Cryptocurrency: Common Requirements for Business Income
Maintaining precise and complete tax records has become increasingly important when a taxpayer makes investments in virtual, digital or crypto-currencies such as bitcoin and ethereum.
When employers pay wages using cryptocurrency, employers should report the wages on employees’ W-2, Wage and Tax Statement.
When a taxpayer mines and receives the currency, the taxpayer is deemed to receive income equivalent to the fair market value of the currency in U.S. dollars. Deductions are allowed for expenses associated with mining if the taxpayer mines cryptocurrency as a business, such as depreciation on computer, internet, or electricity. However, an individual taxpayer will also trigger self-employment tax on the income if the individual taxpayer engages in the mining activity as part of his/her regular trade or business. Therefore, it is essential to maintain all records of gross receipts and pay special attention to the dates that the taxpayer receives payment in cryptocurrency to ensure proper reporting of gross income and self-employment taxes.
An individual taxpayer should use Form 8949, Sales and Other Dispositions of Capital Assets, to report most sales and capital transactions and to calculate capital gain or loss associated with cryptocurrency. These capital gains and deductible capital losses are then summarized on Schedule D, Capital Gains and Losses.
A taxpayer may need to file Form 1099-MISC when he/she makes payments such as rent paid to a U.S. recipient, salaries and wages paid to U.S. employees (report on Form W-2, Wage and Tax Statement) using cryptocurrency. Form 1099-NEC, Nonemployee Compensation may also need to be filed when a taxpayer makes payments to independent contractors for performing services. Furthermore, when a taxpayer settles payments for vendors that accept cryptocurrency as a form of payment, Form 1099-K, Payment Card and Third-Party Network Transactions may also need to be filed.
Record keeping period:
The storage period varies depending on the type and conditions of the record, but please keep the tax return and the documents required for the tax return for at least 3 years from the date of filing the tax return. The following is a guideline for the storage period for federal taxation for different types and conditions. For the sate of California, the statute of limitation for income tax is 4 years, so please use the guidelines below plus one year as a rule of thumb.
1. Keep records for 3 years if situations (4), (5), and (6) below do not apply to you.
2. Keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return.
3. Keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction.
4. Keep records for 6 years if you do not report income that you should report, and it is more than 25% of the gross income shown on your return.
5. Keep records indefinitely if you do not file a return.
6. Keep records indefinitely if you file a fraudulent return.
7. Keep employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.
Record keeping method:
According to the IRS, an electronic storage system helps store and reproduce records by saving images of hardcopy records or transferring records to an electronic storage medium. The IRS has published guides to ensure the proper functioning, quality and governing controls of the system. With the existence of the system, although the taxpayer may discard paper records, it is still best practice to keep original books and records to avoid potential penalties.