Cryptocurrency is confusing enough.
"More like CRYPTIC-currency!"
Dad jokes aside, there’s a lot to wrap your head around with cryptocurrency if you’re a small business owner. Beyond “the blockchain”, the accounting, bookkeeping, and tax side of cryptocurrency can be very intimidating. And costly.
Take it from the office assistant who rode the Bitcoin wave, and sold it for a $110,000 profit. They then used what they made to buy other altcoins.
Then they got a tax bill for $50,000.
But this doesn’t have to happen to you. We’ll walk through some of the things you need to know about how cryptocurrency is taxed, and how to record it in your books.
First, let’s define cryptocurrency
Cryptocurrencies are a virtual currency that allows people across countries to do business without adding costs to the transaction by charging a currency conversion fee. The fees you get charged using cryptocurrency are usually less than the 3% charged by a credit card. The currency is essentially a mobile app or computer program that acts like an online wallet. You then use that online wallet to send and receive currency with others with the same wallet.
Cryptocurrency isn’t actually a currency
Don’t let “currency” in the name trip you up: the IRS doesn’t consider cryptocurrencies as a true currency. They consider it “property”.
That means when you acquire any crypto, you need to record it at its value when you received it. And when you sell it, or use it, you record it at its market value at the time you dispose of it. Any difference in the value from when you get it and the value when you sell or use it in a transaction is recorded as a gain or a loss.
How to record cryptocurrency in your ledger
Let’s say a customer pays you 100 Bitcoin on May 1 (which happens to be worth $100) in exchange for training their feral cat. At this point you would have set up an account on your books in the asset section (where you would list things like cash and what you have billed your customers) to hold the value of the currency you were paid.
This is where you would list the 100 Bitcoin, and include $100 worth of sales in your sales account.
On June 1, you see the value of that same 100 Bitcoin is now worth $150, so you sell it for $150. You would reduce the cryptocurrency account in your asset section by the $100, and increase an account in your income statement section to house the $50 gain on the transaction, and increase your cash by $150.
Now let’s say the price of that 100 Bitcoin went down to $75, so you decide to sell it before you lose all your money. You would increase your cash by $75, reduce your cryptocurrency account by $100, and record a $25 loss in a loss account on your income statement accounts. Keep in mind that you can combine gains and losses in the same account and call it “Gain/Loss on Cryptocurrency”.
Here is how you would record all this in your ledger:
|Paid for cat training:
Increase Bitcoin asset account - $100
Increase Sales account - $100
|Price of Bitcoin goes to $150 and you sell it:
Decrease Bitcoin asset account - $100
Increase Gain/Loss on Sale of Bitcoin account - $50
Increase Cash account - $150
|Price of Bitcoin goes to $75 and you sell it:
Decrease Bitcoin asset account - $100
Decrease Gain/Loss on Sale of Bitcoin account - $25
Increase Cash account - $75
Payments to vendors
If you make a payment to someone in virtual currency with a fair market value of at least $600, you’ll need to report these payments to the IRS on form 1099-MISC.
When you’re “mining” cryptocurrencies, you’re creating new value for that currency (the digital equivalent of printing money, without the inflation). When you mine, you’re creating compensation for yourself. Record the currency you mined in the income account, and record any amounts you have spent to mine the currency as an expense on your books.
When you do your taxes, you will record your income and expenses on the tax form Schedule C if you are not incorporated, or on Form 1120 if you have incorporated. If you use the Schedule C, you will pay self-employment taxes.
Cryptocurrencies are considered property and not currency like regular dollars. So trading cryptocurrencies is just like day trading. You record any currency you pick up at its value on the day you get it. When you sell the currency, you will record the sale for the amount of the value of the currency on that date. If you sold it for more than what you bought it, you’ll record a gain. If you sold it for a loss, you record a loss.
On your tax return, you’ll record the gain or loss on the form where capital gains and losses are recorded, and list them as either long or short term gains or losses depending on how long you had the currency.
Frequently asked questions
Do I treat cryptocurrency like other currencies? Like Mexican Pesos or Japanese Yen?
No. The IRS has determined that crypto should be considered property, like stocks. You only need to record changes in value when you sell what you have purchased. You can read the official IRS statement about that here.
Should I accept cryptocurrency as payment?
It really depends. You’ll actually save money due to lower transaction costs, be able to serve customers around the globe who use cryptocurrencies, and the transactions will process faster. However, if you make a mistake with a crypto payment, you can’t reverse the transaction. Also, crypto is fairly new, so people are still hesitant to use it, particularly big companies, since there have been big swings in value. In other words, you’re not going to have people beating a path to your door just because you accept crypto (unless you’re selling to a very particular crowd).
How do I get set up to accept cryptocurrency, and use it to pay people?
There are three steps:
Set up a merchant wallet account. Coinbase has an option to accept cryptocurrencies.
Integrate the option to accept crypto in your point of sale on your website.
Link these transactions with your accounting software.
One benefit of setting up a merchant wallet account is that a large number of the merchants will convert the transaction into cash, saving you the trouble of keeping track of gains and losses. You would have to make sure you are charging the right amount of crypto to convert to the dollars you want to have made on the sale.
What date do I use to determine the value of the cryptocurrency?
There are two dates you need to know: the date you acquire the unit of cryptocurrency, and the date you either use it to pay for things or sell it to someone else.
If I accept cryptocurrency as payment for the items or services I sell, where do I report this income on my taxes?
Are there any that illegal cryptocurrencies?
At the moment, no. Back in December 2017, the Securities and Exchange Commission, which regulates currencies, issued a statement regarding currencies. In the statement, they warned:
brokers, dealers and other market participants that allow for payments in cryptocurrencies, allow customers to purchase cryptocurrencies on margin, or otherwise use cryptocurrencies to facilitate securities transactions should exercise particular caution, including ensuring that their cryptocurrency activities are not undermining their anti-money laundering and know-your-customer obligations. As I have stated previously, these market participants should treat payments and other transactions made in cryptocurrency as if cash were being handed from one party to the other.
In other words, be careful. If you’re dealing with a cryptocurrency you’ve never heard of before, check with your accountant first before accepting it as payment.
Where can I read more about what the IRS has said about cryptocurrency?
The IRS wrote a short guide to show you how they are treating cryptocurrency transactions. You can find it here.