Cryptocurrency and the Dreaded Amended Return

The Short and Skinny on the What and How of Amending a Tax Return

There are times that a taxpayer should amend a previously filed tax return.  But what requires an amended return?

A taxpayer should amend their return if:

(1) If there was a missed tax deduction or credit;

(2) if the wrong filing status was claimed;

(3) if there is a dependent that needs to be added or removed;

(4) if there was unclaimed taxable income; and

(5) if there was an expense, deduction, or credit claimed that should not have been.  If a taxpayer noticed a mathematical or clerical error, normally they do not have the amend a return, often the IRS will correct those mistakes.

When a taxpayer is required to amend a previously filed return, the taxpayer must complete and mail a paper copy of Form 1040-X.  Form 1040-X must be filed on paper regardless of the taxpayer’s original method of filing.

For each year that needs to be amended, the taxpayer must file Form 1040-X for each year separately and must mail each form in separate envelopes.  These filings must also include the original filed Form 1040.  Form 1040-X has three columns to be completed: (1) Column A shows the original figures; (2) Column C shows the correct figures; and (3) Column B shows the difference between A and C.Penalties and Interest

The IRS has asset penalties in nine different stations.  In this case, the penalties assessed would be “Accuracy-Related” meaning the taxpayer did not claim all income on their form 1040 during the applicable tax year which results in an underpayment of Federal income tax.  The IRS can apply to different Accuracy-Related Penalties.  The first penalty is “negligence or disregard of Rules or Regulations and the second is “Substantial Understatement of Income Tax.

A substantial understatement of federal income tax applies if a taxpayer understates their tax liability by 10% or $5,000 whichever is greater.  When a substantial understatement of federal income tax is applied, the penalty is 20% of the portion of the underpayment of tax that was understated on the return.

Interest is charged on any amount owed by a taxpayer (including penalties) and is due as it accrues.  When a penalty is first assessed, the taxpayer will receive a notice, and if the taxpayer pays the balance in full by the listed, accumulated daily interest will stop.  Interest rates vary and charge quarterly, so it is not possible to determine the amount of interest that will be accruing.

I Own Cryptocurrency and I Do Not Know What it is Worth

Do not worry, the IRS has already published guidelines on this matter.  Since 2014, the IRS has considered Crypto or virtual currency is to treated as property for Federal income tax purposes. See Notice 2014-21, 2014-16 I.R.B. 938. Gain or loss of crypto is only recognized as the sale or disposition and can receive capital gain/loss treatment. See I.R.C. 1(h) Basis (“cost basis”) is the amount you spent to acquire the cryptocurrency.  This also includes fees, commission, and other acquisition costs in U.S. dollars. See I.R.C. 1012: Basis of Purchased Property.

Cost basis can be increased by certain expenditures and decreased by certain deductions. See I.R.C. 1001: Determination of amount of and recognition of gain or loss To calculate the gain or loss in the exchange of crypto is by taking the difference between the fair market value (“FMV”) of the crypto and your cost basis. See Helvering v. Bruun citing I.R.C. 1011 and I.R.C. 1016.

Remember to, based on the taxpayer’s overall income, for the year 2020, Capital Gains tax rates are tiered at 0%, 15%, or 20%. If a taxpayer’s income is between $0 and $40,000, the long term capital gain tax rate is 0%, $40,001 to $441,450 is 15% and $441,451 and over is 20%.

Reporting Crypto: Form 1099-B, Form 1099-K, Other Tax Statements

It is very important to have a good record-keeping system in place to determine the cost basis of cryptocurrency and the realization of gains/losses.

These reports normally come on a schedule 1099-B, 1099-K, or possible other tax reporting statements; however, it is important to note that these exchanges are not required to send such reports, therefore, it calls on the taxpayer to be mindful and detailed regarding your transactions.  It is recommended that if someone is a frequent trader, the taxpayer should download transaction reports from the exchange periodically.

In regards to reporting cryptocurrency on your 1040, a taxpayer only has to report to the IRS four situations:

• If the taxpayer sold cryptocurrency;
• If the taxpayer converted cryptocurrency to conventional currency;
• If the taxpayer exchanged one of the various versions of cryptocurrency for another; and
• If the taxpayer used cryptocurrency to purchase products or services.

If a taxpayer does not keep adequate requirements, the IRS determines the FMV to be a gain or loss.  If it is also not possible to adequately identify cryptocurrency a taxpayer sold and the cryptocurrency was purchased at different times, the basis is the basis of the cryptocurrency the taxpayer acquired first, then the basis of the cryptocurrency of the later acquired.  This is referred to as first-in-first-out.

Resources:

• Virtual Currencies | Internal Revenue Service
• IRS Guide to Related Tax Consequences of Buying, Holding and Selling Bitcoin/Cryptocurrency
• Frequently Asked Questions on Virtual Currency Transactions
• Bitcoin and Beyond – Texas Comptroller
• Tax Treatment of Transactions in Cryptocurrency and IRS Tax Enforcement
• IRS Private Letter Ruling on Taxation of Hard Forks and Airdrops
• Understanding the Tax Basics of Virtual Currency
• Virtual Currency: IRS Issues Additional Guidance on Tax Treatment and Reminds Taxpayers of Reporting Obligations
• Publication 525, Taxable and Nontaxable Income, for more information on miscellaneous income from exchanges involving property or services
• Publication 526, Charitable Contributions, for more information on charitable contribution deductions,
• Publication 544, Sales and Other Dispositions of Assets, for more information about capital assets and the character of gain or loss
• Publication 551, Basis of Assets, for more information on the computation of basis
• Publication 561, Determining the Value of Donated Property, for more information on the appraisal of donated property worth more than $5,000