According to one source, over 6,300 businesses accepted Bitcoin as payment in 2023, which was triple the number in 2022. The writing is on the wall: acceptance of digital currency as a payment method is growing. What does this mean for your business from a tax perspective?
The basics
The IRS saysthat digital assets—cryptocurrency, stablecoins, and non-fungible tokens (NTFs)—are property and not currency. This is so, even though some foreign countries accept it as legal tender. And the label—virtual currency, cryptocurrency, bitcoin—does not affect the tax treatment.
Because digital assets are treated by the IRS as property, the rules for property transactions come into play. The following information is based on IRS FAQs on virtual currency.
Note: Don’t confuse tax rules for digital assets with accounting rules. Under Generally Accepted Accounting Principles (GAAP), digital assets are treated as intangible assets; they are recorded on balance sheets at cost.
Paying for goods and services in digital assets
If you pay for goods or services using digital assets that you’re holding, you need to figure gain or loss on the transaction. The important thing is to recognize that the payment is determined by the value of the digital asset at the time of payment, based on U.S. dollars. This, then, becomes the amount deductible for the goods or services you’ve purchased to the extent otherwise allowed.
If you pay independent contractors $600 or more in the year using digital assets, it must still be reported to them—and to the IRS—on Form 1099-NEC. Again, figure the value of the payments using the fair market value of the digital assets on the date of payment in U.S. dollars.
Small Business Deals
Receiving payment in digital assets
If you receive payment for the sale of goods or services in the course of your business, you must recognize ordinary income. Here’s an example adapted from the instructions to Form 8949:
A self-employed attorney who performs legal services for a client receives one unit of a digital asset with a fair market value of $10,000. The attorney must report $10,000 as self-employment income for income tax purposes; it’s also treated as self-employment income for self-employment tax purposes.
Assume the attorney holds onto the unit for a while and when the value increases to $12,000, the attorney sells it. The attorney must report a gain of $2,000 (the difference between the basis—what was already reported as income—and what was received). Gain or loss is short-term or long-term, depending on how long the attorney held onto the unit before the sale.
The tax treatment applies even for minimal payments for microtasks (e.g., downloading an app and leaving a positive review).
Reporting requirements. Businesses that receive cash payments over $10,000 must report them on Form 8300, and digital assets are “cash” for this purpose. However, the IRS saidreporting is not required on this form for digital assets until regulations are issued.
Using digital assets in payroll
If wages are paid in digital assets, taxable compensation is figured on the fair market value of the digital assets on the date of payment. This is the same amount reported on employees’ Forms W-2.
The fact that wages and salaries are paid in digital assets does not change employment tax rules. Income tax withholding, as well as withholding for the employees’ share of FICA, must still be done. If there are cash wages along with payments in digital currency, then withholding can be taken from the cash portion of compensation. If not, decide how to handle withholding. Regulations say: “Ifwagesare paid in property other than money, theemployershould make necessary arrangements to insure that the amount of the tax required to be withheld is available for payment in money,” but the regulations don’t say how to do this.
Donating digital assets
Again, property rules come into play. Donating digital assets to a charity does not require any recognition of income, gain, or loss on the transaction. If the digital assets were held more than one year, the deduction for the donation is the fair market value at the time of the donation. If held one year or less, the deduction for the donation is the lesser of the basis in the assets or the fair market value at the time of the donation.
The usual substantiation rules for donations apply in order to claim a tax deduction. If digital assets are valued at $5,000 or more, you need a qualified appraisal. The IRS says that the value on a digital currency exchange is not good enough; a qualified appraisal is required.
Conclusion
What all of these tax rules suggest is the need to keep great records on when digital assets are acquired or sold. If you use QuickBooks Online, you can set up an asset accountto track digital assets. Work with your CPA or other tax adviser to be sure you’re maintaining the necessary information to properly report your digital asset transactions at tax time.
And looking ahead, there’s going to be more information reporting of crypto transactions to taxpayers and the IRS. Brokers will be required to report gross proceeds from the sales of digital assets acquired on or after January 1, 2025, and, in the following year, the additional reporting of adjusted basis and the character of gain or loss. Stay tuned!
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