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Cryptocurrency has a Special Role in Income Taxes

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Cryptocurrencies have been around for longer than you think, and we’ve only heard from the Internal Revenue Service (IRS) twice – in 2014 and 2019 – on how they think crypto should impact your tax burden.

From the beginning, the IRS has designated virtual currency as property. Because of this identification, cryptocurrencies are subject to capital gains taxes.

What is Crypto or Virtual Currency?

The most popular cryptocurrencies are house-hold names by now – Bitcoin, Ethereum – but there are thousands out there that you haven’t heard of.

All crypto or virtual currency is a digital representation of value that works outside of national currencies. But just like currency, crypto can be used to exchange value in terms of transactions.

While being marked as “property,” crypto has some of the same properties and characteristics of stocks and are subject to rising and falling values like any investment.

One reason people are pursuing cryptocurrencies is because it is secure. Transactions are encrypted with specialized computer coding and put into a blockchain. A blockchain is essentially a public ledger that lives in the digital world.

 

How do Cryptocurrency and Long-Term Capital Gains Work?

At the onset of cryptocurrency popular, the IRS made sure to put out an initial notice to secure their piece of digital currency income.

That ruling – IRS Notice 2014-21 – stated that the IRS considers cryptocurrency to be property. As property, it is subject to capital gains taxes that are reported on Schedule D and Form 8949 if necessary.

If you hold your cryptocurrency for more than a year, any profits are considered long-term capital gains and are subjected to those tax rates. If you owned your crypto for a year or less before spending or selling, profits are classified as short-term capital gains that are taxed at your ordinary income rate.

If you are worried about how you’ll be taxed, our team of tax strategists can help. There are also tables available online for the current year’s short-term and long-term capital gains tax rates.

 

The 2019 Revenue Ruling and What It Means

In 2019, the IRS released their first updated guidance on cryptocurrency in five years. Many questions needed answering on how to handle some of the interactions of virtual currency. To understand the 2019 guidance, we’ll need to explain two actions first.

Hard Forks

The easiest way to think of a hard fork is when you receive a new credit card if your old one is thought to be compromised. In crypto, the currency on one of those distributed public ledgers undergoes a change that results in a permanent move away from the initial ledger. Sometimes this creates a new cryptocurrency.

The most famous hard fork occurred in 2016 when the Ethereum blockchain included a crowd-sourced venture capital fund called The Distributed Autonomous Organization (DAO). An error in the blockchain code of the DAO enabled someone to steal $45 million in cryptocurrency from the DAO. DAO leadership used a hard fork to create a new cryptocurrency. This made the old cryptocurrency worthless and deprived the digital robber of that $45 million.

Airdrops

Each cryptocurrency holder has a digital wallet. An airdrop occurs when virtual currency is distributed to the wallet address, typically for free. The goal of an airdrop is to create awareness and broad distribution for a blockchain project. It can also be used in hard forks, distributing new cryptocurrency to the holders of the old cryptocurrency.

The 2019 Revenue Ruling provided FAQs with some answers, but also raised more questions about the future of cryptocurrency and taxes. Here’s some of the things that are explained:

  • If a hard fork happens and you receive the same fair market value of new cryptocurrency that you had in the old cryptocurrency, no gross income is recognized.
  • If you get airdropped a new cryptocurrency, then you have an accession of wealth and you must recognize that new cryptocurrency as gross income of that date.
  • If you transfer virtual currency from a digital wallet or account belonging to you to another wallet that is yours, this is a non-taxable event.
  • If you receive virtual currency in exchange for providing services, you recognize ordinary income. Your basis in the virtual currency is the fair market value when the currency is received.
  • If you receive cryptocurrency as a gift, no income is recognized until you sell, exchange, or somehow get rid of the currency. Your basis in the virtual currency gift differs depending on whether you will have a gain or loss when you sell or get rid of the holding.

 

Some Advice from The Richest Doctor

In David Auer’s book, The Richest Doctor: A Modern Parable of Financial Independence, there’s a ton of information about understanding risk and investing smarter. It’s important to learn and know what type of investor you are – the “Too Busy to Learn” investor, the “Accredited Investor Level,” or one of our higher levels. Although the book is for physicians, there is great advice for all high-income professionals.

If you are prepared to learn the ins and outs of cryptocurrency, the better chances you have of investing and understanding the ramifications of gains on your tax picture. We recommend reading up, finding a mentor that is already successful in cryptocurrency investing, and also reading The Richest Doctor to understand how investing and cryptocurrencies might play a part in your financial independence.

There are a lot of nuances to cryptocurrencies. There’s much more to crypto than we could cover in this article. Good luck with any moves you make in this space, and don’t hesitate to reach out to the Provident CPAs team with tax questions!

Why Are So Many Tax Refunds Unclaimed?

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More than a billion dollars is out there waiting to be claimed. Unfortunately, many businesses don’t know they may be entitled to a share of it

Each year before tax time, the IRS announces the amount of unclaimed money it’s holding due to people not properly filing their tax returns. In early 2019, the IRS said there were still unclaimed income tax refunds for the tax year 2015 to the tune of nearly $1.4 billion, and they estimate that there are 1.2 million taxpayers who still didn’t even file a tax return that year.

So, why is there so much in unclaimed funds? And what can you do to ensure you claim what you’re owed?

Where does that money come from?

If the government gets too much tax from individual paychecks or taxpayers otherwise overpay, the only way taxpayers will get those funds back is if they file a tax return at the end of the year and it has the correct information, such as address and payment details. Otherwise, they have three years from the tax return date to clear up any info or file the return and claim the refund. After that three year is up, the money becomes the property of the U.S. Treasury.

So why don’t people claim their tax refunds? There are a few answers, as two tax experts told CBS News earlier this year:

  • Some individuals simply aren’t educated about how to file a return or even the necessity of doing it.
  • Sometimes individuals believe that a smaller refund isn’t worth the fee taxpayers will have to pay a tax professional. So, they’ll avoid claiming their money even if they know they overpaid on taxes.
  • Some taxpayers may want to stay unknown to the IRS, whether due to debts they owe to the government, immigration status, or other reasons.

Another reason that the IRS is sitting on refunds could simply be that a taxpayer has forgotten about their refund and hasn’t done anything to follow up on the money they were supposed to receive. This can happen if a taxpayer provided incorrect bank account information or has a new address, for example.

When businesses can get a tax refund

It’s important to understand the different business structures and when you may be able to claim a tax refund.

A C-corporation is a type of business structure in which the owners or shareholders are taxed separately than the business income. This is the most prevalent type of corporation, and because the profits are taxed both at the corporate level and the personal level, a double tax occurs. However, there are benefits of a C corporation, one of which is the ability to reinvest any revenue back into the company at a lower tax rate.

Other business structures, such as S corporations or LLCs, separate the business’s assets from its owners, but they don’t see that double taxation since income is only taxed once.

Because profits of C corporations are taxed separately than their owners, these businesses are the only type of business that is eligible to receive a tax refund. As with an individual, if the C corporation paid more estimated tax throughout a year, it can technically get a tax refund. This would also be true if your business paid too much-estimated tax on payroll or sales taxes.

Sole proprietorships, S corporations, partnerships, and LLCs are pass-through entities because tax passes to individual tax returns. So, if you run a sole proprietorship, for example, you’ll report your business earnings on your normal individual tax return.

As an LLC business owner, the only way you’d get a tax refund is if your total payments and withholding are more than your total tax liability on your return.

Remember that as a small business owner, it’s not always positive to get a tax refund. If you get money back, that means you overpaid and could have been earning interest on those funds in the interim. This could also interrupt your cash flow.

Filing a tax return

You should never wonder whether you are owed money if you file a proper tax return—and self-employed individuals must file a return if they made over $400 that year. Not doing so comes with some stiff penalties and other consequences.

Beyond the basic legal necessity, it keeps your financial record updated and could help protect you against identity theft. When you file a return using your social security number, that prevents someone else from filing a fraudulent tax return with your number. Even if you’re only now filing for previous years, doing so could still uncover that there had been a fraudulent tax return years back.

When your tax return is past due, it’s important to file it ASAP. Otherwise, you’ll stack up interest charges and late payment penalties.

Finally, if you’re self-employed and you don’t file a federal income tax return, the income you earned won’t be reported to the Social Security Administration—and you thus won’t get the credits toward your social security or disability benefits.

Provident CPA & Business Advisors help successful professionals, entrepreneurs, and investors get more out of their business and work less. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning and business strategy and discover how we help businesses exceed expectations.