How do I report Bitcoin income?

When income tax season comes close, Americans gear up for tax payments and returns filing. It is also the time to start the work for maintaining fresh records for the next financial year. Amid all the developments, participants who have dealt in cryptocurrencies like bitcoins are a worried lot.

In 2017, the Internal Revenue Service (IRS) ordered the Coinbase cryptocurrency exchange to hand over all the necessary data related to the transactions made by more than 14,000 of its customers who bought, sold, received, or sent more than $20,000 worth of bitcoins (BTC) between 2013 and 2015. Those who suspected then that Uncle Sam was prepared to scrutinize and levy the necessary taxes, and penalties, on bitcoin dealings, were correct. On July 26, 2019, the federal body said it will send educational letters to 10,000 taxpayers it suspects "potentially failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly."

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"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 in a press release. "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."

Though these developments may have come as a surprise to some proponents of the cryptocurrency, it is important to realize that taxes are imminent, irrespective of the nature of dealings and the asset classes.

Let’s look at a few important pointers that will help in preparing tax returns for filers who bought or sold cryptocurrencies.

Bitcoin Record-Keeping Is Your Responsibility

There are hundreds of brokers, intermediaries, and exchanges that offer cryptocurrency trading. However, none are obligated to provide tax reports to market participants though a few may do so at their own discretion. For instance, Coinbase does provide a "cost basis for taxes" report.

In the end, the individual is responsible for maintaining the necessary records related to their cryptocurrency dealings.

Say, six months back you bought 10 bitcoins at the rate of $3,000 each or may have received them as a payment for work you did for a client. Today, those bitcoins may be worth $9,000 each, putting your potential profit at $6,000 per coin.

It is your responsibility to have the necessary records showing that you received them at the time when they were worth $3,000, and hence your net income is $6,000 per coin. Failing to maintain such transaction data and documents may lead to your holdings being assessed at today’s value of $9,000 each, significantly increasing your tax burden.

Any dealing in bitcoins may be subject to tax. Say, you received five bitcoins five years ago, and spent one at a coffee shop four years back, spent another two for buying goods at an online portal three years back, and sold the remaining two and got the equivalent dollar amount one month back. For each such transaction on the various dates, you are expected to maintain the dollar equivalent value for each and compute your net dollar income from bitcoins. Your tax liability will be computed accordingly.