Last Updated: August 25, 2020
This article was originally published on Forbes by Shehan Chandrasekera on December 23, 2019
In this post (part 2 of 6), we will take a deep dive into what’s covered under the “receive” category of the crypto question on Schedule 1 and outline taxable and non-taxable transaction. Note that not all cryptocurrency receipts are taxable. Nevertheless, both taxable and non-taxable receipts would require you to check “yes” on crypto question on Schedule 1. For those of you who are still wondering why you have to answer the “crypto question” when you file for taxes, check out why the IRS included it here (part 1 of 6).
Taxable Receipts Of Cryptocurrencies
- Receipt of cryptocurreny as compensation - If you work as an employee or a contractor and get paid in cryptocurrencies, that amount will be taxed as ordinary income on your tax return. You must report this income whether you receive a W-2/1099-Misc or not. Getting paid in crypto is a common occurrence in the tech industry. However, some employers may not know about proper tax filing obligations related to crypto so they may not issue a W-2 not 1099-Misc. However, as the recipient of compensation, it is your responsibility to report ordinary income equivalent to the fair market value (FMV) of crypto at the time you receive it. Further, it is best practice to liquidate some of your crypto into USD to cover federal and state income taxes.
- Receipt of mining income (hobbyist miner) - Imagine a situation where you have several mining machines at your home mining for some type of cryptocurrency. You have a full-time job and do not spend a significant amount of time on the mining operation nor it is your main source of revenue. The above fact pattern implies that you have a hobby rather than a business activity. Whether you have a hobby or a business is based on facts & circumstances of each case and the IRS does not provide any bright line rules. However, you can generally consider these 9 factors in making a determination. If you conduct a mining operation as a hobby, you have to included in gross income FMV of the coins you mined. Unfortunately, you will not be able to write off any hobby related expenses effective Jan 1, 2019. This means that you will not be able to deduct equipment expenses, utilities, etc. on your tax return.
- Receipt of mining income conducted as a trade or business - If your mining operation rises to the level of trade or business as opposed to a hobby, you are eligible deduct business related expenses which are not allowed for hobbies. Assume you have a mining operation, structured as a LLC, carried out at a dedicated warehouse with some staff on board to manage day-today activity. This fact pattern implies that you have a trade or business as opposed to a hobby. In this case, you have to recognize ordinary income equivalent to the FMV of the cryptocurrencies mined. You are also eligible to deduct mining related expenses such as equipment cost, utilities, rent, internet fees, etc which will reduce your taxable income. Income and expenses would be reported on Schedule C, Form 1065, Form 1120 or Form 1120S depending on the underlying tax/business structure.
- Receipt of staking rewards - There is no clear guidance on how or whether staking rewards should be taxed. Nonetheless, staking rewards closely resemble interest income. Going with this logic, it would be taxed as interest income on Schedule B. The amount to be reported is the annual aggregated FMV of rewards at the time you receive it.
- Receipt on interest income arising from decentralized platforms - As a result of platforms in the Decentralized Finance (DeFi) space, now you can collateralize your appreciated crypto positions to generate interest income. This interest income will be credited to your wallet in a form of a cryptocurrency or a stable coin. For example, if you own Dai stable coin, you can deposit them into a Dai Savings Rate (DSR) account to earn interest. Such events will qualify under the “receipt” category of the crypto question and taxed as interest income on Schedule B.
- Receipt of coins pursuant to a hard fork - According to the IRS Rev. Rul. 2019-24, “a hard fork occurs when a cryptocurrency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger”. For those of you who are new to crypto, this may be a somewhat confusing concept to grasp. In simple terms, this is a situation where you hold, for example, 100 units of cryptocurrency A on blockchain X. You paid $1,000 for this. Due to a hard fork, now you receive 100 units of cryptocurrency B (in addition to the 100 Units of cryptocurrency A) on blockchain Y absolutely free. If there is a market value for this 100 units of cryptocurrency B at the time you receive them and you have total control over the new currency, you have to recognize ordinary income equivalent to the FMV of cryptocurrency A. This amount would go on Line 21 of Schedule 1.
- Receipt of coins through an airdrop - Cryptocurrency startups often use airdrops to promote their project and create buzz around social media. Although there is no direct guidance on how to tax these airdropped coins, it is reasonable to think that they are taxed as ordinary income at the time of the receipt. Also note that although Rev. Rul. 2019-24 talks about “airdrops pursuant to a hard fork” and this revenue ruling was not intended to address marketing airdrops.
- Receipt of crypto rewards when you shop - Crypto space is continuously evolving. Now, there are websites and platforms that offer bitcoins as a reward when you shop. These work like cash back programs but the only difference is you get cryptocurrencies instead of cash. This is a new development in the space and the IRS has not clarified related tax implications. However, the most conservative approach is to pay ordinary income taxes at the time you receive these shopping rewards in cryptocurrencies. These would most likely go on other income line on Schedule 1.
Non-Taxable Receipts Of Cryptocurrencies
- Receipt of cryptocurrencies after you purchase them from an exchange, ATM, dealer or other source - You just bought your first bitcoin using USD or your local currency. Luckily, this is not a taxable event. Keep good records of the basis (the amount you paid for it) because that will have the biggest impact on taxes when you sell your bitcoin.
- Receipt of cryptocurrencies after a Coin Swap or Coin migration - Coinswaps closely resemble stock splits. These events are generally non-taxable.
- Receipt of coins as a gift - Mere receipt of a crypto as a gift does not create a taxable event. The basis of the gift you receive depends on whether you have a gain or loss at the time you sell it. Therefore, when you receive a gift, what is extremely important is to keep good records of 2 items: Donor’s basis and FMV of the cryptocurrency at the time you receive it. (A31)
- Receipt of crypto from an exchange/wallet you control to another exchange/wallet you control (Transfers) - This is another common situation where you will fall under the “receipt” category of the crypto question. However, these are transfers and have no tax impact per A35
Overall, this is a comprehensive list of transactions that will fall under the “receipt” category of crypto question on Schedule 1. Some of these transactions may not have any immediate tax impact. But one thing to note is that both taxable and non-taxable transactions mentioned above would require you to check “yes” on crypto question on Schedule 1. The next post will analyze what’s included in the “sell” category of the crypto question.
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Disclaimer: this post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.