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In 2008 a new digital currency called cryptocurrency, or crypto, debuted after Satoshi Nakamoto published the infamous Bitcoin whitepaper.
Cryptocurrency intended to put control back into the holder’s hands without bank or government involvement. By 2018, cryptocurrency was still on the rise, leading to a push for businesses big and small to accept cryptocurrency. As of 2022, 32% of companies accept payments in cryptocurrency.
However, before jumping on the bandwagon, it’s worth getting a better understanding of how this digital currency works for business, including the tax regulations and its fluctuating value.
If your startup is considering delving into cryptocurrency accounting, but you aren’t sure how it works, this blog post is for you.
Crypto accounting for startups: The basics
What is cryptocurrency?
Cryptocurrency is a digital or virtual currency designed to work as a medium of exchange. It uses cryptography to secure and verify transactions and control the creation of new units of a particular cryptocurrency. Crypto is guarded by cryptography – the act of obtaining information with complex codes and algorithms.
Cryptocurrencies are decentralized and not subject to government or financial institution control. Transactions are completed from one person to another vs. from one bank to another. The individual owner can track each piece of cryptocurrency by a unique set of numbers.
While cryptocurrency is an alternative to other forms of payment, modern accounting rules and regulations haven’t fully caught up with crypto transactions. This is why it’s essential to understand business accounting fundamentals and how these rules apply to cryptocurrency.
If cryptocurrency is part of your startup business model, you need to understand its primary function, how to record it, and how it affects your business taxes.
Accounting with cryptocurrency
Businesses must document all purchasing or selling of cryptocurrency when bookkeeping. and convert it back into USD (for US-based companies) via third-party apps. Once you’ve determined the FMV and pulled crypto from your wallet, your bookkeeper needs all of the information from the third-party app to reconcile your books.
At Zeni, we require this method to seamlessly integrate all transactions with traditional business transactions and follow GAAP policies. That way, you don’t have to worry about incorrect filing during tax time due to inaccurate crypto recording.
Taxes and cryptocurrency
As of 2022, the IRS still considers all cryptocurrency (or digital assets) held in business as “property” for tax purposes. There are no taxing or accounting standards explicitly for cryptocurrencies, but the IRS still implements taxes on them. It can get complicated quickly if you don’t know what you’re doing.
When you buy, sell, or trade cryptocurrency, you must report it as a gain or a loss. Gains are taxed under the same bracket as a capital gain, while losses recorded can be used as a tax deduction.
If you use cryptocurrency to purchase goods or services, that is considered a taxable event. Any gains made due to this transaction are taxed, and any losses recorded become deductible.
On the other side of the coin, if you accept cryptocurrency as payment, it becomes part of your business income. You are responsible for paying business income taxes as if it were cash, credit, or a debit card used.
Let’s break it down:
Gain: When the value of cryptocurrency used in a transaction exceeds the original value than when traded.
Example: Company X accepts payment of $10 in cryptocurrency for a service. The same cryptocurrency is worth $15 when used to pay a vendor for $10 in raw materials. Company X made a $5 gain that is recorded and susceptible to gain taxes.
Loss: When the value of cryptocurrency used in a transaction is worth less than the original value when traded.
Example: Company X accepts a client's payment of $30 in cryptocurrency. The company then uses the same cryptocurrency to pay a vendor, but the value has dropped to $15. Company X can claim a $15 loss on their taxes for that specific cryptocurrency loss.
Taxable events using crypto:
- Exchanging cryptocurrency for FIAT (government-issued money)
- Paying for goods, services, or property
- Exchanging one cryptocurrency for another
Non-taxable events using crypto:
- Buying cryptocurrency with FIAT
- Donating crypto to a tax-exempt non-profit or charity
- Transferring crypto between wallets
Managing cryptocurrency transactions
The number one rule we feel all businesses should follow when delving into cryptocurrency accounting is organization. In the same way, AP and AR need organized for accurate financial reporting, you must categorize and report all crypto transactions correctly and in compliance with IRS requirements.
Crypto accounting transaction security
When you go to an ATM and deposit cash into your bank account, the bank accounts for that cash is accounted for via the unique code on each bill and is available for use with your debit card. Exchanging crypto for USD is similar but in reverse.
When you use crypto instead of cash, you’re transferring from your wallet to another user's wallet. Simply put, they are bank-to-bank transfers with equal security.
At Zeni, we suggest using third-party apps to convert and store your cryptocurrency in a digital wallet. Think of your digital wallet as your crypto-only bank account. When you decide to exchange and withdraw, most third-party apps allow you to connect a bank account for deposits.
There’s no arguing that cryptocurrency’s blockchain-style security is nearly impenetrable. However, someone attempting to steal information won’t go for the security system itself. They will go for the user just as hackers do when breaking into bank accounts.
Crypto recording and GAAP compliance
In order to follow current GAAP standards for crypto transaction reporting, the moment you buy or sell cryptocurrency you or your accountant need to record the crypto’s FMV (fair market value). FMV establishes your cash basis for that transaction.
When you’ve gathered your cash basis, you can record the transaction under the “crypto transactions” column in your balance sheet. If a client pays you in crypto, you then debit the payment from your crypto column and credit your asset column on the general ledger.
You have two options from there: convert to USD or keep crypto in your crypto wallet. Regardless of how you store your cryptocurrency, you need to take diligent records of the value at the time of purchase or when you sold/used it to purchase a business-related item.
Both banks and cryptocurrencies have high-level security. Crypto depends on blockchain technology, and banks use their powerful security software; the weak link is the user for both currencies.
How zeni can help with crypto accounting
Cryptocurrency can be helpful for startups. It can expand your customer base by offering an additional way to pay or make vendor payments easier if it’s their preferred way of payment. However, we strongly advise delving into crypto slowly if you’re treading unfamiliar territory.
Different aspects of IRS business regulations inform crypto accounting and tax standards. (hence taxing crypto gains as capital gains.) The IRS bases your income on what you present. You risk your business and assets if you submit false crypto recordings.
At Zeni, we have professional experience with crypto accounting and how to record all crypto transactions accurately and adequately. We cannot process crypto on behalf of our clients, but our bookkeeping software integrates with third-party cryptocurrency processors.
We even offer tax services for our clients using cryptocurrency. To provide the best service, we need all the information on your cryptocurrency transaction to record each gain or loss accurately. That’s why we suggest using a third-party processor to keep everything in check and accurate, so there are no issues during tax time.
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