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Understanding Taxation on Virtual Currency Transactions

November 13, 200

In recent years, cryptocurrency has become more popular for sending and receiving payments, and now the Internal Revenue Service (IRS) is increasing enforcement, monitoring and audits of these virtual currency transactions.


Defined by the IRS as ‘a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the United States dollar or a foreign currency,’ virtual currency is digital or virtual money that is not issued or controlled by a traditional bank. Bitcoin, Litecoin and XRP are among some of the more well-known cryptocurrencies serving as an alternative to traditional currency.


Here are a few things you need to know:

• For tax purposes, cryptocurrency is treated as property and not currency. Taxpayers who sell or exchange virtual currency must recognize their capital gain or loss on a transaction, similar to stocks or bonds. Additionally, there’s short-term and long-term capital gain or loss depending on how long you hold onto the virtual currency, which is also subject to specific tax rules.


• Taxpayers who receive their income as virtual currency in exchange for performing services must recognize this compensation as income, and employers who pay wages with cryptocurrencies must report the U.S. dollar value on W-2 and 1099 forms.


• Beginning in 2021, individuals must answer whether they received, sold, sent, acquired or exchanged virtual currency in 2020 on the front page of the Form 1040.


• The IRS recently issued more guidance on the taxation of virtual currency on its website. Check out the Frequently Asked Questions page on Virtual Currency Transactions for additional information.


The IRS is also getting more serious about unreported and underreported income and other tax compliance issues resulting from cryptocurrency transactions and has set up teams of agents to work on cryptocurrency-related audits.


In 2019, the IRS sent letters to 10,000 digital currency holders who may have failed to pay the necessary taxes or improperly reported taxes on their digital assets. A second round of letters was distributed this year in August.


Contact Anthony Hoffmaster, CPA, CES, MST, by phone 919-435-4413 or email.

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