In the digital world, customers and clients may want to pay you with digital currencies. Bitcoin, Ethereum, USDC, Stellar Lumens, and other digital assets may be down from their peak values, but there’s still plenty of activity happening on their blockchains, including business payments. Here’s a closer look at what you need to know about using digital currency as a form of payment when you’re a solo- business owner.
What are Digital Currencies?
Digital currencies, commonly called cryptocurrencies, are a kind of digital money. Behind the scenes, most digital currencies operate using a software called blockchain, where many computers around the world work together to track transactions and ownership. With blockchain technology, most transactions require a fee paid to the computers responsible for maintaining the cryptocurrency networks.
Popular Digital Currencies
Some of the most popular digital currencies are household names, including Bitcoin, Ethereum, Solana, Binance Coin, XRP, Cardano, Dogecoin, and many more. Thousands of cryptocurrencies exist, though only a handful are useful for legitimate business transactions.
You’ll need a digital wallet to send, receive, or store cryptocurrencies. You can use a free software wallet or pay for a more secure hardware wallet that stores your cryptocurrency keys offline.
Fact: Stablecoins are crypto assets tied to the value of an underlying fiat currency. For example, USD Coin and Tether USD are always worth one dollar per coin if the currencies operate as intended. However, fraud and other risks can result in the currencies losing value.
Digital Wallets and Digital Asset Storage
Every wallet has a public key, used to send and receive cryptocurrency, and a private key, used to unlock the wallet and enable transactions. Keeping your private key secret is critical, as anyone with this code can take any cryptocurrency stored in your crypto wallets with no protections to ensure you get your money back.
Crypto transactions are all one-way, and there’s no method to reverse transactions once they’re sent to the blockchain. If you’re entering cryptocurrency transactions, it’s a good idea to double or even triple-check to ensure everything is accurate before sending.
Are NFTs the Same as Digital Currencies?
NFTs are another type of digital asset, but represent ownership of an image, video, video game asset, or nearly anything else tracked online. They’re also stored in cryptocurrency wallets but don’t have the same type of marketplace and payment value as cryptocurrencies.
Accounting and Tax Implications of Crypto Payments
For taxes, getting paid in cryptocurrency is similar to getting paid in stock. It’s essential to track the value of your currency when received, as you’ll need that information for capital gains taxes when you convert the currency into United States dollars.
For example, let’s say your business does a $1,000 project for a client who wants to pay you in Bitcoin. You do the math and find that based on the current market value of Bitcoin (BTC), the payment value is 0.00003 BTC. Your client sends you the Bitcoin, and you receive the equivalent of $999 in BTC after network transaction fees. Note that fees vary based on network activity and the market value of cryptocurrencies constantly fluctuate, so this estimate is just an example.
| Activity - Accounting Treatment | In USD (For Accounting) |
|---|---|
| Payment Value - Revenue | $1,000 |
| Network Fees - Expense | $1 |
| Deposit to BTC Wallet | $999 |
Now you have 0.00003 BTC in your Bitcoin wallet. But over the next few months, the value of your Bitcoin grows to $1,100. You decide to sell and withdraw the entire amount. After fees, you receive $1,095.
| Activity - Accounting Treatment | In USD (For Accounting) |
|---|---|
| Sale Amount | $1,100 |
| Network and Exchange Fees - Expense | $5 |
| USD to Bank Account - Asset | $1,095 |
| Investment Gain Recognized - Income | $96 |
Those few transactions are easy enough to comprehend, but the accounting and taxes are a little more complicated. Here’s what you must do to handle your bookkeeping and taxes appropriately.
Accounting
- Receiving the cryptocurrency payment: When you receive the payment, you mark the invoice as paid. Instead of increasing your cash balance, however, you would add the value of your Bitcoin to a different short-term assets account, perhaps named “Cryptocurrency Holdings” on your general ledger. You would also add the cryptocurrency network fee as a business payment expense of $1.
- Converting the cryptocurrency to dollars: When you sell the cryptocurrency for dollars, you would lower your Cryptocurrency Holdings account balance to zero and increase your cash on hand by the amount received after fees. Again, the fee would be added to your ledger as a payment or transaction expense, this time for $5. If you regularly transact in crypto for your business, you may want to add an account for your preferred cryptocurrency exchanges, such as Coinbase, to work similarly to a bank account for tracking.
- Withdrawing the dollars to your business bank account: When you transfer the funds to your bank account, you lower your cash balance at your crypto exchange in your bookkeeping records and increase the cash balance in your bank account. Now, the funds work like any other dollars held by your business.
Income Taxes and Capital Gains
A couple of transactions here have tax implications. You must recognize business income, as you would with any business payment. In addition, you have two expenses and capital gains.
- Payment from your client: When you accept the payment from your client, you recognize $1,000 in revenue and $1 in expenses. Depending on how your business is structured, that comes to $999 in taxable income.
- Sale of cryptocurrency: When selling the cryptocurrency, you need to recognize any gains (or losses) as an investment gain. The cryptocurrency increased in value by $101 while you held it, but you paid $5 in fees to sell it for dollars. That yields a net $96 gain, profits your business must recognize for tax purposes.
Translating this information into your tax return can be complex. If you’re unsure how to proceed, consider working with a trusted crypto tax expert.
Note: Collective doesn’t advise on the impacts of receiving digital currency or converting holdings to fiat money.
Legal Considerations of Payments Using Crypto
Accepting cryptocurrency payments is legal. However, the laws regarding cryptocurrency transactions and taxes are rapidly evolving. If your business uses crypto assets, Americans should stay apprised of the latest guidance from the Securities and Exchange Commission (SEC), Federal Trade Commission (FTC), Internal Revenue Service (IRS), Commodities Futures Trading Commission (CFTC), and any other regulating bodies.
For individuals and businesses in the United States, most exchanges require Know Your Customer (KYC) information, including your Social Security number or other taxpayer identification number, a copy of your photo ID, and contact details. This information is used for identity verification, tax reporting, and anti-money laundering purposes.
Risks and Benefits of Digital Currency Payments
If you use cryptocurrency correctly, it’s generally a very secure payment method. The blockchain acts as an irrefutable ledger showing who owns which currencies. However, as with any payment form, it’s important to understand the risks.
- Incorrect or incompatible wallet address: If you give your client the wrong cryptocurrency wallet address or give one for a different blockchain, your crypto won’t show up in your wallet as expected. For example, you can’t send Ethereum to a Bitcoin wallet.
- Cybersecurity and fraud: Hackers are on the lookout for cryptocurrency wallet information. Your cryptocurrency holdings are as good as theirs if they can access your private keys. Also, fraudsters regularly target cryptocurrency users with scams.
- One-way transactions: If you make an error when sending cryptocurrency or your client makes a mistake, there’s generally no way to fix it. Transactions are permanent. No financial institutions or credit card companies will reverse the transaction or help you. If the funds are gone, they’re gone for good.
- Cryptocurrency values and volatility: Many have made millions of dollars with cryptocurrency, but others have experienced significant losses. When holding crypto, there’s always a risk that the value will dramatically decrease in a short period.
- No government backing: Unlike fiat currencies, like US dollars and Euros, there’s no government backing for cryptocurrencies. Crypto derives its value from the community using the currencies.
Practical Tips for Managing Digital Currency Payments
If you decide cryptocurrency is a helpful tool for your business, you could be making a good decision. Cryptocurrency can cheaply and quickly facilitate payments from clients abroad, to contractors overseas, and much more. However, it’s essential to understand how crypto works, the accounting and tax implications, and manage your risks.
To ensure a positive experience with cryptocurrency, consider the following tips:
- Establish dedicated wallets and accounts for your business: Just as you should keep your personal and business bank accounts separate, you should keep your business crypto separate.
- Always double-check wallet addresses: Due to the nature of cryptocurrency transactions, it’s wise to double-check, or even triple-check, before clicking the send button or sharing your wallet address.
- Prepare your accounting ledger in advance: Set up accounts to track cryptocurrencies on your balance sheet, as well as capital gains and crypto-related expenses for your profit and loss statement.
- Set aside funds for taxes: When you get paid by a client, you should plan for taxes. When you sell cryptocurrency for a gain, you should consider setting more aside to cover capital gains taxes.
- Plan for tax reporting: Tax reporting for cryptocurrency can be highly complex. Understand your options and review tools to help you prepare tax statements, including for income earned through staking (network fees you earn for holding an eligible cryptocurrency).
It’s also imperative that you follow cybersecurity best practices. Use a unique password on every website and keep your computer and phone updated with the latest security patches. Keeping your apps updated fixes known bugs and security holes that digital bad guys try to use to steal your money and data.
Bottom Line: Cryptocurrency Payments for Small Business
Cryptocurrencies offer an interesting opportunity for business payments. In fact, the Stellar Lumens currency is designed for cheap and fast international payments. However, crypto isn’t without its risks. Furthermore, tax and accounting implications can turn cryptocurrency payments from a fun concept into a bookkeeping headache.
If you weigh the pros and cons and decide cryptocurrency payments make sense for your business, be sure you fully understand how cryptocurrencies work and how to handle accounting and taxes. Otherwise, you could stumble into a cryptocurrency nightmare.
