Can I Be Audited Based on Virtual Currency Transactions?

 Posted on November 23, 2020 in Tax Audits

The IRS pays close attention to taxpayers’ income and financial transactions, and there are a variety of reasons it may conduct tax audits. In recent years, virtual currencies such as Bitcoin have been a growing concern for the IRS, and many cryptocurrency owners have received notices regarding their requirements for reporting transactions involving these currencies. This scrutiny is likely to increase in the future as the use of virtual currencies becomes more widespread. In fact, the IRS released a draft of the 1040 tax form for 2020, and one of the first questions that is included on this form is “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” This indicates that those who own or trade cryptocurrency may face audits if they do not meet their requirements for reporting transactions and paying applicable taxes.

Tax Issues Related to Virtual Currency

Even though cryptocurrencies may be used similarly to currency issued by the United States or other countries, they are not recognized as legal tender. Instead, virtual currencies are considered property, and taxes may apply to transactions involving these currencies. If a person receives virtual currency in exchange for performing services, either as an employee or an independent contractor, this will be considered taxable income.

When virtual currency is sold or exchanged for other property, a taxpayer will be required to report gains or losses on a federal income tax return. These gains or losses are calculated by comparing the taxpayer’s basis in the virtual currency, or the fair market value of the currency at the time it was acquired, with the amount received in exchange for the virtual currency. Capital gains taxes may apply to gains made when selling virtual currency, and a taxpayer may be able to deduct losses in these transactions.

The IRS has also noted that some types of transactions are unique to cryptocurrencies. A “hard fork” may occur when there is a protocol change that results in the creation of a new cryptocurrency in addition to the cryptocurrency that exists on a distributed ledger. A hard fork may be followed by an “airdrop” in which new cryptocurrency units are distributed to owners of existing cryptocurrency. While a hard fork will not always have tax consequences, any new cryptocurrency received through an airdrop will be considered taxable income equal to the fair market value of the cryptocurrency at the time it is received.

Contact Our San Jose, CA Tax Audit Attorney

If you currently own virtual currency, or if you have bought, sold, earned, or exchanged cryptocurrency, you should be sure to understand how your taxes will be affected. If you are facing an audit related to virtual currency transactions, John D. Teter Law Offices can help you determine how to proceed. We will work with you to make sure you meet all of the IRS’s requirements and help you avoid or minimize tax penalties. Contact our San Jose tax compliance lawyer by calling 408-866-1810.

Sources:

https://www.irs.gov/pub/irs-drop/n-14-21.pdf

https://www.irs.gov/pub/irs-drop/rr-19-24.pdf

https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions

https://news.bitcoin.com/irs-prioritizes-cryptocurrency-first-question-on-1040-tax-form/