Bitcoin and other cryptocurrencies have a reputation for extreme volatility. In the past 12 months alone the price of bitcoin has risen more than 70% to all-time highs and dropped in excess of 55%. Despite these wild price swings, adoption of the coin has shown much steadier growth with more businesses accepting crypto payments on a regular basis.
About one-third of small- to mid-sized businesses now accept bitcoin as a form of payment and many larger retailers have made it easier for customers to buy products with the coins.
But before following suit, companies must carefully consider some important issues related to the unique treatment of cryptos by the IRS and examine what impact sudden swings in their value could have on a firm’s financial health.
Tax implications: Track those coins
When a company decides to accept cryptocurrencies it must take important steps in the checkout and tracking processes to ensure they are properly handled as required by the Internal Revenue Service (IRS).
Cryptocurrencies aren’t treated like currency by the IRS, even when they’re used for payments. Instead, they are viewed as assets that attract capital gains taxes if eventually sold at a profit.
Cryptos have become a focus of tax inspectors. This is evident from the fact that that questions on coin trading appear on the first page of individuals’ tax forms. This suggests that the IRS is likely to take a more hands-on approach to checking discrepancies that may exist between any payments processed and what’s declared in tax statements.
It’s important to be aware, then, that keeping evidence of when crypto is received as a payment will be critical. The records that must be kept include:
- When the cryptos were received
- The amount of crypto received – particularly the number of coins
- The price of the crypto at the time when it was received
- Any fees paid when processing a crypto payment
- The cost of the product that the crypto purchased
When measuring gross income and capital gains taxes, this information will help the IRS determine what type of payment was processed and when. Also, it will provide a rundown of the products purchased to demonstrate that the coins were not used to buy illegal items.
Tracking payments to this level of detail needn’t be a burden for company finance departments that use a digital, end-to-end payment solution. This will help streamline record keeping processes, making the preparation of tax documents at the end of the year much easier.
Determine how sales proceeds will be handled
Companies that receive crypto have to be transparent about what they plan to do with the coins once a sale has processed.
There are several options when it comes to unloading or keeping the coins. Some companies will want to immediately cash them into dollars, securing gains if possible. Others will hold on to the cryptocurrencies until at least a year passes to avoid paying short-term capital gains taxes. Or they may prefer to hold onto the coins, hoping they’ll appreciate and result in significant long-term gains.
The reasons for accepting crypto in the first place will be a good indicator of what action to take post-payment. Say a business is looking to draw in additional customers by using crypto payments as a selling point. It may want to cash out immediately since it doesn’t believe in the long-term benefits of the coins. A big believer in the digital currency may want to hold the coins in the hope their value will appreciate.
Either way, a conversation with financial planners and accountants before taking the plunge into accepting crypto is recommended.
Remember, each of these strategies will have implications for capital gains taxes. Clients who immediately sell the coins will register the investment as a short-term gain on their returns form, while those who hold their assets for longer than a year will pay long-term capital gains taxes should their assets appreciate or should they cash out at a profit.
Avoid overexposure to coins
It’s not unusual for investors to become so enthused with an idea or concept that they commit all their energy and focus to it. Doing so with cryptos carries unique risks.
High exposure to coins can be particularly problematic for clients who want to hold onto their crypto in the hope they will appreciate in value. Coin prices can drop, resulting in profit losses from sales. This can result in volatile swings in your company’s profitability or, potentially, liquidity.
It’s vital that businesses always have access to liquidity; you never know when a crisis will arise that pinches resources and requires immediate funding. Yet, while bitcoin and other cryptos can be easily bought and sold, that does not mean the markets for them are particularly liquid. Since the price of cryptos can drop significantly in a moment, business owners need to be careful they don’t cash out at a time when values suddenly depreciate. That could result in an inability for the payments to cover costs, impacting an owner’s ability to maneuver in a crisis.
Instead, it’s advisable that owners determine what proportion of the business they are comfortable exposing to potential losses from their crypto holdings. As prices rise, they may want to cash out to reduce that exposure and keep it in line with the agreed mark.
While this strategy prevents owners benefiting from further appreciation in the coin, it at least locks in gains that can help avoid a liquidity crunch. Note, there are tax implications associated with selling high, especially if crypto prices reverse again.