It's a brave new cyber world that we live in, one where virtual currency exists to exchange and pay for things globally. Certainly, this throws a whole new monkey wrench into basic accounting platforms and raises a few questions. How is accounting for cryptocurrency handled by an accountant, and just what in the world is it anyway? Here is the definition of cryptocurrency from Techopedia:
Cryptocurrency is a type of digital currency that is based on cryptography. Cryptocurrency uses cryptography for security, making it difficult to counterfeit.
In no way is Bitcoin the only cryptocurrency floating around on the Internet; in fact, there are dozens of other cyber-currencies, like intangible asset Namecoin to Hashcoin, even Beertoken. However, Bitcoins are the most frequently used form of this new digital currency, so we'll focus on it and how to handle accounting functions that involve them.
What are Bitcoins?
Bitcoins are electronic currency -- digital assets -- and are created using complex mathematical equations, while being policed by millions of users called 'miners'. Basically, they are long strings of computer code that have a cash value, and completely bypass traditional banks through crypto transactions. They are very controversial because they are unregulated by the securities and exchange commission and banks, governments and law enforcement agencies have not figured out what to do about them.
Though Bitcoins and other cyber-currencies are used worldwide, some of the guidelines around this asset class that the United States government put in place are useful. At this point, Bitcoins are passed from one online wallet to another, and stored on a computer, smartphone, or in the cloud. Since banks are not needed to move the money or to store it, they are more like gold nuggets than real money. They have an assigned fair value measurement at the time of purchase; for instance, as we were writing this, the price is about $403 per Bitcoin, down considerably in the last few days.
Basically, Bitcoins can be bought and sold much like any other commodity. In fact, you need a digital wallet to keep Bitcoins in. The prices fluctuate quickly and widespread appreciation or depreciation is very common.
Using Bitcoins as an example, here are some advantages of using them:
- Get around the banking system to avoid its fees for transferring money. It is a decentralized, non-regulated currency as opposed to the dollar, which is regulated and managed by a central bank
- No transaction fees from third parties
- They can be used internationally for purchases at any business that accepts Bitcoins as payment
What are the disadvantages of using Bitcoins?
- Risk of loss due to hacking or an exchange shutting its doors
- Avoidance of financial scrutiny by the government for tax evasion, though this is still somewhat untested
- Stored Bitcoins are vulnerable to devaluation or seizure if they are used in connection with illegal activities.
Accounting for Cryptocurrency
In an article, "Cryptocurrency: Bitcoin or Beertokens?" from AccountingWEB , the author writes that a number of U.S. states have issued guidance on how to tax transactions involving Bitcoin, and it can be assumed that other countries will follow suit eventually. According to the article written by Kara Sommers, "In general, for state income tax purposes, the IRS treats cryptocurrencies as property. Thus, transactions using virtual currency are subject to the same rules as barter transactions." Sommers also writes that a recent ruling by the U.S. Commodity Futures Trading Commission classified cryptocurrency as a commodity and that might have an effect on any future rulings by the IRS.
Accounting for cryptocurrency might seem a little confusing at first as they are an intangible asset. Again, we can look at some guidelines around digital assets that the US has put in place to deal with them for direction:
For federal tax purposes, Bitcoins and other crypto assets are considered property. Tax considerations and accounting principles that apply to property apply to them.
- Cryptocurrency is NOT treated as currency to determine losses or gains under tax laws.
- Taxpayers MUST include the fair market value of the digital assets as taxable income when they are used to pay for goods or services.
- The fair market value is determined as of the date acquired; basically, as an accounting treatment it is (virtually) exchanged for U.S. dollars for tax purposes.
- From a tax perspective, a taxpayer can have a virtual loss or gain; for instance, if they bought the Bitcoins when they were at their peak of $1000 or so, they would have a loss.
- Accounting services simply need to keep in mind that for regulatory compliance when accepting Bitcoins as income, they must choose a valuation strategy, place them on the Schedule C or 1120 Form, and reduce by business expenses throughout the year to reduce the risk of major accounting and tax issues.
Of course, the most important accounting practice for digital assets is to record the value of the cryptocurrency at the time you receive it and at the time you “spend” it. In this way, you can accurately calculate gains and losses on your financial statements.
Digital assets are often very complicated and controversial to deal with, especially when they are not regulated by central banks. It will likely take some time for laws and regulations to be developed that work perfectly with digital currencies.
There is no need to be overwhelmed by the accounting and tax issues around digital assets, as long as you implement the right tools and best practices.
Applications for Cryptocurrency Management
Assets like these often don't fit directly into existing accounting software's boxes; however, they can be tracked through integrations with trading platforms such as Coinbase or Gemini. Some companies like Libra Tax are setting up their own software specifically for digital currencies, to track data in a way that is compliant with the IRS.
There is also a cryptocurrency asset tracker service available through tracking website Pricewise . The service is currently only available for Android devices and costs $3.99 per month, but they plan to launch an iOS version soon.
Here are some of the steps you can take to ensure your accounting practices are optimized for handling cryptocurrencies: If you have employees who are paid in cryptocurrency, you must comply with all the applicable rules regarding payroll withholding and tax reporting.
If you receive income in crypto form (whether as payment for services or goods or as a salary), make sure to report it accurately on your tax return Schedule C, which is where self-employed individuals list their business revenue and expenses.
As always, make sure you retain all the records related to your crypto transactions for as long as necessary.
If you purchase cryptocurrency for investment purposes, use those digital assets as a capital asset rather than a personal expense.
Keep in mind that if you want to use digital assets as a capital asset, your capital losses and gains must be calculated against capital gains and losses of other like-kind assets (e.g., stocks, bonds, etc.).
Digital assets are not treated as cash; therefore, if you exchange it for cash or deposit it in your bank account, the full amount is treated as income on your tax return.
Keep an eye out for IRS updates regarding cryptocurrency – the agency has stated that it will be releasing more details regarding how virtual currency is treated for tax purposes.