Will owning Bitcoin disqualify you from receiving government benefits?

Some years back I wrote an article about Crowdfunding, and how funds raised can count towards your gross income.

"Crowdfunding sites generally use a payment processor like PayPal to handle the donations, and PayPal is responsible for reporting information to the IRS on payments of $20,000 or more made up of 200 or more transactions, which creates a 1099-K form. If you earn other income through PayPal, perhaps from an online business, that income could be combined with your crowdfunded money to create a bit of a financial mess.

This is a lesson Jay Lake, a science-fiction author, learned the hard way. Friends and family raised a hefty $48,000 for an experimental process to aid in Jay’s colorectal cancer treatment via a YouCaring.com campaign. When Lake received his 1099-K form from PayPal for his book royalty income, he was surprised to see the donated funds included as income as well."

It was no surprise I received comments like: "Does it matter if you have to claim the money as income and pay a little tax on it? After all, it was “free money,” right”? 

The problem really is not centered around having to pay taxes on the funds, but more so having the funds being included in your gross income at all. This may result in you being disqualified or limited from certain income-based government benefits programs like Medicaid, Social Security, and Disability.

If you receive disability, social security, a health insurance tax credit, or any other type of income-based assistance, the extra income could push you over the income limit for your assistance -- making you ineligible for the program. This loss could result in additional financial stress to your life. Even if you’re not eligible for one of these programs, the additional income could bump you into a higher tax bracket.

Why the IRS Cares About Crypto

This same theory can be carried over to owning Bitcoin, or any other cryptocurrency. The IRS is not likely to turn a blind eye on collecting taxes on the millions of dollars on crypto trading each year.

While you may not receive a 1099-MISC from each of these investments made, it is still your responsibility to report any earnings received. Just as you would if the funds were in your checking, savings, or other investment account, earnings must be included as income.

Similar to how an investment in stocks work, the amount you purchased the investment for is your cost basis. This amount includes any fees associated as well.

While you hold the investment, you only include in your income dividends earned, not the growth. For example, if you purchased $1,000 of crypto, and the purchase cost you $5 in fees, your costs basis would be $1,005. If that investment grows to $2,500, and you are still holding it, you do not own anything.

However, once you sell it, you owe taxes on the difference between the purchase price and the sell price. If your crypto has increased in value to $2,500, then you will owe taxes on $1,495 ($2,500-$1,005).

Sounds pretty easy, right? Kind of. Often times when you trade crypto, you end up transferring the funds to a wallet on a different network. There are a few reasons an investor many choose to do this. Maybe another platform allows for low-rate loans hedging the crypto, while another may pay a higher dividend for coins sitting in the account. Either way, fees may be associated with the move, and often time the cost basis does not get tagged with the move.

When an investor sees a good amount of growth in a fund, they may opt to shave off some of the gains, waiting for another market dip to buy back in. This moving and shaking makes tracking cost basis rather difficult. It can also trigger a taxable event if a sell, or conversion, took place.

Some US based crypto platforms send out a 1099-MISC but may only include the sell amount. One investor reported receiving a tax form from Coinbase, a cryptocurrency exchange platform, totaling over $12,000 being reported to the IRS. However, after calculating the cost basis and fees, the taxable amount was less than half that.

Coinbase's disclosures state: "Users are solely responsible for reporting and paying any applicable taxes arising from transactions" and "Coinbase shall report information with respect to your transactions, payments, transfers, or distributions made by or to you with respect to your activities" "to a tax or governmental authority to the extent such reporting is required by applicable law."

But what does this have to do with income-based aid? Depending on the growth, basis, and dividends, your income may increase significantly. This can, in turn, disqualify you for many of those government assisted programs.

These programs often require you to report any accounts or assets you own. Since cryptocurrency is an asset, reporting it is a requirement, even if it is housed on a foreign exchange.

I have read countless responses and comments from investors suggesting that since their account is housed on a foreign exchange, therefore not producing a tax document, there is no real need to report it.

If you feel that way, then “say hello to my little friend”, Al Capone, convicted of 22 counts of tax evasion in 1931. One of the first items on the Form 1040, just under your name and address, is the question, “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” In case you are unsure, it is talking about crypto. If you answer yes, then you must report it. Answer no, and it can be called evading taxes.

It is important to consider how crypto investing may affect your overall financial life, and make sure to check for income and asset limits for any programs you are involved with. The overall volatility with digital assets means high swings up and down. One day you may be over the asset level, another day you may not. How will this affect the benefits you rely on?

Michelle holds the financial designations of ChFC®, CRPC®, CEPF®, FPQP™, CFF, CCC, CFHC, is a Registered Investment Advisor Representative and President of Personal Money Planning. She is writes Fix Your Budget blog, and has over 28 years of experience in the financial industry.