Do taxpayers have to report crypto rewards from credit card usage? How do you protect yourself from the lack of tax law clarity?
Are you at risk when collecting crypto card rewards?
Many taxpayers are concerned about the tax exposure of using crypto-backed credit cards offered by Crypto.com, Uphold, and others. When you use a crypto-backed credit card, multiple events happen simultaneously.
Breaking down crypto card rewards.
First, when you are purchasing a product or service with your crypto card, the activity is not taxable.
Secondly, the credit or debit card issuer sells some of your cryptos on deposit to pay the card bill. The 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 capital loss.
Third, many card issuers offer a reward for using their card. These rewards are often in the form of cryptocurrency.
Should crypto card rewards be reported as income?
Most credit cards offer rewards. These are redeemable when paying for certain transactions such as 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?
A general principle.
The general principle from the tax regulations section 61 reads: 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 applies 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 addressed 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.
Do you have to report crypto rewards?
Does this mean that the taxpayer doesn’t have to report crypto rewards from credit card usage? Well, there is more to it than just comparing the situation to frequent flyer miles.
Are crypto 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 this fine 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 were issued or necessary.
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 rewards reported on a 1099 are considered payouts.
If the credit card company issues a Form 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, however. A taxpayer can be sure not to receive a 1099 if using a foreign credit card.
What makes the entity foreign?
An entity is considered foreign if it is 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 rewards treated as virtual currency?
Is the taxpayer safe if not reporting reward cryptos earned from using 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, and to cryptocurrencies. Virtual currency reporting (now known as digital asset reporting) has become a top priority for the IRS.
What happens if you get audited for crypto 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 crack down?
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 you protect yourself?
Learn more about IRS Guard Dog at CryptoTaxAudit. An ounce of prevention is worth a pound of cure.
DISCLAIMER: Opinions and perspectives of the author, host, and guests. It should not be construed as U.S. taxpayer advice. There are often multiple interpretations of tax law. Various strategies may be suited to specific individuals and for particular situations. Seek out professional tax, legal, or financial advice from CryptoTaxAudit or from other reputable companies.