If you owe the IRS back taxes, they can revoke or refuse to renew your USA passport.
The Fixing America’s Surface Transportation (FAST) Act of 2015, the IRS is required to notify the State Department of taxpayers the IRS has certified as owing a “seriously delinquent tax debt” (IRC Sec. 7345). In July 2019, the IRS temporarily suspended passport certification procedures for anyone who had a case open with the Taxpayer Advocate Service (TAS).
Since then, the agency has determined that a blanket, systemic exception for anyone with an open TAS case is overly broad and could undermine the effectiveness of the FAST Act to collect a seriously delinquent tax debt. Therefore, the IRS will resume passport revocation procedures for affected taxpayers. According to the IRS, the agency will continue to fairly and impartially oversee the certification process with the State Department to uphold the law while also respecting the rights of all taxpayers.
The U.S. Senate has passed, and President Trump is expected to sign into law, a broad package of reforms aimed at the IRS. Among other things, the Taxpayer First Act contains several new protections for taxpayers, along with provisions intended to improve the IRS’s customer service.
Stronger safeguards against identity theft
Several of the bill’s provisions address tax-related identity theft. For example, the bill generally requires the IRS to notify a taxpayer as soon as practicable when it suspects or confirms an unauthorized use of the individual’s identity. The IRS also must:
Provide the taxpayer instructions on how to file a report with law enforcement on the unauthorized use,
Identify any steps the individual should take to permit law enforcement to access his or her personal information during the investigation,
Provide information regarding the actions the taxpayer can take to protect him- or herself from harm, and
Offer identity protection measures, such as the use of an “identity protection personal identification number” (IP PIN).
The bill also requires the IRS to establish a program within five years that allows all taxpayers to request IP PINs to better secure their identity when filing their tax returns. This protection currently is available only to victims of tax-related identity theft.
The IRS must provide a suspected victim with additional notifications regarding whether it has initiated an investigation into the unauthorized use and whether the investigation has substantiated such unauthorized use. It also must notify the individual of whether any action has been taken against someone relating to the unauthorized use or whether any referral for criminal prosecution has been made.
And the IRS must ensure that victims of tax-related identity theft have a single point of contact at the agency throughout the processing of their cases. That contact must track the taxpayer’s case to completion and coordinate with other IRS employees to resolve the taxpayer’s issues as quickly as possible.
Greater appeals rights
The Taxpayer First Act codifies into law the IRS’s already-existing, independent Office of Appeals. It also expands taxpayers’ rights of appeal regarding tax matters.
For example, under the law, the IRS must provide certain taxpayers who request a conference with the Office of Appeals with access to the non privileged portions of the case file on the disputed issues no later than 10 days before the scheduled conference date. Currently, taxpayers must file a Freedom of Information Act request to gain access to their case files.
The resolution process available through the appeals office generally is available to all taxpayers. If a taxpayer’s request to appeal an IRS notice of deficiency is denied, the IRS must give the taxpayer a written notice with a detailed description of the facts involved, the basis for the denial and a detailed explanation of how the basis applies to the facts. The notice also must describe the procedures for protesting the denial.
Customer service improvements
The bill gives the IRS one year to develop and submit to Congress a comprehensive customer service strategy. The strategy must include a plan to extend assistance to taxpayers that’s secure and designed to meet reasonable taxpayer expectations. The plan must adopt appropriate customer service best practices from the private sector, including online services, telephone callback services and training of customer service employees.
Separately, the bill requires the IRS to supply helpful information to taxpayers who are on hold during a telephone call to any IRS help line. That information includes common tax scams, where and how to report tax scams, and additional advice on how taxpayers can protect themselves from identity theft and tax crimes.
Additional provisions
The Taxpayer First Act tackles many other areas, including:
Structuring. The bill establishes new protections from IRS enforcement abuses of so-called “structuring laws.” Those laws let the agency seize taxpayer assets when a taxpayer appeared to make bank deposits in amounts just under the $10,000 trigger for bank reporting requirements.
Whistleblower reforms. The bill permits the IRS to disclose to a whistleblower tax return information related to the investigation of any taxpayer about whom the whistleblower has provided information (to the extent necessary to obtain information that isn’t otherwise reasonably available). It also mandates certain updates to whistleblowers on investigations and adds anti retaliation provisions.
Electronic filing. The IRS generally must eventually require individuals filing 10 or more returns — down significantly from the current 250-return threshold — to file electronically. The lower threshold will be phased in, falling to 100 returns for 2021 and 10 returns in 2022. Special rules apply to partnerships.
And that’s not all
The far-reaching bill will affect a variety of other areas, such as cybersecurity, innocent spouse relief, private debt collection and misdirected tax refund deposits. We’ll keep you abreast of these and other relevant tax developments.
The IRS has released the depreciation deduction amounts which are pursuant to Internal Revenue Code (IRC) Section 280F. This code section discusses the depreciation deduction limits for passenger automobiles (including trucks and vans) first placed in service during 2019. For passenger autos acquired before 9/28/17 and placed in service during 2019, the depreciation limits are $10,100 for the first year ($14,900 with bonus depreciation), $16,100 for the second year, $9,700 for the third year, and $5,760 for each succeeding year. Typically bonus depreciation is taken by default for tax year 2019.
If a taxpayer is leasing a car, there are also lease inclusion amounts which is really giving the lease expense a haircut. This is discussed in Rev. Proc. 2019-26. Most small business owners use their auto’s for business. However, one needs to be careful in how they deduct the expense and depreciation of the vehicles. There are also additional considerations for luxury autos, and automobiles that weigh over 6,000 lbs., which allow for larger deductions.
Clients often ask us – “is it better to lease or purchase?” The answer is, well, it depends. Here are some quick thoughts.
If you drive a lot of miles, say over 12,000 miles a year, you will typically have to pay more or get a penalty for too many miles under a lease. However, if you like to get a new car often, then a lease might work out. Purchasing a car generally allows a business owner to deduct a large amount in the first year using accelerated depreciation, but one still needs to navigate through the depreciation limitations above. However, depreciation for vehicles above 6,000 gross vehicle weight may allow for more. Now, most of this discussion is regarding passenger auto’s and SUV’s, so if you purchase commercial vans or trucks for your business the depreciation rules and deductions are generally much larger as they are viewed as not being passenger autos.
Anyway, as one can see there are specific rules and considerations for deducting your vehicle. The IRS doesn’t allow for deductions for personal use, and personal use technically can also include commuting to and from work. So, discuss this topic with your tax advisor and make sure you understand your plan, your deductions and your risk.
For passenger autos acquired after 9/27/17 and placed in service during 2019, the depreciation limits are $10,100 for the first year ($18,100 with bonus depreciation), $16,100 for the second year, $9,700 for the third year, and $5,760 for each succeeding year. Also, the IRS has released the lease inclusion amounts for lessees of passenger autos first leased in 2019. Rev. Proc. 2019-26.
Once your 2018 tax return has been successfully filed with the IRS, you may still have some questions. Here are brief answers to three questions that we’re frequently asked at this time of year.
Question #1: What tax records can I throw away now?
At a minimum, keep tax records related to your return for as long as the IRS can audit your return or assess additional taxes. In general, the statute of limitations is three years after you file your return. So you can generally get rid of most records related to tax returns for 2015 and earlier years. (If you filed an extension for your 2015 return, hold on to your records until at least three years from when you filed the extended return.)
However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.
You’ll need to hang on to certain tax-related records longer. For example, keep the actual tax returns indefinitely, so you can prove to the IRS that you filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)
When it comes to retirement accounts, keep records associated with them until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)
Question #2: Where’s my refund?
The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Refund Status” to find out about yours. You’ll need your Social Security number, filing status and the exact refund amount.
Question #3: Can I still collect a refund if I forgot to report something?
In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later. So for a 2018 tax return that you filed on April 15 of 2019, you can generally file an amended return until April 15, 2022.
However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.
The IRS opened the 2018 income tax return filing season on January 28. Even if you typically don’t file until much closer to the April 15 deadline, this year consider filing as soon as you can. Why? You can potentially protect yourself from tax identity theft — and reap other benefits, too.
What is tax identity theft?
In a tax identity theft scheme, a thief uses your personal information to file a fraudulent tax return early in the tax filing season and claim a bogus refund.
You discover the fraud when you file your return and are informed by the IRS that the return has been rejected because one with your Social Security number has already been filed for the same tax year. While you should ultimately be able to prove that your return is the legitimate one, tax identity theft can cause major headaches to straighten out and significantly delay your refund.
Filing early may be your best defense: If you file first, it will be the tax return filed by a would-be thief that will be rejected — not yours.
What if you haven’t received your W-2s and 1099s?
To file your tax return, you must have received all of your W-2s and 1099s. January 31 was the deadline for employers to issue 2018 Form W-2 to employees and, generally, for businesses to issue Form 1099 to recipients of any 2018 interest, dividend or reportable miscellaneous income payments.
If you haven’t received a W-2 or 1099, first contact the entity that should have issued it. If that doesn’t work, you can contact the IRS for help.
What are other benefits of filing early?
Besides protecting yourself from tax identity theft, the most obvious benefit of filing early is that, if you’re getting a refund, you’ll get that refund sooner. The IRS expects more than nine out of ten refunds to be issued within 21 days.
But even if you owe tax, filing early can be beneficial. You still won’t need to pay your tax bill until April 15, but you’ll know sooner how much you owe and can plan accordingly. Keep in mind that some taxpayers who typically have gotten refunds in the past could find themselves owing tax when they file their 2018 return due to tax law changes under the Tax Cuts and Jobs Act (TCJA) and reduced withholding from 2018 paychecks.
Need help?
If you have questions about tax identity theft or would like help filing your 2018 return early, please contact us. While the new Form 1040 essentially does fit on a postcard, many taxpayers will also have to complete multiple schedules along with the form. And the TCJA has changed many tax breaks. We can help you ensure you file an accurate return that takes advantage of all of the breaks available to you.
The IRS has some good news for certain taxpayers — it’s waiving underpayment penalties for those whose 2018 federal income tax withholding and estimated tax payments came in under their actual tax liabilities for the year. The waiver recognizes that the Tax Cuts and Jobs Act’s (TCJA’s) overhaul of the federal income tax regime made it difficult for some taxpayers to determine the proper amount to have withheld from their paychecks or include in their quarterly estimated tax payments for 2018.
The new tax system
Many taxpayers started seeing more money in their paychecks in February 2018, after their employers made adjustments based on the IRS’s updated withholding tables. The revised tables reflected the TCJA’s increase in the standard deduction, suspension of personal exemptions, and changes in tax rates and brackets.
The TCJA roughly doubles the 2017 standard deduction amounts to $12,000 for single filers and $24,000 for joint filers in 2018. It also eliminates personal exemptions, which taxpayers previously could claim for themselves, their spouses and any dependents. In addition, it adjusts the taxable income thresholds and tax rates for the seven income tax brackets.
But, as the IRS cautioned when it released the revised withholding tables, some taxpayers could find themselves hit with larger income tax bills for 2018 than they faced in the past. This is because of some of the changes described above, as well as the reduction or elimination of many popular tax deductions. The tables didn’t account for the reduced availability of itemized deductions (or the suspension of personal exemptions).
For example, taxpayers who itemize can deduct no more than $10,000 for the aggregate of their state and local property taxes and income or sales taxes. Itemizing taxpayers also can deduct mortgage interest only on debt of $750,000 ($1 million for mortgage debt incurred on or before December 15, 2017) and can’t deduct interest on some home equity debt.
The higher standard deduction and expansion of family tax credits may offset the loss of some deductions and the personal exemptions. Indeed, the IRS predicts that most 2018 tax filers will receive refunds.
Taxpayers, however, generally can’t be certain how the numerous TCJA changes will play out for them, putting them at risk of underpayment penalties for 2018. The Government Accountability Office last year estimated that almost 30 million taxpayers will owe money when they file their 2018 personal income tax returns due to under-withholding. Those particularly at risk include taxpayers who itemized in the past but are now taking the standard deduction, two-wage-earner households, employees with non-wage sources of income and taxpayers with complex tax situations.
Underpayment penalties
The tax code imposes a penalty (known as a Section 6654 penalty) if taxpayers don’t pay enough in taxes during the year. The penalty generally doesn’t apply if a person’s tax payments were:
At least 90% of the tax liability for the year, or
At least 100% of the prior year’s tax liability. (The 100% threshold rises to 110% if a taxpayer’s adjusted gross income is more than $150,000, or $75,000 if married and filing a separate return.)
Taxpayers generally can also avoid the underpayment penalty if they owe less than $1,000 in additional tax after subtracting their withholding and refundable credits.
The 2018 waiver
The IRS’s waiver lowers the 90% threshold to 85% — the IRS won’t penalize taxpayers who paid at least 85% of their total 2018 tax liability. For those who paid less than 85%, the IRS will calculate the penalty as it normally would.
To request the waiver, a taxpayer must file Form 2210, “Underpayment of Estimated Tax by Individuals, Estates, and Trusts,” with his or her 2018 federal income tax return.
Shutdown concerns
The IRS already has indicated that it will issue refunds despite the government shutdown that has furloughed about 800,000 federal workers. The IRS is recalling some of its furloughed employees and plans to have about 46,000 of its employees back on the job in the coming days. Those employees represent only about 57% of its total workforce. These employees will be using newly updated systems and forms, which could result in further delays. In addition, they could face an onslaught of questions from taxpayers confused by the TCJA changes.
Moreover, the recalled employees won’t be paid during the shutdown, and declines in morale may hurt productivity. Unpaid workers at other federal agencies have called in sick at higher rates than usual since the government’s partial closure, and the union that represents IRS employees has sued the Trump administration over the pay issue.
Act now for 2019 taxes
The underpayment penalty waiver is effective only for 2018. The IRS is urging taxpayers to review their withholding now to ensure that the proper amount is withheld for 2019, especially taxpayers who end up owing more than expected this year. If you have questions regarding the waiver, please don’t hesitate to call us.
The IRS has announced that it will begin accepting paper and electronic tax returns for the 2018 tax year on January 28, but much remains to be seen about how the ongoing shutdown of the federal government will affect this year’s filings. Although the Trump administration has stated that the IRS will pay refunds during the closure — a shift from IRS practice in previous government shutdowns — it’s not clear how quickly such refunds can be processed.
Effects of the shutdown on the IRS so far
An estimated 800,000 federal government workers have been furloughed since December 22, 2018, due to the impasse between President Trump and Congress over funding for a southern border wall. The most recent contingency plan published for the IRS lapsed on December 31, 2018, but it provided that only 12.5% of the tax agency’s approximately 80,000 employees would be deemed essential and therefore continue working during a shutdown.
The furloughs are necessary because the standoff over the border wall has prevented the enactment of several of the appropriations bills that fund the federal government. Tax refunds aren’t paid with appropriated funds, but IRS employees are. In the past, the IRS hasn’t paid tax refunds during shutdowns because it didn’t have the appropriated funds it needed to pay the employees who process refunds. Trump administration attorneys, however, have determined that the agency can issue refunds during a shutdown.
The IRS likely will need far more than 12.5% of its employees on the job to process refunds when it starts accepting filings. In 2018, the IRS received 18.3 million returns and processed 6.1 million refunds in the first week of tax season. By just one week later, it had received 30.8 million returns and issued 13.5 million refunds. Even though the IRS has indicated that it intends to recall “a significant portion of its workforce” to work, it has provided few details, and those employees would have to work without pay. The IRS says it will release an updated contingency plan “in the coming days.”
TCJA complicates the picture
The implementation of the federal tax overhaul could further complicate matters for taxpayers. The 2018 tax year is the first to be subject to the Tax Cuts and Jobs Act (TCJA), which brought sweeping changes to the tax code, as well as new tax forms. Various TCJA implementation activities, such as the development of new publications and instructions, will continue because they’re funded by earlier appropriations legislation.
Be aware that taxpayers and their accountants may not be able to contact the IRS with questions. When the IRS’s main number on January 9 was called, this recorded message was received: “Live telephone assistance is not available at this time. Normal operations will resume as soon as possible.”
During the 2013 government shutdown, taxpayers also couldn’t receive live telephone customer service from the IRS, and walk-in taxpayer assistance centers were shuttered. At that time, the IRS website was available, but some of its interactive features weren’t. Treasury Secretary Steve Mnuchin has stated that the IRS will call back enough employees to work to answer 60% to 70% of phone calls seeking tax assistance during this shutdown, which could lead to widespread taxpayer frustration.
Tax filing deadlines are still in effect
Regardless of how IRS operations proceed, taxpayers still need to comply with the filing deadlines. Individual taxpayers in every state but Maine and Massachusetts must file by April 15, 2019; filers in those two states have until April 17, 2019. Individuals who obtain a filing extension have until October 15, 2019, to file their returns but should pay the taxes owed by the April deadline to avoid penalties. If you have questions about tax filing, please contact us.
The Internal Revenue Service has released an updated Priority Guidance Plan to give tax professionals and taxpayers information about the areas of the Tax Cuts and Jobs Act and other matters where it plans to provide more clarity in the near future.
This third quarter update to the 2017-2018 plan that the IRS issued late Wednesday reflects 13 additional projects, along with information about guidance the IRS has already published during the period from Oct. 13, 2017 through March 31, 2018.
In its initial implementation of the Tax Cuts and Jobs Act, the IRS plans to provide guidance in areas such as the business credit for wages paid to qualifying employees during family and medical leave, along with guidance on reportable policy sales of life insurance contracts.
The IRS also plans to release guidance on the new Section 199A, the deduction of qualified business income of pass-through entities, a murky area of the tax reform law where many practitioners have been demanding guidance. The IRS said in the priority plan it would be issuing “computational, definitional, and anti-avoidance guidance” on Section 199A. The IRS also plans to issue guidance on adopting new small business accounting method changes in its initial implementation of the TCJA. It will also be providing guidance on computation of unrelated business taxable income for separate trades or businesses, as well as changes to electing small business trusts, and on computation of estate and gift taxes to reflect changes in the basic exclusion amount. There will also be guidance coming out on certain issues relating to the excise tax on excess remuneration paid by “applicable tax-exempt organizations.”
The IRS has already released guidance in several areas, including opportunity zones, dispositions of certain partnership interests, withholding and optional flat rate withholding, according to the document.
Another important set of items on the Priority Guidance Plan is President Trump’s executive order withdrawing some earlier Treasury regulations and proposed regulations on matters such as estate, gift and generation-skipping taxes and the definition of a political subdivision.
Last month, the IRS asked the public for input on other items that should be added to the Priority Guidance Plan (see IRS looks for recommendations on priority guidance on new tax law). The update to the plan will identify the guidance projects that the Treasury and the IRS intend to work on as priorities from July 1, 2018, through June 30, 2019.
Staffers on Congress’s Joint Committee on Taxation have also been working on a so-called “Blue Book” that will provide more details on various provisions of the new tax law, along with a set of technical corrections to the tax reform law that they hope to have it in legislative form by the end of the year (see Congressional staff aims to finish technical corrections to tax reform bill). The prospects for passing another tax law anytime soon in Congress are far from certain, although some lawmakers hope to introduce legislation extending the individual tax cuts beyond 2025.
Tax Day was Tuesday, April 17, for most taxpayers, though some folks took advantage of the extra day granted by the Internal Revenue Service (IRS) following computer system issues. Even with the extra day, not every taxpayer who needed to file made it on time. What about you? Maybe your hard drive died,maybe you ate some bad fish, or maybe your dog ate your return. I’m not judging. The question isn’t so much “what happened?” but rather “what happens next?”
Here’s what to do next if you didn’t get your return filed on time:
Don’t panic. It won’t get you anywhere. Too many times, taxpayers completely freak out over a missed deadline and decide that there’s no point in filing now and decide to fix it later. Don’t be that taxpayer. Later might not come: Fix it now.
Double-check whether you needed to file in the first place. We all think we need to file but not everyone needs to. If your income or other circumstances mean that you don’t need to file, you’re in the clear. But be careful: Whether you need to file can change from year to year so don’t assume that you won’t need to file next year if you get a free pass this year.
File today. If you didn’t file on time, get your return together as soon as you can. If you are due a refund, there is no penalty for filing a late return after the tax deadline. But if you owe, penalties and interest are calculated based on the passage of time: The more time that goes by, the more you will owe.
Use Free File. For those taxpayers who qualify (and the IRS estimates that about 70% of taxpayers do qualify), Free File is available through October 15. Just as it sounds, Free File allows taxpayers to prepare and file returns electronically for free. For more information, check out Free File on the IRS website here.
Pay attention to available extensions and relief. The IRS has announced that taxpayers affected by natural disasters, including individuals and businesses affected by Hurricane Maria, have extra time to file this year. For more details or to see if you’re eligible, check the IRS website. Additionally, some taxpayers are automatically entitled to extra time, including those who are out of the country or on active duty in the military.
File even if you can’t pay. A lot of taxpayers figure that if they can’t pay, they shouldn’t bother to file. No, no, no: Penalties are assessed both for failure to file and failure to pay if you will owe taxes. The failure-to-file penalty is usually 5% for each month or part of a month that your tax return is late; if your tax return is filed more than 60 days after the due date, the minimum penalty is the lesser of $210 or 100% of the unpaid tax. So don’t make a bad situation worse by failing to pay and failing to file.
If the dog really ate your tax return, or if something else happened to prevent you from filing on time, tell the IRS. The IRS does have the ability to abate penalties for reasonable cause (the law, however, generally bars the ability to abate interest). If you file late – and you think you have reasonable cause for doing so – you can request an abatement using form 843, Claim for Refund and Request for Abatement (downloads as pdf).
Find a good tax preparer. You can ease a lot of your stress by using a good tax preparer. Since it’s immediately after the tax season rush, you want someone who isn’t closing up shop tomorrow with no plans to reappear until next year. Call around. Ask for referrals. Find someone that you can trust. Make sure you feel comfortable (ask questions). And then follow through.
Pay as much as you can. If you can pay something – anything – make a payment. If you can’t pay it all at once, there are alternatives, including setting up an installment agreement with IRS. But don’t use your lack of funds as an excuse to do nothing. See again #6.
Plan for next year. Like Christmas, Tax Day comes at the same time every year (okay, maybe not every year, since considering those IRS glitches, you did get an extra day this year). But a lot of the stress associated with Tax Day – like shopping for Christmas – can be avoided with a little bit of planning. Maybe this is the year that you invest in a scanner for those receipts. Or you hire that tax pro (see again #8). Or you set up personal finance software to track your income and expenses for the year. Whatever you need to do to ensure that you file on time next year (or file with an extension), plan to do those things now.
On March 25, 2014, the Internal Revenue Service (IRS) released Notice 2014-21 stating that virtual currency is treated as property. In English, this means that virtual currency like Bitcoin will be subject to income tax just like it is treated as cash or property. The taxability will depend on the type of transaction and how it is received. The type of tax treatment will be similar based on current transactions dealing with cash and existing tax laws. Let’s look at three common examples:
Employment & Independent Contractor Relationship: We all know, that if you work for someone as either a employee or independent contractor and you are paid in cash, that the cash amount is taxable as compensation or income. Thus if you work for someone and they pay you in Bitcoin or another virtual currency, the IRS is now stating that transaction is taxable based on the fair market value (FMV) on the day of receipt (assuming the taxpayer is using the cash basis of accounting). If a taxpayer is using the accrual method of accounting, income would be triggered differently. Thus the employee or contractor would be taxed just like they received cash. Some items to consider are: (1) Will you receive a W-2 or 1099-k?, (2) The income most likely would be subject to self-employment tax, or Federal and state withholding, payroll tax and don’t forget additional Medicare tax (AKA Obamacare), (3) Tracking the income at the date of receipt will provide a tax basis / cost, (4) Tracking a gain or loss on the date of conversion from Bitcoin to cash or property. Thus, there are many things to consider. The fact that virtual currency will eventually be converted into cash or property creates an additional step not generally created if paid in cash.
Mining Operation: If you own or are a partner in a mining operation then the mining operation will generate income when a Bitcoin or virtual currency is mined. Depending on the entity structure type (i.e. sole-proprietorship, C Corporation, S -Corporation, Partnership, LLC) the taxability of the income will be treated differently. When a business is in the business to generate a profit, then expenses to run the business can be deductible against the income. Side note, there are exceptions if the business is deemed illegal. Anyway, thus in a virtual mining operation, the hardware, software, utilities and other operating expense can be used to reduce the taxable income. Then depending on the entity structure, the income will be taxed differently. The mining operation taxability is similar to any other for profit business, but again, another step is created due to a virtual currency being used. Since virtual currency mining isn’t like normal manual labor mining, the tax issue of this business being active or passive is more relevant. This again, can change the tax results. For example, will Net Investment Income Tax (NIIT) / (AKA: Obamatax) be due?
When the virtual currency is mined, the FMV of that currency will generate income. That currency value on that date should be tracked as it will generate income and also create a tax basis for the currency. If the virtual currency is exchanged into US dollar, then the transaction has ended and income is generated. However, if the virtual currency is held for a period of time, then the business should keep track of the FMV on the date it was mined and generated income. Later when the virtual currency is exchanged into US currency, that transaction will create another taxable transaction based on currency exchange tax laws. Thus tracking the virtual currency from mined date to exchange date is very important. As with any business it is also important to make sure the business is properly tracking and supporting expenses and chooses the entity structure wisely. For example, an S Corporation structure can generate less tax than a sole proprietorship or partnership / LLC. Entity structures need to be throughly reviewed based on the business operation and consideration of the partners / shareholders.
Let’s discuss an example. A mining operation generates three (3) bitcoins. The value of those bitcoins on the day they are mined is $700 a coin, so income under the new IRS ruling would be $2,100 for that week. If the bitcoin is exchanged into cash on the mining date, then the income step is over. However, if the bitcoin isn’t exchanged into dollars on the mining date then the company needs to track the bitcoin and later when it is exchanged into cash at $800 a coin, there would be $300 of additional income. However, if the exchange rate is $600 a coin, there would trigger a $300 loss. The mining income and exchange income should be tracked separately due to various tax laws.
If you are part of a pool mining operation, then the above still needs to be considered and then other tax items like, passive versus non-passive come up slightly differently. Also, the pooling operating agreement should have an operating agreement, explanation about tax ramifications and who is the tax matters partner. All these items discussed come up with any business.
Investing in Virtual Currency: If an individual invests in virtual currency, then the transaction should be treated just like any other investment. For example, buying a stock. The opportunity to be taxed at the lower long term capital gains rate is possible. The long term capital gains tax rates are generally either 15% or 20%, and then one must not forget the Net Investment Income Tax (NIIT) / (AKA Obamatax). The individual will need to track their cost basis / tax basis, the date of purchase, the date of sale and the sales price. The holding period will determine if the transaction will qualify for the reduced long term capital gains rate or not.
In summary, now that the IRS has taken the position that they will treat virtual currency like property from a tax law perspective, income tax now becomes an issue that virtual currency holders didn’t really have to worry about in the past. It will be interesting to see any debate about the IRS notice and to see how the community will deal with the IRS notice. Will the community provide the IRS with W-2’s, and 1099’s, or not? Will the community report virtual currency holdings or not? It is hard for the IRS to track transactions if they are not reported, but this IRS notice is telling the taxpayer, the law, and the taxpayer would need to comply.
If we look at how aggressive the IRS has been over the last five years regarding offshore bank accounts then one could argue that this taxation on virtual currency is here to stay. The community and network of virtual currency has also provided support that the currency is valuable and easily converted into good and world currencies. So, if you are involved with virtual currencies, now is the time to speak with your tax advisor and create a plan on how to deal with the taxation and create a strategy just like any other successful business.
The IRS notice can be found at http://goo.gl/ONYs4y as of today. However, if the link doesn’t work, go to www.irs.gov and search the website for Notice 2014-21. Please feel free to ask questions and comments. Please contact us if we can be of assistance.
