The Internal Revenue Service (IRS) is not known for providing clear and easy to follow information. Unfortunately, the agency’s recent mailings to those who hold digital currencies provides yet another example of the confusing and misleading information the agency can provide.
What were the mailings?
As discussed in an earlier post, available here, the IRS sent mailings out to thousands of taxpayers who own digital currency. The agency stated the mailings were supposed to provide guidance on tax reporting obligations.
Is digital currency taxable?
Yes. Digital currency, or cryptocurrency, is subject to tax obligations. However, it is not the same as income or other savings accounts. As far as the IRS is concerned, cryptocurrency is a type of property. As with all other forms of property like real-estate and stocks, the IRS expects taxpayers to report any capital gains and losses that result from the sale of the property.
How does the IRS know about cryptocurrency holdings?
Bitcoin and other digital currency companies will issue the cryptocurrency holder a Form 1099-K if the holder makes more than 200 transactions per year and has gross cryptocurrency transactions that exceed $20,000. A copy is also sent to the IRS.
Why is this problematic?
An example provided by Coin Telegraph, a digital currency specific publication, explains why the total transaction report on the 1099-K is misleading. In this example, a taxpayer who purchases $10,000 in cryptocurrency and then sells the digital currency for $9,500. Although the taxpayer would have a capital loss of $500, the 1099-K would state the taxpayer had $19,500 because it lists the total transactions.
The IRS sent out thousands of mailings earlier this year encouraging taxpayers to report their cryptocurrency holdings. The correspondence refers the taxpayer to review information on Form 1099-K. These numbers are not helpful for IRS reporting purposes because, as noted above, taxpayers are generally only expected to report their capital gains or losses. This disparity could lead the IRS to have inappropriate tax obligation expectations and fuel confusion for taxpayers.