Virtual Currency: Taxation Rules on the Books and in the Making
Hi, thank you for tuning in and welcome to our Emerald Planning GEM podcast series. GEM is an acronym for Get Educated in Minutes. We created this podcast series to help you address some of your most pressing planning concerns in a timely, concise, and actionable manner. I’m Rachel Ling, senior wealth planning analyst for Wilmington Trust Emerald Family Office & Advisory® and your host for today’s show. Today, I’m going to answer the question: What are some tax considerations surrounding virtual currency?
For the purpose of this conversation, I will discuss convertible virtual currency, which has value similar to real currency or acts as a substitute for real currency and is simply known as virtual currency. Virtual currency is the term the IRS uses and is the type for which the IRS has issued explanations of various income tax consequences. For owners of nonconvertible virtual currency, be sure to consult with your tax advisor. From a U.S. federal tax stance, virtual currency is presently classified as property, a capital asset1. Let’s begin by discussing what kinds of events may not trigger taxation:
- Generally, when one purchases virtual currency, there is no income or capital gains taxation at that time. (State sales-related tax is a whole other animal yet to be fully discovered, so it’s good to know the rules in the states that may affect you). At the point of purchase, it would be wise to properly record your basis in that virtual currency, as well as the date of purchase. These will become important for disposition purposes.
- If one owns virtual currency, one can generally transfer it from one wallet that they own to another wallet that they own without creating a taxable event. Again, record keeping may be important even at this level of transaction because these kinds of self-transfers may cause future tax issues if basis isn’t properly tracked.
- If one is given a gift of virtual currency, there will typically be no taxes due at the time.
- Similarly, when one gives a gift of virtual currency (within the allowable IRS limit), tax will likely not be due at that time either.
- If one donates virtual currency to a qualified organization, no gain, loss, or income will typically be recognized from the charitable donation, and there may be an opportunity for an income tax deduction, meeting certain qualifications and possible reporting requirements for noncash donations.
Presently, the taxation of virtual currency may be applied in a few ways. Those I’ll discuss here include income tax, capital gains, and briefly, estate taxes. Again, we strongly suggest that before any sale, gifts, charitable donations, or other transactions first consult with your tax advisor to review potential income tax impact. Many tax rules apply, the rules are complex, and the IRS and executive and legislation focus may develop more tax law changes.
Ordinary income tax may apply if:
- One is paid in virtual currency, including if one earns it by mining (or other fee-based methods of validating transactions)
- And income tax may be triggered if one receives new virtual currency as a result of a hard fork2
Perhaps a caveat to pay attention to regarding income taxation is that the fair market value of the virtual currency at the time one was paid would be the taxable amount, regardless of future growth or loss of value. The amount received is taxable as ordinary income, and the fair market value becomes your cost basis. Lastly, I’ll mention a new reporting requirement on the horizon which is slated to take effect for virtual currency transactions that occur in 2023, with reporting requirements taking effect in 2024, specifically, virtual currency transactions where you receive above $10,000 worth must be reported on Form 83003.
Another type of tax that may apply is capital gains and capital loss treatment because remember virtual currency is a capital asset. And so, transactions like buying goods, or paying for services, and converting it to U.S. dollars are basically akin to a sale of the virtual currency to complete the transaction and will generally trigger capital gains or losses. Here are a few points to remember:
- Basis is important
- Holding periods apply; short-term gains or losses occur if the unit was held for a year or less; long-term gains or losses occur if held for more than one year
- Depending on the taxpayer’s level of income and filing status, gains from investment sales may be subject to the 3.8% Medicare tax
- Essentially, when one buys something with virtual currency it will typically be a taxable event
Because virtual currencies are currently tagged as capital assets and not securities, they are not subject to the wash sale rule for now. Proposals have been made to subject virtual currency to wash sale rules, but this has not yet come to pass.
Also, currently, if virtual currency is held in an exchange, the custodian has no obligation to provide close-of-year records or tax forms similar to what you may expect from your traditional securities broker. So, the record keeping and reporting burden is solely on the asset owner. However, due to recent legislation with respect to virtual currency transactions that occur in 2023, with reporting requirements again taking effect in 2024, virtual currency “brokers” (like exchanges and wallet custodians) will be required to provide transactors form 1099-B for crypto currency transactions conducted on their platforms4. A caveat here may be that what constitutes a custodian of virtual currency may still be vague, so this, like so many other points, is still not 100% definitive.
And lastly, an additional way virtual currency could be taxed, under qualifying circumstances, is upon the owner’s death, when assets transfer to heirs. While not everyone may have a taxable estate on the federal level, individual states may have their own estate taxes which may be applicable, again, under qualifying circumstances. It is prudent in general to be mindful of the estate taxes in states that will affect you directly, for example, the state you reside in and any state where you may hold property, including virtual currency.
As a closing note, you may have heard about President Biden’s executive order in March of 2022 which seeks to “ensure the responsible development of digital assets5.” So, it is safe to say that U.S. lawmakers are tuned in, and perhaps precedential work is already underway, which is to say more rules, more procedures, and additional clarification are likely to come. However, it could take years for meaningful legislative infrastructure to form around virtual currency and its associated technology.
Thanks again for joining us today. I hope this GEM has helped give you some insight into planning around your virtual currency assets. Please contact your Wilmington Trust advisor if you would like to learn more about how we can help with your tax planning. We would be glad to speak with you. If you have a topic that you would like us to discuss on a future GEM, please let us know. Send an email to Emerald@wilmingtontrust.com. See you next time!
1IRS Notice 2014-21 https://www.irs.gov/irb/2014-16_IRB#NOT-2014-21
2IRS Notice 2014-21 https://www.irs.gov/irb/2014-16_IRB#NOT-2014-21 Hard Fork: IRS Notice 2019-24 https://www.irs.gov/pub/irs-drop/rr-19-24.pdf
3H.R.3684 - Infrastructure Investment and Jobs Act https://www.congress.gov/bill/117th-congress/house-bill/3684/text
4H.R.3684 - Infrastructure Investment and Jobs Act https://www.congress.gov/bill/117th-congress/house-bill/3684/text
5Executive Order on Ensuring Responsible Development of Digital Assets https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/
Basis (or Cost Basis): The original purchase price of an asset or investment. It is the number used by accountants and tax preparers to compute the gain or loss on certain types of assets, such as stocks, bonds, real estate or business equipment.
Capital asset: Most things you own and use for personal or investment purposes. Examples include a home, personal-use items like household furnishings, and stocks or bonds held as investments.
Capital gains: When you sell a capital asset, the difference between the adjusted basis in the asset and the amount you realized from the sale is a capital gain or a capital loss. Generally, an asset’s basis is its cost to the owner, but if you received the asset as a gift or inheritance, refer to Topic No. 703 for information about your basis. For information on calculating adjusted basis, refer to Publication 551, Basis of Assets. You have a capital gain if you sell the asset for more than your adjusted basis. You have a capital loss if you sell the asset for less than your adjusted basis.
Disposition: The action of distributing or transferring property or money to someone, in particular by bequest.
Eexchanges and wallet custodians: A crypto exchange is a platform for buying and selling cryptocurrencies. In addition to trading services, crypto exchanges also offer price discovery through trading activity, as well as storage for crypto. Custodial wallet services include offerings from crypto exchanges where a third party has control over your private keys (and therefore, your crypto).
Fair market value: The price an asset would sell for on the open market that considers the economic principles of free and open market activity.
Form 1099-B: A broker or barter exchange must file this form for each person:
- For whom they sold stocks, commodities, regulated futures contracts, foreign currency contracts, forward contracts, debt instruments, options, securities futures contracts, etc., for cash;
- Who received cash, stock, or other property from a corporation that the broker knows or has reason to know has had its stock acquired in an acquisition of control or had a substantial change in capital structure reportable on Form 8806; or
- Who exchanged property or services through a barter exchange.
Form 8300: Known as “Report of Cash Payments Over $10,000 in a Trade or Business,” this form provides valuable information to the Internal Revenue Service and the Financial Crimes Enforcement Network (FinCEN) in their efforts to combat money laundering. Money is "laundered" to conceal illegal activity, including the crimes that generate the money itself, such as drug trafficking, tax evasion and terrorist financing.
Hard fork: Occurs when a cryptocurrency undergoes a protocol change resulting in a permanent diversion from the legacy distributed ledger. This may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger.
Mining: The process that several cryptocurrencies use to generate new coins and verify new transactions. It involves vast, decentralized networks of computers around the world that verify and secure blockchains—the virtual ledgers that document cryptocurrency transactions.
Ordinary income: Any type of income earned by an organization or individual that is subject to standard tax rates.
Qualified organization: Includes nonprofit groups that are religious, charitable, educational, scientific, or literary in purpose, or that work to prevent cruelty to children or animals. You will find descriptions of these organizations under Organizations That Qualify to Receive Deductible Contributions. IRS Publication 526.
Qualifying circumstances: Regarding triggering federal estate taxation in 2022, qualifying circumstances is when an individual taxpayer’s estate exceeds $12,060,000 (other factors may contribute to the application of Federal estate tax, visit irs.gov for more information). Qualifying circumstances for estate taxes in individual states can vary broadly. Please consult your tax advisor.
Securities: A certificate attesting credit, the ownership of stocks or bonds, or the right to ownership connected with tradable derivatives.
Wash sale rule: Wash sale rules occur when you sell or trade securities at a loss and within 30 days before or after the sale you: buy substantially identical securities, acquire substantially identical securities in a fully taxable trade, or acquire a contract or option to buy substantially identical securities. Internal Revenue Service rules prohibit you from deducting losses related to wash sales. For more information about wash sales, read IRS Publication 550, Investment Income and Expenses (including capital gains and losses).