authored by Mirit Hoffman (Reif), Adv. & Dave Wolf, Adv.
Although the IRS has not yet announced a tax amnesty for people who failed to report their gains and income from Bitcoin and other cryptocurrency, there is speculation that it might happen soon according to a senior U.S Justice Department attorney. “At some point people will need access to this money, and they are going to have to have a means of coming forward, whether it is through the traditional [Internal Revenue Manual] voluntary disclosure procedure or whether there is a separate project," said Mark F. Daly, senior litigation counsel at the Justice Department's Tax Division. This could be an addition to the current IRS voluntary disclosure programs for offshore bank accounts, which are the 2014 Offshore Voluntary Disclosure Program and the Streamlined Filing Compliance Procedures.
Bitcoin values have increased by more than 1,000 percent just in 2017. "With such increases in value, there is also a temptation to avoid taxation", Daly said.
The IRS found that that there is a reporting gap between the 2013 through 2015 registered account holders on Coinbase and the number of people who actually reported their cryptocurrency holdings to the IRS. The IRS is taking this seriously enough that it is training the IRS Criminal Investigation Division regarding cryptocurrency transactions and has entered into a contract with Chainalysis Inc., for a web-based cryptocurrency tracking tool license.
Recently, the United States District Court of California ordered Coinbase to supply the IRS with the identities of all users in the U.S. who conducted at least one Bitcoin transaction equivalent to at least $20,000 between 2012 and 2015. Coinbase will be required to turn over the taxpayer’s ID number, name, date of birth, address, transaction logs, and account statements on 14,355 account holders out of its nearly 6 million customers.
This is similar to how it started with UBS and the Swiss bank avalanche, which lead to the success of the existing voluntary disclosure programs. The estimated value of the cryptocurrecy economy at the time of writing this article is in the area of $160 billion. With millions of transactions and the meteoric rise of Bitcoin in just a few years, the IRS is gearing up.
Cryptocurrency taxation in the US:
- For federal tax purposes, cryptocurrency is treated as property and not as currency. Hence all the same rules as selling an asset and capital gains apply to any gains or losses from the sale of cryptocurrency, such as Bitcoin.
- A taxpayer who receives cryptocurrency as payment for goods or services must, in computing gross income, include the Fair Market Value (FMV) of the cryptocurrency in U.S. dollars, as of the date it was received.
- When a taxpayer "mines" cryptocurrency, the FMV of the cryptocurrency as of the date of receipt, is includable in his gross income.
- Generally, self-employment income includes all gross income derived by an individual from any trade or business carried on by the individual as other than an employee. Consequently, the FMV of cryptocurrency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax.
- If payments of $600 or more were made using cryptocurrency to an independent U.S. contractor for services preformed, the payment needs to be reported to the IRS on Form 1099-MISC.
- Third Party Settlement Organizations (TPSO) are required to aggregate payments made with cryptocurrency together with real currency if the number of transactions settled exceeds $200, and the gross amount of payments made exceeds $20,000. When determining whether the transactions are reportable, the value of the cryptocurrency is their FMV in U.S. dollars, on the date of payment.
- Payments made using cryptocurrency are subject to backup withholding to the same extent as other payments made in property.
- In the past, taxpayers used IRC Section 1031 as a means to defer taxation when they exchanged one cryptocurrency for another. The GOP tax bill that was passed in December 2017, eliminates this possibility. The new law amends IRC Section 1031 (a)(1) to delete “property” and replaces it with “real property”, this means that the “in kind” exemption will no longer apply to exchanges of cryptocurrencies and any exchange would be subject to tax at the time of the exchange. This change has gone into effect as of January 1, 2018.
- Taxpayers may be subject to penalties for failure to comply with tax laws, such as accuracy-related penalties under IRC Section 6662. In addition, failure to timely or correctly report cryptocurrency transactions when required to do so may be subject to information reporting penalties under IRC Sections 6721 and 6722. However, penalty relief may be available to taxpayers and persons required to file an information return who are able to establish that the underpayment or failure to properly file information returns is due to reasonable cause.
At the moment, the United States Treasury’s Financial Crimes Enforcement Network (FinCEN), does not expect cryptocurrency to be reported as part of the FBAR reporting. “Right now, we have not put out any guidance on reportability of bitcoin or any other virtual currency as part of FBAR. That being said, we do not expect it to be reported,” Jeremy Kuester, deputy associate director for policy at FinCEN, said at the American Institute of CPAs' National Tax Conference on November 7th, in Washington. “As the regulations are currently written, a virtual currency wallet would not fall under our definition of an account.”
Kuester added that FinCEN may still consider putting out official guidance since it is still continuing to monitor the evolving situation.
Cryptocurrency taxation in Israel:
On January 11, 2017, the Israel Tax Authority (ITA) posted draft regulations relating to the taxation of cryptocurrency. The main points are as follows:
The definition of "asset" in the Income Tax Ordinance (New Version) 5721–1961 (hereinafter: the “Ordinance”) includes tangible and intangible assets. Cryptocurrency meets the fundamental definition of an "asset" as per the Ordinance.
A sale of cryptocurrency will be taxed as a sale of an "asset" and the gain will be classified as capital income and taxed accordingly to the rates for capital gains as set forth in the Ordinance. Consequently, the seller of cryptocurrency is required, within 30 days from the date of the sale, to submit to the ITA, Form 1399 that includes the calculation of profit/loss resulting from the sale, the tax calculation and an advanced payment on the tax. In addition, the seller will need to attach documentation proving that the income was derived from a sale of cryptocurrency as requested by the Assessing Officer of the ITA dealing with his file.
A taxpayer, whose income from selling cryptocurrency is classified as a business, will be subject to the tax rates under clause 121 or 126 of the Ordinance since his income will be defined as business income. It is important to clarify that the revenue of a person that is engaged in marketing and selling cryptocurrency will be classified as profit and not capital gain.
When a taxpayer "mines" cryptocurrency, they are usually paid a fee in newly created coins. The mining activity can be a sign of the existence of a business, thus classifying the income as profit. On the other hand, if the taxpayer makes an additional profit through a purchase of cryptocurrency (not through mining) the classification will be determined separately either as profit or as capital gain.
In transactions in which an asset is sold or a service is provided and the payment is in the form of cryptocurrency, the ITA will consider this as a barter transaction and the cryptocurrency that was received as payment for the assets/service on the day of the transaction will be treated as income.
The payment value will be determined in accordance with the FMV of the cryptocurrency in NIS. The FMV will be based on the internet site that was used to purchase the cryptocurrency for the barter transaction or other similar sites. However, if the purchased asset/service has a fixed or quoted market price, the value of the cryptocurrency will be according to the market price of the purchase. All transactions paid via cryptocurrency are subject to withholding tax as applicable and according to the withholding tax regulations.
Value Added Taxes (VAT):
Cryptocurrency is considered an intangible asset and is therefore defined as "goods" per the Value Added Tax Law 5735- 1975 ("the VAT Law") in every aspect (transaction price, billing date, tax rates, etc.). If one carried out a transaction in cryptocurrency, and the transaction had a commercial nature, he will be required to report it in accordance with the VAT regulations. The use of cryptocurrency as payment for a service/asset is defined as a barter transaction. Consequently, the value of the transaction will be determined for VAT purposes via the VAT Law.
Since technology changed the way we think about money, the IRS and the ITA will most likely start making the reporting of cryptocurrency a compliance priority in an aim to prevent money laundering and tax evasion. We suggest that you stay ahead of the game by establishing a record-keeping system and keeping track of when you acquire and when you dispose of the cryptocurrency, so that you are ready for whatever might lie ahead.
Dave Wolf, a U.S. and Israeli tax attorney, is a partner at Dave Wolf & Co. Law Firm, a law firm specializing in taxation and wealth management and can be reached at 02-626-2595. Mirit Hoffman (Reif), an Israeli tax attorney, is Of Counsel to the firm and can be reached at 052-240-7999.
The content of this article is intended to provide a general guide to the subject matter and is not a substitute for legal consultation. Specific legal advice should be sought in accordance with the particular circumstances.