As they continue to gain popularity, cryptocurrencies like Bitcoin and Ethereum are creating new challenges for tax professionals like accountants and bookkeepers. These virtual currencies are making their way into the real world, as they are being accepted for goods and services by more and more businesses, putting them in a gray area between being currency and property.
With cryptocurrencies entering modern society, it’s more important than ever that tax preparers understand the basics of accounting for cryptocurrency. And with the IRS taking a keen interest in cryptocurrency taxation, it’s more important than ever that you’re properly preparing your clients’ Bitcoin and Ethereum tax returns. If not, your clients could face steep penalties from the government, and no one wants that.
Here are the basics of accounting for cryptocurrency that every tax pro needs to know:
- Cryptocurrency is property. In the United States, cryptocurrency is not taxed the same as U.S. currency. Instead, it’s treated as property, just like stocks, bonds, and other securities.
- All cryptocurrency transactions are taxable events. Whether you’re buying, selling, or trading your crypto, all of your gains or losses are taxable. In the case of where you exchange one type of cryptocurrency for another. For example, if you sell Ethereum to purchase Bitcoin, the price you sold your Ethereum for is the cost base for your Bitcoin.
- It’s harder to account for cryptocurrency if your client uses more than one type. Transactions between more than one type of cryptocurrency can be complicated to account for. Whether your client is buying, selling, or transacting between different types, calculating the cost bases, adjusted cost bases, fair market values, and losses and gains can be time-consuming and requires a high level of accounting expertise.
- Your clients’ capital losses or gains are calculated based on the fair market value minus the cost base. To determine the capital losses or gains, you need to calculate the cost base, which is the purchase price of the crypto plus and other fees, all divided by the quantity of the holding. After that, you subtract the cost base from the fair market value to figure out the capital loss or gain.
- The IRS can audit crypto-transactions. Some people in the crypto community think that the IRS won’t audit taxpayers because of cryptocurrency, but that is incorrect. The IRS has started scrutinizing crypto users, and even sent letters to more than 10,000 crypto traders regarding their past returns. The best way to avoid an audit is to correctly calculate your clients’ taxes the first time and report them accurately to the IRS.
- You cannot pay the IRS in cryptocurrency. While the IRS will tax you based on your crypto activity, they won’t accept cryptocurrency payments. So, if your clients have most of the money tied up in crypto, they may want to consider selling some of it to pay their tax bills.
- All cryptocurrency transactions are reported at fair market value in U.S. dollars at the time of the transaction. This means that your clients need to keep track of what they paid for their crypto on the day they acquired it and the day they sold it. If they don’t, you won’t be able to reconcile their accounts, and their tax returns will be inaccurate.
- There is a difference between trading cryptocurrency as a hobby or as a business. If you mine cryptocurrency as a hobby, you include the value of any coins earned as other income on Form 1040. If you are mining as a business entity, you report your income on Schedule C.
- Cryptocurrencies vary wildly across different countries. In some places, using cryptocurrency is illegal. In other countries, there are steep regulations. And in yet other countries, the rules regarding cryptocurrencies are lax. If your clients are using cryptocurrency for international transactions, make sure to familiarize yourself with the regulations in the countries your clients are conducting business.
- Cryptocurrencies can be used for illegal activities. Since its inception, cryptocurrencies have been used for illegal activities because of both their anonymity and because they aren’t regulated by banks or the government. Tax evasion, money laundering, and other illegal practices have been paid for with cryptocurrency. Because of this, you need to protect yourself and your clients by keeping bookkeeping records that are beyond reproach.
As cryptocurrency becomes more common, it’s vital that bookkeepers and accountants arm themselves with the most up-to-date tax knowledge available. By doing this, you can protect your clients’ best interests as well as your professional reputation in the financial community.