What does a De Minimis Exemption mean for crypto?

De Minimis rule? It’s a real mouthful, right? Regardless if you can say it or not as a cryptocurrency owner, this is something that you need to know. Especially since it can have a real impact on how you use your crypto in your personal business transactions.

So, what is the De Minimus exemption rule? Since it is tax season, you guessed it.  This has something to do with taxes. The rule refers to how you should be reporting capital gains from Bitcoin and other cryptocurrencies on tax returns in the U.S.  De Minimus is a Latin expression, which means, “about minimal things.” So the De Minimus exemption will provide a guideline on the minimum threshold under which a crypto user would be exempt from paying taxes on capital gains realized from their crypto transactions.

Before we delve into more detail, let’s backtrack just a little bit. After all, to understand the changes we first need to know how are we currently taxing our cryptocurrency now.

Spend Your Crypto Wisely

So you’ve accumulated some Bitcoin, and now you would like to spend your hard-earned crypto to buy a cup of coffee or to do some online shopping.  Well, not so fast, before you make that purchase, there are some things you need to consider.  

If you pay taxes to the Internal Revenue Service (IRS) in the United States, then every time you use your cryptocurrency in a transaction, there are tax consequences. Even if it’s just for something minor, like buying a cup of coffee. 

Report Your Taxes

You see, the IRS considers crypto to be property, not currency.  This means when you crypto it to pay for something, you aren’t really paying for anything. Rather, you are disposing of some property.  This means that you must now report it on your income tax return as either a capital gain or loss.

As the IRS states in Notice 2014-21, “For federal tax purposes, virtual currency is treated as property.  General tax principles applicable to property transactions apply to transactions using virtual currency.  A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.”  

Furthermore, when a transaction has occurred, Notice 2014-21 states, “Transactions using virtual currency must be reported in U.S. dollars.  Taxpayers are required to determine the fair market value of the virtual currency in U.S. dollars”. This value is “determined as of the date of payment or receipt.”  

Keep Accurate Records

Put simply, what this means is that every time you use your crypto to purchase goods and services, you must know what your crypto is worth. You will need to know the worth of your crypto both at the time that you acquired it and at the time that you spend it.  With the wild price fluctuations seen in cryptocurrencies, this can be a lot to keep track of. Remember, since you need to report all gains in U.S. dollars, you must also keep track of the exchange rate.

Another thing you must know is how long you’ve held your crypto until you’ve disposed of it through selling, trading, giving away, etc.  You will need to apply a different tax rate depending on whether you’ve held your crypto for a short term or a long term period. A short term period applies to crypto held for less than a year. If you are able to classify your gains as a short term period you will be paying taxes on your gains as ordinary income according to your tax bracket.  If you’ve held it longer than a year, you will have to consider your earnings as a long term gain. This means you will be paying taxes of between 15 to 20 percent. For current taxation rates, please consult the IRA website.

The Bottom Line

The bottom line is you must establish a record-keeping system to track all of your bitcoin and other crypto transactions.  Detailed records are a must if you want to accurately report the income from all your transactions using crypto.  

So taken altogether, it sounds like an accounting nightmare, right?  Especially if you are using your crypto frequently for small transactions.  Or if you are trading on multiple exchanges or own a number of crypto wallets.  Which could explain this interesting finding? 

The IRS is After You

By one estimate, approximately 8% of the adult population in the U.S. own some form of crypto. This means approximately 150 million taxpayers in the U.S. From this number, the IRS would expect to receive about 12 million tax returns reporting some sort of cryptocurrency income.  But, in reality, the actual figure is far, far less than that. One suggestion is that it is only just less than a fraction of one percent.

So maybe you are thinking that compared to other people your taxes aren’t very much. Since your taxes don’t amount to much, why would the IRS be interested in you? After all, they’re only after the big offenders. Well, think again!

Back in July 2019, it was reported that the IRS was in the process of sending letters to 10,000 U.S. digital currency owners. Each of these owners was believed to have potentially failed to pay the necessary taxes or had improperly reported taxes on their digital assets.  IRS Commissioner Chuck Rettig stated, “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. The IRS is expanding our efforts involving virtual currency, including increasing use of data analytics.”  This is a scary realization. Why? Because some taxpayers could be subject to criminal prosecution.  

Compliance is Key

Okay, so this matter is more serious than we initially thought.  The IRS is cracking down on offenders, big and small.  In 2018, Coinbase, the largest U.S. crypto exchange, was forced to comply with a court order to provide the IRS with information on accounts worth at least $20,000.  It is quite possible that the IRS used the information provided by Coinbase to send out those 10,000 letters. So it would seem, then, that the IRS has the ability to gather records on any user at any time to determine their crypto activity.  Coinbase alerts its users that all transactions should be reported. Even if there is no gain or loss, or the gain or loss is immaterial.

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U.S. Congress Proposes a New Tax Bill

As the use of cryptocurrency continues to grow, and transactions involving crypto becomes more mainstream, we can expect that more regulation will be coming down the pipes.  Currently, the amount of tax delinquency continues to be a gray area. As a result, the IRS is looking for ways to enforce more stringent tax compliance. This is especially important in the world of crypto where transactions are anonymous and devoid of any connection to governments or banks.

In light of all this, a leading cryptocurrency advocacy group, Coin Center, has been working with the U.S. Congress on a new tax bill governing the treatment of cryptocurrencies.  With this bill, we believe it will be easier than ever before for crypto holders to use crypto like any other currency. Even for small transactions.

Introducing the Virtual Currency Tax Fairness Act

The Virtual Currency Tax Fairness Act was brought to life on January 16, 2020.  The bill would create an exemption for potential capital gains that would arise from the use of cryptocurrencies in day to day commerce.  Under this bill, an individual would be exempt from paying capital gains tax on a transaction. That is if the amount of the gains is under $200. This exemption is known as the De Minimis exemption.

If passed, the bill could be instituted for the 2020 fiscal year. The bill would cover transactions taking place after December 31, 2019. The Virtual Currency Tax Fairness Act is not something new.  Actually, just back in 2017, the government proposed a similar bill. The 2017 bill would have created a de Minimis exemption for gains under $600. That bill did not move forward.

Opponents of this bill fear that this could result in even greater tax evasion.  Crypto holders would now have a loophole by which they can develop more advanced tax evasion techniques.  This would also add to the administrative burden of the IRS, who would now have to comb through countless transactions, to monitor the activity.  This might also encourage the increased adoption of crypto, which may be something that the government may not want.

What This Means for Bitcoin Users

Well for one thing, if the bill passes, it would put Bitcoin and other cryptos in the same level playing field as foreign currency, which currently has a similar exemption.  This would make it easier for crypto holders to use their crypto for small day to day transactions, without fear of triggering a capital gain or loss that must be reported.  

However, it does not do away with the need to maintain accurate records in order to determine if there is a taxable event.  

Having the exemption, though, might take away the inhibition that some may have of using their crypto to pay for daily small purchases, such as buying a meal at a restaurant.  Making it easier to use might encourage more people to look into adopting crypto as a form of payment. This would benefit businesses looking to widen its target consumer base.  And it would also benefit the crypto holder who would now be able to spend their crypto more easily.

A primary limitation of this exemption might be the potential volatility of the price of Bitcoin and other cryptos.  One must be aware of how a wild price swing could result in a fluctuation above or below the exemption, creating a taxable event.

For miners of Bitcoin, the tax situation is a little more complex.  Any coin received from mining is considered to be ordinary income. The resulting amount is the value of the coin on the date it was mined.  However, when that coin is later exchanged for goods and services, it is to be treated as a disposal of property. This means it may now be subject to capital gains tax. 

A Benefit To Crypto Taxpayers

Having a De Minimis exemption would be a highly favorable outcome for crypto enthusiasts.  It would benefit crypto taxpayers because it would simplify the process of reporting taxes triggered by using cryptocurrencies.  At the same time, it would still allow the IRS to capture revenue from larger crypto transactions. For investors and long term holders of crypto, this rule will likely have minimal effect on their tax reporting. But for those looking to use crypto as a form of currency for small transactions, as is often envisioned for the future, this bill would be greatly beneficial in encouraging wider use and acceptance.

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