What are the tax implications of accepting cryptocurrency as payment for goods or services?
In the eyes of federal tax authorities, cryptocurrency received as revenue in the course of doing business is not considered the same as regular currency. According to the IRS, cryptocurrency is not actually considered legal tender. Rather, it is considered property.
When a business accepts cryptocurrency as payment for goods or services, the fair market value of crypto payments received is considered to be ordinary income subject to income taxes, including self-employment tax. Furthermore, if a business receives and holds cryptocurrency in a digital currency "wallet" and later uses cryptocurrency to pay business expenses, the act of using crypto funds to pay bills creates a taxable event for the business owner.
Do I have to convert cryptocurrency into dollars immediately?
The short answer to this question is "it's a good idea." When a business accepts cryptocurrency as payment for goods and services, the transaction must immediately be recorded as income using the fair market value of the cryptocurrency on the date of receipt. Technically, you are not obligated to exchange or convert the cryptocurrency into U.S. dollars immediately. However, if you do not do so, and the value of the crypto goes up, you could find yourself having to pay both income taxes as well as reporting and having to pay taxes on capital gains when the currency is ultimately converted into dollars or used to pay for business expenses. If the value goes down before you convert it, declaring the loss can be complicated.
Keep in mind that there can be variations in the way different cryptocurrency exchange services value transactions. It is important for business owners to be consistent with the exchange used to reduce the likelihood that the IRS will question your approach.
It is also important to understand that cryptocurrency transactions happen almost immediately and are irreversible. So, if your business takes cryptocurrency payments, the sale is final and cannot be reversed. If your customer pays you too much using cryptocurrency, or if you inadvertently charge them too much and don't realize it until after they have paid, there is not a simple way to provide a refund or to make change. Ultimately, you could make a payment to the customer using cryptocurrency — although doing so might create a taxable event for you and your customer.
What are the tax implications of owning cryptocurrency?
As mentioned above, your business will owe ordinary income taxes on cryptocurrency received based on the fair market value on the date received, regardless of when you choose to exchange the crypto. If you do not immediately convert cryptocurrency you received from your business customers into dollars but wait until a later date to do so (or choose to wait until a later date to use the cryptocurrency received to pay business expenses), you will have to determine whether the cryptocurrency appreciated (went up) — or depreciated (went down) — in value. That's because you will be subject to capital gains taxes on the amount of growth. You will have capital losses if the cryptocurrency decreased in value.
If you owned your cryptocurrency for less than a year before exchanging it or using it for your own payments, you will have to report short-term gains or losses. If the holding period was more than a year, then long-term capital gains tax rules, and lower capital gains tax rates, apply. The good news is that you can deduct cryptocurrency capital losses against other realized capital gains, just as you can for other types of investments.
How do I prepare for tax season when I have cryptocurrency?
Ultimately, the IRS expects all taxpayers to maintain records that sufficiently support the information provided on tax returns. Businesses that accept cryptocurrency are expected to keep accurate and up-to-date records showing the fair market value of cryptocurrency when it is received and when it is exchanged, sold, or used for payment.
Keeping a detailed log of cryptocurrency transactions can help you prepare for tax season. As a best practice, your cryptocurrency log should include the following transaction information for every cryptocurrency wallet your business uses:
- The date you received the cryptocurrency.
- A description of what currency was received.
- The number of units received, sold, or exchanged.
- The U.S. dollar value of the crypto payments at the date and time of receipt.
- Fees paid related to cryptocurrency, including exchange fees, as you may be able to deduct these fees as ordinary and necessary business expenses.
- The fair market value of the cryptocurrency on the date used (in order to calculate your gain) if you used it to pay business expenses rather than exchange it.
- The cost of the transaction for which you were paid, and the goods or services your customers paid for using cryptocurrency.
In addition to your crypto log, you should also retain related statements and receipts to substantiate the log. And, if you pay employees using Bitcoin or another cryptocurrency, you'll need to report the fair market value of the cryptocurrency on the date each payment was made so you can accurately report compensation on W-2 forms at the end of the year.
How do you report crypto revenue and losses to the IRS?
You should report your crypto revenue the same way you report revenue received using traditional currency. For many small business owners, this is done using Schedule C of IRS Form 1040.
If you realized a gain or loss because you received and held cryptocurrency, you'll need to report the transactions on IRS Form 8949 — Sales and Other Dispositions of Capital Assets. You will then summarize your capital gains and any deductible capital losses on Schedule D for Form 1040. If you have crypto capital losses that exceed your capital gains, you can use up to $3,000 of the excess losses to offset your ordinary income. The remainder of your crypto capital losses will be carried forward to the next tax year.
Small business tax rules can be confusing enough without factoring in the challenges that come with accepting cryptocurrency from customers or using cryptocurrency to pay for business expenses. Fortunately, Tax Legal Help is available when you need it. To learn more about how cryptocurrency may impact the tax picture for your small business, reach out to a Rocket Lawyer network attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.