Cryptocurrencies like Bitcoin or Ethereum have gained significant popularity over the past few years and into 2019. Therefore the Internal Revenue Service (IRS) has issued in 2019 cryptocurrency tax guidance and also has started issuing thousands of warning letters to non-compliant cryptocurrency investors.
The IRS is aware that “virtual currency” may be used to pay for goods or services, or held for investment. Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency — i.e., the coin and paper money of the United States — but it does not have legal tender status in any jurisdiction. Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.
How is virtual currency treated for federal tax purposes?
For federal tax purposes, virtual currency is treated as property – not as currency. General tax principles applicable to property transactions apply to transactions using virtual currency.
This means that crypto must be treated like owning other forms of property such as stocks, gold, or real-estate. Just like trading stocks then, you are required to report your capital gains and losses from your cryptocurrency trades on your taxes. Failing to do so is considered tax fraud in the eyes of the IRS.
How Do You Calculate Your Crypt Capital Gains/ Capital Losses?
The first step is to determine the cost basis of the holdings. Essentially, cost basis is the amount of money that was put into purchasing of crypto assets (it includes the purchase price plus all other costs associated with purchasing the cryptocurrency). The second step in determining capital gain or loss is to sub-tract the cost basis from the sale price. Sale price is often refer red to as the Fair Market Value.
We can summarize the calculation of capital gain/loss with the following formula:
Fair Market Value – [(Purchase Price of Crypto + Other fees) / Quantity of Holding] = Capital gain/loss
The federal tax rate that will be applied to the gain will depend on the holding period of the assets: the preferred long-term capital gain rate will be available for assets held for more than a year.
It is also important to add that capital gains and losses on the sales of virtual currency will be taxable in most states where the individual is a resident.
Form 5471 Reporting
U.S. citizens and U.S. residents who are officers, directors, or shareholders in certain foreign corporations are responsible for Form 5471 filing, an information return of U.S. Persons with respect to Certain Foreign Corporations.
Who must file the Form 5471?
Generally, all U.S. persons described in the following situations must complete Form 5471:
- U.S. person who owns 10% or more of a CFC (“controlled foreign corporation,” a foreign corporation with more than 50% U.S. owners),
- U.S. person who owns 10% or more of a SFC (“specified foreign corporation,” either a CFC or a foreign corporation with corporate domestic shareholders),
- U.S. person who acquires or disposes of stock in a foreign corporation that will put their ownership percentage above or below 10%,
- U.S. person who is an officer or director of a foreign corporation where more than 10% of the foreign corporation changes ownership,
- A person who becomes a U.S. person while owning 10% of the foreign corporation.
The rule to determine the ownership is more complicated than it seems like; the filing requirement can be triggered through direct, indirect, or constructive ownership. Note that “U.S. person” can refer to individuals, corporations, partnerships, estates, or trusts.
When do you need to file?
Form 5471 is filed with your income tax return by the due date (including extensions).
What are the penalties if you failed to file on time?
There is a penalty of $10,000 for failing to file Form 5471, with an additional penalty of up to $50,000 for continued failure to file. These penalties are assessed for each Form 5471 that needs to be filed. Failure to file Form 5471 will also result in a reduction of the foreign tax credit.
What is the tax impact of Form 5471?
The Tax Cut and Jobs Act (TCJA) enacted a one-time “transition tax,” also known as the Section 965 tax, on U.S. shareholders of SFCs. This is a tax on the accumulated earnings and profits of the foreign corporation, to be paid in 2017 (and po-tentially 2018 for fiscal years).
The TCJA also introduced the GILTI tax (“Global Intangible Low-Taxed Income tax”) starting in 2018, to be reported on Form 8992. The GILTI inclusion essentially taxes U.S. shareholders on their share of a CFC’s earnings. Due to the implementation of GILTI, the Internal Revenue Service has substantially revised Form 5471 and added several new schedules.
Form 5472 Reporting
What is Form 5472?
The purpose of Form 5472 is to report all transactions between the corporation filing the tax return (“the reporting corporation”) and all related parties, with a separate Form 5472 for each related party. Common transactions seen on this form include loans between the two companies, management or consulting fees, interest paid, and the purchase or sale of goods. Note that the transactions are from the perspective of the reporting corporation.
Who must file Form 5472?
Form 5472 needs to be filed by a corporation that is 25% foreign-owned – either directly, or indirectly.
When must Form 5472 be filed?
Form 5472 is due at the same time as the corporate tax return.
What is the penalty for not filing?
There is a penalty of $25,000 per form if it’s not filed on time, with an additional penalty of $25,000 per month for continued failure to file after being notified by the IRS. Note that these penalties have substantially increased since 2017.
As the penalties for noncompliance with these forms grow ever steeper, it’s more important than ever to be diligent and thorough when completing these forms. Peace out!
