The digital world is changing a lot. So, you’re probably wondering how to change with it, especially when it comes to your business. And, that may make you think about the latest buzz in finance—cryptocurrency.
If you’re thinking about adding crypto payments to your business dealings, the questions can start stacking up. What is crypto? How do you accept crypto payments? And, how do you factor cryptocurrency into your accounting? Keep reading to learn more about cashing in on crypto.
What is cryptocurrency?
Before we dive deep into crypto payments and how you can use them in your business, let’s take a look at what cryptocurrency actually is.
Cryptocurrency is a form of digital currency that is decentralized and highly encrypted. Decentralized currency is currency that has no central authority controlling the value like the U.S. does with the dollar. The encryption prevents counterfeiting or duplicating the cryptocurrency.
Like true currency, cryptocurrency has an assigned value. Think of it like digital gold. There is value, but the value is not like a $20 bill. The value is assigned at the time of purchase rather than predetermined by the government.
But, the lack of central authority means that there are no government protections for cryptocurrency. Unlike standard currency, the U.S. government does not insure crypto. So, the government cannot step in to return any money that is lost in the event a crypto business is hacked or closes.
Now that we’ve explored what cryptocurrency is, let’s take a look at crypto payments.
What are crypto payments?
Like the name suggests, crypto payments are payments made with cryptocurrency. The digital payments are much like credit card or bank payments, but they are treated differently. Credit cards and bank payments use standard currency (e.g., the dollar). And, credit card companies and banks charge transaction fees to merchants who accept those payments.
Crypto payments, however, are digital and do not have the same transaction fees as credit cards or banks. Some transaction fees are higher, while others are lower. Businesses may use crypto payments to avoid transaction fees altogether or to process payments faster.
Digital currency does not have the same bank timing or credit card timing as ACH bank transactions (e.g., standard two-day timing) and credit card payments. As such, crypto payments may be more desirable for anyone seeking to process payments faster.
On the advantages of accepting crypto payments, Ben Reynolds, CEO and Founder of Sure Dividend, said:
Businesses can save money by utilizing cryptocurrency to receive payments for online purchases since it’s more affordable with lower transaction fees. With blockchain technology, cryptocurrency transactions are more time-efficient, which helps prevent customers from overspending their money since instant transactions allow customers to see more accurate updates on their finances.
But, how do you account for crypto payments in your books if you decide to accept them in your business? Let’s take a look.
Recording crypto payments in your books
Because cryptocurrency can be confusing, you may be wondering how crypto transactions should look in your accounting. Remember how we said cryptocurrency is more like digital gold? Think of crypto as property when recording it in your books—that is how the IRS defines cryptocurrency.
When you record crypto payments in your books, use the value at the time you receive it and the value at the time you spend it. You may receive cryptocurrency through a cryptocurrency market or through a customer. The IRS also determines guidelines for recording crypto for tax purposes.
The IRS guidelines are:
- Do not treat cryptocurrency as true currency to determine losses or gains for tax purposes.
- Include the fair market value of the cryptocurrency as taxable income.
- Determine the fair market value as of the date the cryptocurrency is purchased.
Taxpayers can have virtual losses and gains, depending on the price the crypto was purchased for and the current costs. Record the gains and losses when you purchase or spend the cryptocurrency.
You also need to determine a valuation strategy when recording crypto payments in your books. Why, you ask? Because the IRS requires businesses to record cryptocurrency on Schedule C or Form 1120. Treat cryptocurrency as you would other property on the tax filings.
How to treat cryptocurrency for tax purposes
The IRS requires companies to treat cryptocurrency as property (e.g., an asset) when filing business tax returns. Apply the general tax principles for property transactions to virtual currency transactions.
Use IRS Publication 551, Basis of Assets, to determine the basis of the property when receiving cryptocurrency for goods or services.
Cryptocurrency as taxable income
Any time you receive property in exchange for performing a service, that property is taxable income for the purposes of the IRS. Because crypto payments are digital property payments, you must report the payments as ordinary income. The IRS determines the value of the property based on the fair market value.
Record the fair market value at the time you receive the crypto payment in your tax filings. If you make a payment of cryptocurrency to someone, also record the fair market value at the time you exchange the cryptocurrency.
What is the fair market value of cryptocurrency?
Calculate the fair market value of cryptocurrency by finding the date and time you recorded the transaction in the general ledger. The IRS uses a worldwide index of cryptocurrency to assign a fair market value based on the exact date and time of the transaction. Fair market value is the cryptocurrency price at the time of purchase or sale.
Let’s say you accept a Bitcoin transaction that is valued at $400 at 12:00 p.m. PST on January 1, 2021. The fair market value of that same amount of Bitcoin may decrease to $200 by 12:00 p.m. PST on February 1, 2021. Show a loss in your tax filings due to the decrease of the fair market value over time.
If you choose to accept or exchange crypto payments as part of your business, remain up-to-date with the IRS rules and regulations. And, set up a plan for how you will exchange the cryptocurrency while protecting your business from potential losses. Consider hiring an accountant to help you navigate the world of cryptocurrency to ensure you remain compliant with the IRS. An accountant may be able to assist you with how to accept crypto payments as well.
Recording assets as income is easy in Patriot’s online accounting software. Simply calculate the value of your property and enter the information into your account. Try it free for 30 days today.
This is not intended as legal advice; for more information, please click here.