Find out if taxpayers have to report crypto rewards from credit card usage and how to protect yourself from unclear tax law.
Many taxpayers are concerned about the tax exposure of using a crypto-backed credit card offered by Crypto.com, Uphold, and others.
When you use a crypto-back credit card, multiple events are happening.
Let’s Break Crypto Credit Rewards Down
First, you are purchasing some product or service. This is not taxable.
Secondly, the credit card issuer sells some of your cryptos on deposit to pay the credit card bill. This gain on the sale of crypto is taxable as either a short or long-term capital gains event. The gain is the difference between the sale price and the original purchase price. If the gain is negative, then it is commonly called a loss.
Third, many card issuers offer a reward for the use of their credit card. These rewards can be in the form of cryptocurrency.
Should Crypto Credit Card Rewards Be Reported As Income?
Most credit cards give point rewards, which are redeemable in paying certain transactions, travel services, products, or cash paid against the credit card bill. Do the credit card companies have to report these distributions? Does the taxpayer have to report them on a tax return?
The general principle from the tax regulations section 61 is: A taxpayer must include in gross income all income from whatever source derived unless specifically excluded by law (Code Sec. 61(a)). Gross income includes income realized in any form, whether in money, property, or services. Thus, income may be realized in the form of services, meals, accommodations, stock, or other property, as well as in cash (Reg. Sec. 1.61-1(a)).
When trying to determine if a section of the law would apply to cryptocurrency transactions, it is helpful to find similar situations to see how the laws and regulations are applied to that situation. For example, how are frequent flyer miles taxed?
How Are Frequent Flyer Miles Taxed?
IRS announcement 2002-18 partially addresses the question: should the employee pay taxes on the frequent flyer miles earned the employer pays for business travel? In a backhanded way, the IRS says they do not have to be reported on the income tax return.
The announcement acknowledges that for lack of official guidance, the IRS “has not pursued a tax enforcement program with respect to promotional benefits such as frequent flyer miles.” In effect, the IRS conceded that they weren’t fully enforcing the law.
Does this mean that the taxpayer doesn’t have to report crypto rewards from credit card usage? Well, there is more to it.
Are Crypto Credit Rewards Payouts or Rebates?
In 2012, Citibank issued 1099-MISC tax forms to its customers when rewards in excess of $600 were awarded. Citibank’s action forced its clients to report the income on their tax returns. The clients weren’t happy.
Why did Citibank do this?
The IRS assesses a fine of $250 per 1099-MISC not issued when a company intentionally disregards the reporting regulation. This would have been a staggering penalty if the IRS enforced against Citibank. Citibank issued the 1099’s not out of clear IRS guidance but out of financial fear of other IRS rules.
Other U.S. credit cardholders took a different approach. They treated the rewards as a rebate rather than a payout. A rebate is just a price reduction on the price of goods sold. Rebates aren’t reported as income, thus no 1099 forms.
If crypto credit card rewards are treated as rebates, then there is no income tax on the receipt of the coins.
The coins would have a cost basis of the fair market value in USD on the date that you receive unrestricted ownership of the coins. These coins do not need to be reported on your tax return.
Crypto Credit Rewards Reported On A 1099 Are Considered Payouts
If the credit card company issues a 1099 on the rewards, the rewards must be treated as a payout and reported as income.
Foreign entities are not required to issue 1099-MISC forms to U.S. taxpayers. A taxpayer can be sure not to receive a 1099 if using a foreign credit card.
What makes the entity foreign?
It must not be incorporated in or have an office in the U.S. If no 1099-MISC is issued, then IRS Announcement 2002-18 states that the IRS would not penalize the taxpayer who doesn’t report the rewards.
Are Crypto Credit Rewards Treated As Virtual Currency?
So is the taxpayer safe not reporting reward cryptos earned from the use of a credit card?
In 2014, the IRS issued notice 2014-21, which defines virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.”
The term “store of value” is very broad. It could be applied equally to frequent flyer miles, credit card points programs, grocery store loyalty cards, as to cryptocurrencies.
Virtual currency reporting has become a top priority for the IRS.
Now on Form 1040, each taxpayer is asked, “did you receive, send, sell, exchange, or have any financial interest in virtual currency? Yes or No?”
We believe that 75-90% of U.S. taxpayers should check YES.
What will happen If I get Audited For My Crypto Credit Rewards?
Does this mean that the IRS will be increasing enforcement of reporting of credit card rewards? Or will the IRS be selective in which virtual currencies they crackdown?
The tax law is not clear. An argument could be made that IRS Notice 2014-21 doesn’t constitute adequate guidance on credit card reward cryptos treatment. This would not be a strong argument.
A taxpayer will be subject to the discretion of the IRS auditor whether these rewards are taxable as income unless the auditor is appealed.
A taxpayer choosing not to report the rewards should note this uncertain tax position on Form 8275 to avoid a 20-40% accuracy penalty if audited.
How Can Taxpayers Protect Themselves From A Crypto Tax Audit?
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