HOUSE PASSES PPP DEADLINE EXTENSION

Last night (Tuesday March 16th) the House of Representatives voted 415 -3 to extend the Paycheck Protection Program (PPP) from March 31, 2021 to May 31, 2021.

Although this bill must pass in the Senate and be signed into law by the President, with almost unanimous support I feel it is likely to become a reality.

With the changes made to the program both recently (an example would be Schedule C filers being allowed to use Gross income instead of net profit) and since the Consolidated Appropriations Act passed on December 27th, it makes sense to extend the deadline.

The changes made since passing the Act in December are, among other items, error codes put in place by the SBA to reduce fraud. While that is a very good idea, these codes have caused significant delays on applications that are legitimate. The extended time gives borrowers, the SBA, and professionals, like me, that are assisting borrowers much needed time to properly file necessary paperwork.

I will update everyone when and if this bill becomes law.

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Jeff Skolnick, CPA, M.S. Taxation

AMERICAN RESCUE PLAN ACT OF 2021

On Thursday afternoon March 11th Joe Biden signed the $1.9 trillion dollar stimulus bill into law. The new law is cited as the American Rescue Plan Act of 2021. There were a number of provisions that affect taxpayers, and I am going to cover some of them here.

Extension of Unemployment Assistance

The original CARES Act that was signed into law last March 27th contained a provision where those individuals receiving state unemployment assistance also received $600 per week of unemployment funds from the Federal government called Pandemic Unemployment Assistance (PUA). This figure was eventually dropped to $300 and was set to run out on March 14, 2021. The new law extends the $300 per week through September 6, 2021.

Taxation of Unemployment Benefits

The Rescue Plan allows the first $10,200 of unemployment received by a taxpayer (or, in the case of a joint return, received by each spouse), to be excluded from income if the Adjusted Gross Income (AGI) of the taxpayer is less than $150,000. This rule only applies to 2020. The new law does not currently extend this same income tax treatment to unemployment received in 2021, therefore taxpayers should be aware of the tax ramifications.

Limitation on Excess Business Losses

Noncorporate taxpayers are limited to the amount of losses they are allowed to take on their income tax returns from businesses. The limitation is $500,000 for joint filers and $250,000 for everyone else. Business losses would include losses on Form Schedule C (for sole proprietors or single member LLCs) as well as pass-thru income such as from an S corporation or partnership (also multi member LLCs treated as partnerships). This provision was slated to sunset after December 31, 2025. The new law extends this provision to December 31, 2026.

Changes to COBRA Subsidies

COBRA coverage allows workers that are laid off to stay on their company’s health plan as long as they pay the full premium. The new law will subsidize these COBRA payments allowing laid off workers to stay on their company health plans for free through September 30, 2021.

Recovery Rebates to Individuals

The new law provides $1,400 per taxpayer ($2,800 for joint filers) plus $1,400 multiplied by the number of dependents of the taxpayers, regardless of the age of the dependent. This includes college students as well as parents.

Eligible individuals must not be a dependent of another taxpayer.

There is also an eligibility limitation based on AGI.

Single taxpayers with AGIs of no more than $75,000 are fully eligible for the credit. The credit phases out for those with AGI in excess of $75,000 until they reach $80,000. There is no credit allowed for those with AGI of $80,000 or more.

Married taxpayers filing jointly must substitute the figures $150,000 for $75,000 and $160,000 for $80,000. 

Taxpayers classified as Head of Household must substitute the figures $112,500 for $75,000 and $120,000 for $80,000. 

An example of how this works will help. Let’s say we have a married couple with 2 children as dependents. The law allows a $5,600 credit ($1,400 multiplied by both spouses and both children). If the taxpayers AGI was $150,000 or less, all $5,600 may be claimed. If the taxpayers had an AGI of $155,000 (halfway between $150,000 and the full phaseout of $160,000), then 50% of the credit or $2,800 would be allowed. If the taxpayers had $160,000 or more of AGI none of the credit would be allowed. In other words, the credit is phased out ratably between $150,000 and $160,000.

Payments will be based on either 2020 income tax returns or 2019 income tax returns for those have not yet filed 2020.

Child Tax Credits

Child tax credits which were previously available for children under the age of 17 in the amount of $2,000 have been expanded. The new credit allowed is $3,000 per child under age 18 and $3,600 per child under age 6. These amounts are only for 2021.

One more change to this credit is the credit is fully refundable. Under prior law the credit was 70% refundable. If a family had a child eligible for the $2,000 credit but had no income tax liability, they would only receive $1,400 (70% of the $2,000 credit). If the family had an income tax liability of $500, they would be allowed a $1,900 credit ($500 vs. income tax and $1,400 refundable). If the tax liability were $600 or more, then this family would receive the full $2,000 credit. Under the new law, the family would receive the full $3,000 (or $3,600) regardless of whether or not they had an income tax liability.

One big thing to keep in mind are the AGI limits. Under the Tax Cuts and Jobs Act (passed in December of 2017), the credits discussed did not phase out until AGI exceeded $400,000 for joint filers and $200,000 for everyone else. This was to be the law for years 2018 through 2025.

The new law uses threshold amounts of $150,000 for joint filers, $112,500 for head of household filers and $75,000 for everyone else. Credits phase out at the rate of 5% for each dollar of AGI in excess of these limits.

While there are increased amounts for 2021 the reduction in AGI limits may disallow this credit for many taxpayers that have been eligible in years 2018, 2019 and 2020.

Advance Payments

The law provides that advance payments will be made to parents of either $300 or $250 per child per month (depending on whether they were under 6 or under 18). You must beware. These are advance payments on the 2021 income tax returns. Unlike stimulus payments, if taxpayers receive too much in the way of advance payments based on their income, they will have to pay it back.

 Earned Income Tax Credit

For 2021 the minimum age for taxpayers without children to claim the credit had been 25. The new law changes this for 2021 to 19, except for students (age 24) and qualified former foster or homeless youth (age 18).

The credit is allowed for separated spouses.

Normally the credit is disallowed for taxpayers with investment income exceeding $2,200. This limit has been raised to $10,000.

Lastly, taxpayers are allowed to use 2019 income to calculate this credit if it is more beneficial than using 2021 income.

Child and dependent care

Prior law allowed a dependent care credit for dependents under age 13 and dependents or spouses over age 12 that are physically or mentally unable to care for themselves.

This credit was available to taxpayers that incurred dependent care expenses that allowed them to work.

The credit ranged from 35% down to 20% based on a taxpayer’s AGI.

The maximum credit allowed was $3,000 for 1 qualifying dependent and $6,000 for 2 or more qualified dependents.

This credit was not refundable and was allowed only against any income tax liability.

The new law, which only pertains to 2021, makes the credit fully refundable. This means eligible taxpayers will receive the full credit whether or not they have an income tax liability.

It increases the credit to $4,000 for 1 qualified dependent and $8,000 for 2 or more qualified dependents.

The credit allowed is increased from 35% to 50% and does not begin to phase out (down to 20%) until AGI exceeds $125,000. Under prior law this amount began phasing out when AGI exceeded $15,000.

The credit phases out by 1% for each $2,000 (or fraction thereof) by which a taxpayer’s AGI exceeds $400,000.

For 2021 the amount of dependent care assistance allowed to be provided by employers tax free to employees is increased from $5,000 to $10,500.

Family and sick leave credits

The law allows a credit for sick and family leave which is applied against Federal payroll taxes. The credits apply through September 30, 2021 and are available to employers and self-employed individuals.

The maximum allowed for paid family leave is increased from $10,000 to $12,000.

Employee Retention Credit

The Employee Retention Credit (ERC) has been extended through December 31, 2021.

Below is a recent article I had written which explains the ERC for both 2020 and 2021. Again, keep in mind, the 2021 ERC has been extended for all 4 quarters of 2021.

The Employee Retention Credit (ERC) was originally part of the CARES Act which was signed into law on March 27, 2020. The ERC allows eligible taxpayers a credit against Form 941 taxes (Federal withholding, Employer and Employee Social Security and Medicare taxes). The Consolidated Appropriations Act 2021 was signed into law on December 27, 2020 and made significant changes to the ERC. I will now outline the latest provisions of both the 2020 ERC and the 2021 ERC.

2020 ERC

Who is eligible for an ERC?

The ERC is available to employers of any size that paid wages and meet one of the two following tests:

The first test is for any business that has its operations fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19. As an example, I have a number of hair salons as clients in the New Jersey / New York area. All of these salons were shut down for approximately 3 months from between approximately March 20th through their reopening on June 22nd of 2020. These salons would be eligible for the credit for any wages paid during the shutdown period.

This same first test still applies to 2021.

The second test is one in which the business had a reduction of its gross receipts of more than 50% when compared to the same quarter of 2019. To use my salons as an example. Each salon was open for 10 days in the 2nd quarter. Gross receipts were down by 80 – 90% in most cases. These salons would be eligible under this second test as gross receipts are clearly less than 50% of the corresponding 2019 quarter. This test allows the taxpayer to count as wages all wages from the first day of the quarter gross receipts fell below 50% up through and including the quarter where gross receipts are at least 80% of the corresponding quarter in 2019.

I will explain this second test by giving an example. Let’s say gross receipts in 2019 were $100,000 in each of the four quarters for an annual total of $400,000. Sales for 2020 were $90,000 in the 1st quarter, $10,000 in the 2nd quarter, $70,000 in the 3rd quarter and $95,000 in the 4th quarter. We now test each quarter. In the 1st quarter sales were down 10%, therefore the taxpayer is not eligible. The 2nd quarter gross receipts are down 90% from the 2019 amount ($100k in 2019 compared to $10k in 2020). The taxpayer is now eligible for the 2nd quarter and the 3rd quarter. The 3rd quarter sales are only 70% of the 2019 figure and therefore since the salon has not reached 80%, it is automatically eligible in the 4th quarter. The 4th quarter is only down 10% compared to the 2019 figure, however, the law states you are eligible up to and including the quarter where gross receipts are restored to at least 80% of the 2019 corresponding quarter. If the 3rd and 4th quarter figures of 2020 were reversed ($95,000 in the 3rd quarter and $70,000 in the 4th quarter), then the salon would not be eligible for a credit in the 4th quarter. The salon reached the 80% threshold in the 3rd quarter which means although it is eligible in 3rd quarter, it is not in the 4th quarter.

The second rule above pertains only to the 2020 ERC credit. The rules change in 2021 and I will get to them shortly.

Please keep in mind the two tests are completely separate. If your business is eligible because you were shut down, and not because your receipts dropped by at least 50%, then you are eligible only during the shutdown period. It is generally more advantageous if a business can qualify under the second test.

Aggregation Rules

I want to point out that related employers (generally companies that share greater than 50% common ownership) must be looked at in total to determine the gross receipts test. Additionally, if just one entity has its operations partially or fully suspended, then all related entities are considered to be partially or fully suspended. Aggregation rules can be complicated and are beyond the scope of this writing. I just want to say if you have companies that may be related discuss it with a professional to ensure that you apply the law correctly.

What wages specifically can be included in the computation?

Qualified wages for eligible employers with greater than 100 full-time employees are wages paid to employees not providing services during the period of eligibility. Full time employees are employees working at least 30 hours per week. If you employ more than 100 full time employees than only wages for employees being paid that are not working are counted. There is a limitation on these employees based on the amount such employees would have been paid for working an equivalent duration during the 30 days immediately preceding the coronavirus crisis. All this last sentence means is that employers were not allowed to boost someone’s pay rate during a period of eligibility in order to increase the credit.

Qualified wages for eligible employers with no more than 100 full-time employees are all wages paid whether or not the employee is working or not during the period of eligibility.

While the 100-employee test focuses on full time employees, the actual computation counts full and part time employees. If a company employs more than 100 full time employees than the wages of all full and part time employees that are being paid but not providing services are counted.

If a company has 100 or less full-time employees than all the wages of the full and part time employees are counted.

Group health benefits of employees are considered qualified wages.

Are there any other limits on eligible wages?

Wages of more than 50% owners and related parties to a more than 50% owner are not eligible wages. In addition, there is a limit of $10,000 per individual in 2020.

There are also exclusions for pre-existing paid time off, severance pay and wages where other credits have been taken such as paid family and medical leave credit.

Only wages incurred after March 12, 2020 are eligible.

What is the amount of the credit?

The credit is a 50% credit of qualified wages, or up to $5,000 per individual in 2020. Let’s say an employer has two employees, Employee 1 that earns $2,000 each quarter and Employee 2 that earns $15,000 each quarter. This includes the employee’s wages and health benefits. Lastly, I will assume the entity was eligible for the ERC in the 2nd, 3rd, and 4th quarters of 2020. Employee 1 will earn $6,000 while Employee 2 will have compensation of $45,000 in 2019. The ERC would be 50% of $6,000, or $3,000 and 50% of $10,000 (remember there is a $10,000 limit per employee), or $5,000. The business has an $8,000 credit. In actuality the 2nd quarter would show a $6,000 credit ($1,000 credit on Employee1 and a $5,000 credit on the Employee 2). The 3rd and 4th quarters would each have a $1,000 credit (all on Employee 1 and none on Employee 2 because the limit had been reached).

If this is such a great credit, why haven’t I heard of it before?

The original law had a provision which stated any employer that received a PPP loan was not eligible. PPP was a better deal and that’s why PPP was in the news every day and there was little mention of the ERC.

The new law passed December 27th, 2020 changes the rules and allows employers that received a PPP loan to also receive an ERC. You must be careful.  Wages considered for PPP loan forgiveness may not be used for ERC purposes.

Further, the law states that we are to assume this was always the law. Eligible taxpayers are able to file amended payroll tax Forms to claim the 2020 ERC. If you are filing an amended Form 941-X solely for the change in the law pertaining to the allowance of PPP borrowers to also obtain an ERC, then you can file one amended 4th quarter 2020 Form 941-X to correct all quarters of 2020.

Reduction in income tax deductions by the amount of ERC

The law requires taxpayers that obtain an ERC to reduce their tax deductions by the amount of the ERC. In my example of the employer that obtained an $8,000 credit, that same employer would be required to reduce the deductions on their 2020 income tax return by $8,000.

2021 ERC

While the shutdown test remains in place in 2021, the second test has changed. Employers are eligible on a quarter-by-quarter test. If the gross receipts for the any quarter of 2021 are less than 80% of the gross receipts of the corresponding 2019 quarter the employer is eligible. The new law changed this from 1st and 2nd quarters of 2021 to all four quarters of 2021. Additionally, employers have the option of using the prior quarter for the test. Let’s say the 1st quarter of 2021 was only down 15% compared to the 1st quarter of 2019, but the 4th quarter of 2020 was 25% lower than the 4th quarter of 2019. The taxpayer may choose to use the 4th quarter of 2020 for the computation instead of the 1st quarter of 2021. The same would hold true for an employer calculating the 2nd through 4th quarters of 2021. The employer could choose to use the prior quarter for the computation. This is only for purposes of qualifying under the gross receipts test. If an employer is eligible the actual computation of the quarterly ERC would be based on wages on the appropriate quarter (not the prior quarter used for the gross receipts test).

What other changes were made for 2021?

In 2020 there was a limitation of $10,000 of wages per employee for the year. In 2021 this figure has changed to $10,000 per quarter. The new law changed this from the first 2 quarters of 2021 to all four quarters of 2021.

The credit has been increased in 2021 from 50% in 2020 to 70% in 2021. This means that while the limit was a $5,000 credit per employee in 2020 ($10,000 multiplied by 50%), it is now up to $28,000 per employee in 2021 ($10,000 per quarter multiplied by 70%).

Let’s look at another example. An employer has two employees, Employee1 and Employee 2. Employee 1 makes $6,000 in the 1st quarter, $12,000 in the 2nd quarter and $8,000 each in the 3rd and 4th quarters. Employee 2 makes $15,000 in each of the four quarters. The credit in the 1st quarter would be $6,000 X 70% ($4,200) + $10,000 X 70% ($7,000) or $11,200.

The 2nd quarter would be $10,000 X 70% for both employees or a total of $14,000. The employer is limited to $10,000 of wages on Employee 1 even though that employee did not use the full $10,000 amount in the 1st quarter. In other words, the employer cannot carry over any amount under the $10,000 threshold.

The 3rd and 4th quarters would be $8,000 X 70% + $10,000 X 70% or $12,600 for each quarter.

The test of full-time employees was changed from 100 to 500 full time employees; therefore, it is a much easier eligibility test for employers to reach. The advantage of meeting this test is that all wages, not just wages of those being paid and not working, are eligible for the credit.

Reduction in income tax deductions by the amount of ERC

The law requiring taxpayers that obtain an ERC to reduce their tax deductions by the amount of the ERC remains in place for an ERC taken in 2021.

How this might affect PPP loan forgiveness

We know from the law passed in December of 2020 that employers that obtained a PPP loan can now also obtain an ERC but cannot use the same wages for both. We also know that borrowers of PPP loans must utilize 60% of the loan proceeds for payroll in order to obtain forgiveness.

Without the passage of this law, we might just use 100% of wages for PPP forgiveness and be finished. Now it may be beneficial to utilize some of the other allowed expenses (in 2020 it was rent, mortgage interest and utilities) in order to maximize the ERC. Let’s take an example where an employer obtained a $100,000 PPP loan. Let’s also assume the employer had $40,000 of rent during the covered period of the PPP loan. If the employer applies for forgiveness using $60,000 of payroll and $40,000 of rent, then they now have $40,000 of payroll that may be eligible for the ERC. I say may be eligible because there are additional rules ($10,000 cap per individual and/or wages of individuals owning more than 50% of the entity).

These computations may become complex. Take an example of a borrower that obtained a PPP loan before the PPP Flexibility Act passed on June 5th of 2020. This borrower has the option of using an 8-week covered period or a 24-week covered period. There could be a situation where during the 8-week covered period the employer meets the full-time equivalent requirement of their forgiveness because they maintained all employees during the 8 weeks but subsequently reduced their work force based on economic conditions. Using a 24-week covered period might reduce forgiveness, however being able to use 6 months of rent and freeing payroll for the ERC may result in a bigger benefit from the ERC than the reduction in forgiveness. My point is you must coordinate your PPP loan forgiveness with the ERC in order to maximize your benefit.

Premium Tax Credit

For 2021 and 2022 there is an expanded credit which is accomplished by changing the percentage of premium the taxpayer is required to pay.

The law also eliminates the requirement, for 2020 only, that a taxpayer that received advanced credits in excess of what would be allowed based on their 2020 income figures shown on their tax return, has to repay the amount they were overpaid.

For example, let’s say a taxpayer, based on estimated income and family size amounts provided to an insurance carrier received a credit on their health insurance of $300 per month, or $3,600. When the 2020 income tax return is prepared it shows that the taxpayer should have only received a credit of $3,000. In all other years, the taxpayer would be required to pay back the $600 difference. Again, in 2020 only, this money does not have to be repaid.

Miscellaneous Provisions

EIDL advance grants and restaurant revitalization grants are not included in gross income.

Student loans discharged in 2021 through 2025 are not included in income.

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Hang in there and stay safe,

Jeff Skolnick, CPA, M.S. Taxation

LATEST ON STIMULUS BILL AND PPP AS OF FEBRUARY 28 2021

STIMULUS BILL

The House of Representatives passed President Biden’s $1.9 trillion stimulus package. The bill now moves to the Senate where Democrats hold a slim majority 50/50 with Vice-President Harris as the tie breaking vote. The fact that the majority is so close in the Senate will most likely lead to some amendments to the House version.

The major provisions, as I’ve read so far (I have not seen the actual bill passed by the House) are as follows:

Democrats are pushing to have the bill become law by March 14th. This is the date that current federal unemployment benefits are set to expire.

Direct stimulus payments of $1,400 for individuals earning less than $75,000, phasing out between $75,000 and$100,000. For couples, these figures would be less than $150,000, phasing out between $150,000 and $200,000. It is to be based on either 2019 or 2020 income and would include adult dependents (including college students and disabled adults).

The House package extends federal unemployment benefits until August 29, 2021 and increases the weekly amount from the current $300, to $400.

The child tax credit which is currently $2,000 for children under the age of 17 would be increased to $3,000 and would be available for children under the age of 18. There would be a higher credit for children under the age of 6 ($3,600). One more change to this credit is the credit would be fully refundable. Currently the credit is 70% refundable. If a family has a child eligible for the current $2,000 credit but has no income tax liability, they will only receive $1,400 (70% of the $2,000 credit). If the family had an income tax liability of $500, they would be allowed a $1,900 credit ($500 vs. income tax and $1,400 refundable). If the tax liability were $600 or more, then this family would receive the full $2,000 credit. Under the new House bill the family would receive the full $3,000 (or $3,600) regardless of whether or not they had an income tax liability.

The item causing the most controversy is the provision that raises the federal minimum wage from its current level of $7.25 an hour to $15 an hour by 2025. Senate parliamentarian Elizabeth MacDonough ruled that Democrats could not include this provision under budget reconciliation. If it would have been allowed, the Democrats could have passed the provision with a simple majority, meaning no Republican votes would be necessary.

Currently the positions of each side are Democrats feel that raising the minimum wage is necessary to help families, while Republican leaders believe the raise to $15 per hour will hurt small businesses and cost jobs. The Senate version of the Stimulus bill will likely contain a raise to either $10 or $11 an hour. I expect we will be hearing more about this from both sides of the political aisle in the coming days.

There are also provisions in the bill that cover the following items:

• Assistance for struggling families to help with rent, mortgages, utilities, property taxes and homelessness.
• Employer incentives to offer paid sick and family leave.
• Increased subsidies of premiums for individuals and families covered by Obamacare.
• Economic Injury Disaster Loans to small businesses and grants for bars and restaurants.
• Money for state and local governments.

I will cover some of these provisions once the final version of the bill becomes law. This writing is just to give you an idea of what is currently going on.

LATEST ON PPP

Guidance is expected to come as early as Monday March 1st on provisions aimed at assisting the smallest businesses eligible for PPP.  The overall changes that were made last week and require guidance are as follows:

14-day period that began Wednesday February 24th and extends to March 9th and allows only businesses with fewer than 20 employees to apply.

Sole proprietors, independent contractors and self-employed individuals will receive higher loans as their maximum will be based on their gross income instead of their net income. Guidance is required on whether borrowers who have already received loans are able to apply for additional funds. In addition, lenders will need to update their systems to comply with these changes.

Elimination of restriction that borrowers with a felony arrest or conviction in the last year, other than one related to financial assistance fraud, are eligible for a PPP loan. No business with a 20 percent or more owner that has an arrest or conviction for a felony related to financial assistance fraud within the last five years is eligible for a PPP loan.

Under the original rules of PPP, businesses with individuals of at least 20% ownership that are currently delinquent or have defaulted on student loans within the last seven years were not eligible for PPP loans. This restriction is eliminated.

Access to the program will be granted for non-citizen business owners that have Individual Taxpayer Identification Numbers (ITINs) instead of social security numbers. This would include Green Card holders and those here on a visa.lat

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Hang in there and stay safe,

Jeff Skolnick, CPA, M.S. Taxation

VIRTUAL CURRENCY – BE WEARY OF HIDDEN TRAPS

As many have you may have read the IRS is attempting to crack down on what they believe to be a large number of unreported transactions revolving around virtual currency.

Virtual currency, as explained in IRS Notice 2014-21 “is a digital representation of value that functions as a medium of exchange, a unit of account and/or a store of value.” It may be used as legal tender in some instances but does not have legal tender status.

Convertible virtual currency, according to the same notice, has an equivalent value in real currency. The most popular convertible virtual currency is Bitcoin.

Why am I discussing this now?

The IRS added the following question to the 2019 income tax return Schedule 1:

“At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in virtual currency?”.

• You must answer yes to this question if you received cryptocurrency (crypto)
• Sold crypto.
• Traded one crypto for another crypto (for example Bitcoin for Ethereum)
• Used crypto to buy goods and services.

Selling, trading, or using crypto (the last three bullet points listed above) results in taxable gains and/or losses and must be reported on your income tax return.

You may answer no to this question if you merely held crypto, during the year, in a wallet or transferred it between wallets you own.

Schedule 1 was not a schedule required to be filed by all taxpayers. In 2019, it was filed for taxpayers that had income from sources other than wages, interest, dividends, capital gains/losses, retirement, or social security. These would include, but not be limited to, taxable state refunds, earnings from a business reported on either Schedule C or F, income from rental real estate, royalties, partnerships, S corporations or trusts and unemployment income.

Schedule 1 was also used to report reductions to a taxpayer’s Adjusted Gross Income (AGI). These adjustments would be from educator expenses, self-employed health insurance, 50% of self-employment tax paid, retirement fund deductions, alimony paid, student loan interest, tuition, and fees to name a few.

In 2020 the question was moved form Schedule 1 to page 1 of the return where every taxpayer will now see it. The question must be addressed to the best of your ability. There are penalties for intentionally lying on your income tax return.

As I stated earlier, the IRS clearly sees virtual currency as a vastly underreported area and is going to crack down on these transactions.

Without getting too detailed part of the allure of virtual currency is that once recorded and time stamped, transactions cannot be altered and are therefore available forever.

IRS Notice 2014-21 was written in March of 2014 and outlined the IRS position on virtual currency. The notice treats virtual currency as property, and not currency. While most taxpayers understand that if they purchase a virtual currency, for example Bitcoin at a value (let’s say $20,000) and sell it at a later date, income or loss will be recorded. There are some other situations addressed by this notice.

If taxpayers receive virtual currency as payment for goods or services, it must be included in income at it’s Fair Market Value (FMV) at the time of receipt. The taxpayer would then have a basis in the currency equal to the amount reported in income. For example, if I prepare a business tax return and receive payment in the form of virtual currency with a value of $3,000, then I report $3,000 as income and my basis in the currency is $3,000. If I sell or trade the currency for more than $3,000, I recognize a gain and if I sell or trade the currency for less than $3,000 then I recognize a loss.

The type of gain/loss realized depends on why the currency is exchanged. If I trade one form of virtual currency for another, sell it for a gain or loss or use it to buy goods or services it is going to be a capital gain or loss. If I receive virtual currency for goods or services that I sell that would be recognized as ordinary income. Examples of this would be the $3,000 I received for tax preparation mentioned earlier or if I sold inventory of my business (an example might be clothing from a department or online store).

Other reportable transactions include the FMV of mined virtual currency. Virtual currency is mined using computers to solve complex equations. The FMV of mined coins would be reported as income.

Virtual currency paid as wages must be reported at the FMV at the time of payment.

The one area that taxpayers may not be aware of is when virtual currency is exchanged for goods and services it is taxed. Although I realize investors can purchase and exchange partial shares of currencies my next example will assume that one Bitcoin was purchased. If a taxpayer purchases 1 Bitcoin for $20,000, and later when the Bitcoin is worth $45,000, purchases a car, then the taxpayer recognizes a $25,000 capital gain. It would be either a long-term or short-term gain depending on whether the taxpayer held the asset for more than a year (which would make it long-term) or for a year or less (which would make it short-term).

While most taxpayers understand if they had purchased the Bitcoin at $20,000 and later sold the coin for $45,000 that they would have a recognized capital gain, many do not realize that simply spending the coin will result in a recognized gain or loss. I find the easiest way to understand this concept is to assume each time you spend a virtual currency, think of it as selling the currency first and then using the cash from the sale to purchase the good or service.

To illustrate how crazy this can get let’s look at another example. In this example a taxpayer has purchased 1 Bitcoin for $20,000 and now it is worth $40,000. If the taxpayer buys lunch for $15 using the virtual currency, they recognize a capital gain of $7.50 (the coin had doubled in value). By the same token if a taxpayer purchased the coin at $40,000 and the value dropped to $30,000 and the taxpayer purchased an automobile for $30,000, the taxpayer would recognize a $10,000 loss.

How will the IRS know about my transactions?

I refer back to one of the driving forces of virtual currency. Once transactions are recorded, they are not able to be altered. This means the record of each transaction is available forever.

In 2018 the IRS forced Coinbase, a digital currency exchange, to release the information of any user that had at least $20,000 of transactions in any year between 2013 and 2015. The result was the IRS obtained over 13,000 names and sent letters to over 10,000 individuals to put them on notice regarding these transactions.

My belief is the IRS is going to continue to receive more and improved data on investors by requiring improved reporting by currency exchanges in the future and anyone involved with virtual currency transactions should be aware. Again, if the information remains available forever and cannot be altered, then taxpayers must respect the laws surrounding these transactions or be prepared to pay the consequences.

How quickly is the IRS expected to crack down on these transactions?

From everything I’ve read I believe the IRS intended to start cracking down in 2020 and possibly even in 2019. The effort has been pushed back some because of the Pandemic. The IRS is still reeling from the mountain of paper returns sitting in offices across the country. Additionally, when the new stimulus package eventually becomes law, the IRS will most likely be issuing stimulus checks. Based on these circumstances I don’t expect the IRS to devote the resources necessary to crack down on these transactions in 2020.

With that said, I do believe this is a hot button that is not going away, and I expect the IRS pursuit of these transactions to increase beginning next year.

What should taxpayers do now?

My recommendation is taxpayers start to get their house in order as soon as possible. Again, I do not believe this issue will be going away. If anything, my belief is we will see more uses of virtual currency in the future which will result in additional scrutiny.

This is a very simplified overview of crypto and I have not even discussed the complex areas of when crypto currencies incur hard forks or soft forks or air drops. Just keep in mind that these types of transactions also bring tax consequences. This article was meant to give an overview of the taxation of cryptocurrencies and explanations of these types of transactions are beyond the scope of this writing. They are, however, prevalent and I wanted to mention the terms, so you are aware of them.

It is my opinion that if you are investing in virtual currencies, then you should be speaking with a professional familiar with these rules in order to avoid unintended consequences.

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Hang in there and stay safe,

Jeff Skolnick, CPA, M.S. Taxation