, but both Canadian and Swedish tax authorities are treating bitcoins as an asset. Also, the German Finance Ministry says bitcoin is not classified as e-money or a foreign currency, but is rather a financial instrument under German banking rules. It is our sense that unless Congress enacts legislation to treat bitcoins as a foreign currency, the IRS will treat bitcoins as an asset.

If you buy bitcoin for purposes of appreciation and then sell it, then if (1) bitcoin is an asset, you will have capital gain and loss, and (2) if bitcoin is a foreign currency, then under Section 988 you will have ordinary income and loss.

Is bitcoin a commodity?
There is no definition in the Internal Revenue Code of “commodity.” Black’s Law Dictionary 342 (4th ed. 1968) defines commodity: a movable article of value that can be bought or sold. A bitcoin is not movable property, so arguably it’s not a commodity. But at the Senate hearing, academics and financial industry players warned that bitcoin could be regulated as a commodity if market volatility continues. Such financial regulation may or may not impact the tax treatment.

Most bitcoin investors and traders will prefer capital gains tax treatment
After the astronomical rise in bitcoin this past year, most investors and traders may prefer capital gains and loss tax treatment. Consider this example: An American investor bought bitcoin at $17 just over 12 months ago and he sold it recently for $1,200. Is he entitled to significantly lower long-term capital gains tax rates of up to 20% in the top bracket and up to 15% in the second top bracket? That’s 20% lower than the top ordinary rates of 39.6% and 35%.

In this example of incredible appreciation, investors and traders will prefer that the IRS views their bitcoin transactions as trading in a commodity or other capital asset held for price appreciation. As long as the investor did not acquire the bitcoin as part of his business or for personal reasons this tax treatment seems safe to deploy on 2013 tax returns — until the IRS says otherwise.

It’s important to also consider tax treatment for commodities sold in a business vs. trading in commodity futures contracts. A farmer sells his wheat and reports ordinary gain or loss treatment in his trade or business. Conversely, a commodity futures trader holds “capital assets” subject to capital gain or loss treatment. Regulated futures contracts benefit from lower 60/40 capital gains tax rates (60% is a long-term capital gain — even on a day trade — and 40% is ordinary tax rates).

Say a trader’s regulated futures contract expires and he takes delivery of bushels of wheat. If he sells those bushels of wheat in less than 12 months, he receives short-term capital gains treatment, not ordinary gain or loss treatment or lower 60/40 tax rates since the bushel does not qualify as a Section 1256 contract.

Can bitcoin traders use ordinary loss tax treatment in Section 475?
What goes up fast and irrationally may also go down fast and irrationally. New investors may wind up with big trading losses and they may wish for ordinary loss treatment instead of $3,000 capital loss limitations and large capital loss carryovers.

As the bitcoin trading market expands, some bitcoin traders may be able to achieve trader tax status (business treatment) on trading that asset class. It is not clear whether they can make a Section 475 MTM election for trading bitcoin to have business ordinary gain or loss treatment. Section 475 allows “Traders in Securities and or Commodities” to make the election. The term “commodities” above really refers to trading Section 1256 contracts or regulated futures contracts; Section 475 does not seem to include bitcoin. However, if bitcoin becomes regulated as a commodity, it may qualify for Section 475 treatment.

A potential case for using Section 988 ordinary gain or loss treatment
If you don’t qualify for trader tax status in bitcoin, perhaps you can convince the IRS to respect the Fed’s label of “virtual currency,” and argue your bitcoin trades qualify for application of Section 988 (foreign currency transaction) ordinary gain or loss treatment.

Section 988 is the default tax treatment for spot forex trades, which is a huge trading marketplace. Spot forex traders write off trading losses in full as ordinary losses on line 21 of Form 1040 (Other Income). If they have trader tax status, they use Form 4797 Part II business ordinary loss treatment, which feeds into Net Operating Loss (NOL) calculations.

Section 988 allows forex traders and investors, but not manufacturers and other operating businesses, to file a contemporaneous internal opt-out or capital gains election. Many forex traders file a capital gains election and navigate their way into lower Section 1256g lower 60/40 tax rates, too. Section 988 does not allow a capital gains election on holding physical currency and that would apply to holding bitcoin, too if Section 988 were to apply. Section 988 rules for forex traders are complex and beyond the scope of this article.

Bitcoin as a digital currency
In general, American vendors accepting bitcoin as a digital currency in their trade or business should report bitcoin transactions as they would with a foreign currency. Simply translate the foreign or digital currency back into U.S. dollars on the date of receipt. There are no grounds to defer recognition of these transactions simply because it’s in bitcoin.

Holding bitcoin in your business
What happens if a trade or business decides to hold bitcoin for appreciation after acquiring it in a regular business transaction? Is it ordinary gain or loss from holding a commodity in your trade or business, or a capital gain or loss from holding onto a commodity or capital asset for appreciation? Both can be the case and it depends on intention, facts and circumstances.

In the earlier example, the farmer stockpiles wheat in a grain elevator, perhaps waiting for higher prices. The farmer may also hedge wheat prices in the futures market. Under the “hedging rule,” the wheat farmer still has ordinary gain or loss on storing and hedging wheat.

Also, consider the example of a manufacturer who holds foreign currency reserves for later use in foreign markets or for appreciation. The manufacturer also may hedge his foreign currency in the futures market. Like the farmer, the manufacturer has ordinary gain or loss on all these transactions.

An Internet vendor is not a commodity farmer of bitcoin and it’s conceivable that he could segregate bitcoin as a commodity or capital asset held for investment.

Bottom line
Bitcoin is a hot asset for traders and investors and you should learn the tax rules before you plow your money in. If you acquired bitcoin in your business, make sure you reported your sale transactions correctly.