Many people have been making money on Bitcoin and other cryptocurrencies. This includes buying, selling, and trading digital currency, as well as mining Bitcoins. However, any income made from dealing in Bitcoins is not immune from taxation in the U.S. The IRS has sent letters to more than 10,000 taxpayers, warning them about tax violations. 

Do Bitcoin Earnings Qualify as Income?

The position of the Internal Revenue Service (IRS) is that gross income means “all income from whatever source derived.” The IRS has issued guidance on the tax treatment of virtual currency transactions, including Bitcoin, in Notice 2014-21. The IRS position is that virtual currency is property and the sale or exchange of virtual currency has tax consequences that may result in tax liability. 

The basis of virtual currency is generally the fair market value of the virtual currency as of the date of receipt. If the fair market value at the time of exchange is greater than the taxpayer's adjusted basis, the taxpayer has realized a taxable gain. Similarly, loss of fair market value at the time of exchange would be a loss. 

Taxpayers may be subject to penalties for failure to comply with IRS tax laws, including subjecting taxpayers to penalties for underpayment and reporting penalties. 

Bitcoin and Virtual Currency Notices 

The thousands of taxpayers may have been unaware that they need to report gains and losses involving Bitcoin and virtual currency trades and exchanges. The letters are intended to notify taxpayers of the tax and filing obligations involving virtual currency and correcting past errors. 

According to the IRS news release: 

"Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest, and penalties," said IRS Commissioner Chuck Rettig. "The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations."

According to the IRS, taxpayers who do not report the income tax consequences of virtual currency transactions may be liable for tax, penalties, and interest. Taxpayers could also face possible criminal prosecution.

How Did the IRS Find Out About Bitcoin Transactions?

The Bitcoin and cryptocurrency transaction information generally comes from digital currency exchanges, like Coinbase. Federal court orders have required reports and records for digital transactions. According to an article in The Wall Street Journal, “Coinbase turned over data on customers who bought, sold, sent or received digital currency worth $20,000 or more between 2013 and 2015.”

The information provided to the IRS includes the customer's name, taxpayer identification number, birth date, address, and account statements.

Questions About Cryptocurrency and Taxation in Maryland 

For taxpayers who did not receive a letter from the IRS and may have had taxable gains involving cryptocurrency transaction, they may be eligible to voluntarily disclose their virtual currency transactions in exchange for reduced penalties. 

If you received a letter from the IRS about Bitcoins or cryptocurrency transactions, contact Gabaie & Associates, LLC  for a free consultation. If you did not report Bitcoin transactions or have questions about whether your virtual currency transactions are taxable events, you may be facing assessments and penalties. Contact Juda Gabaie online or call (410) 862-2198 for help with your IRS or Maryland tax issues.