The Internal Revenue Service taxes foreign currencies at their value in dollars, which can create recordkeeping and exchange challenges. You may have to pay taxes on gains if you make a profit on exchanging currencies. You must keep detailed records and note the exchange rates used in case you are audited by the IRS.
Foreign Earned Income
Earned income is taxed at its value in dollars on the day you receive it. This requirement applies to all businesses owned by U.S. citizens, even if they are based in another country. You must keep a record of the exchange rate you use to calculate your journal entries. Use IRS Form 2555 to report your foreign earned income for the year. If you are not itemizing deductions on your tax return, you may use the shorter Form 2555EZ.
Currency Trading Markets
The tax rate on a foreign currency trade depends on the type of exchange contract you have executed. Ordinary exchange contracts are taxed at the ordinary capital gains rate. The rate is based on the length of time the currency was held. If you hold the currency for one year or more before selling it, the gain will be taxed at the long-term rate. Gains on futures contracts are split 60/40 between long-term and short-term capital gains rates.
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Tax on Currency Exchanges
If your company exchanges currency at a profit, it must pay tax on the gains it realizes from the transaction. The type of taxes on currency trading depends on the form of currency the company holds. Basic currency is taxed at ordinary income rates no matter how long the company holds it before selling. Currency held for investment purposes is taxed at capital gains rates.
If the company has held the currency for more than one year, the gain is taxed at the long-term capital gains rate. The company will be taxed at the short-term capital gains rate if it sold the currency within one year of its purchase date. Stocks, bonds and other investments the company holds in other currencies are taxed as if they were valued in dollars.
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Personal Exemptions for Exchanges
To prevent unnecessary paperwork, the IRS exempts certain small currency exchanges from taxation. You and your employees do not have to report direct exchanges of less than $200 made for personal reasons. This allows you to exchange currency while vacationing in another country without worrying about taxes when you exchange the money back into dollars upon returning to the U.S.
Bitcoin and Taxes
With the rise of Bitcoin, you may be wondering whether this currency is considered foreign for tax purposes. After all, there are foreign currency exchange rates for Bitcoin. According to the team at Golding Lawyers, if you and your United States dollars are located in the United States, nothing about the Bitcoin you buy is considered foreign. This is not the case when the Bitcoin is held in an offshore wallet; then, it is subject to Foreign Account Tax Compliance Act reporting.
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However, they also note that when Bitcoin is being used to purchase items, the IRS views this as a transfer or exchange of one property for another, rather than a simple payment transaction. Thish leads to capital gains questions. It's best to consult with a tax advisor if you deal in Bitcoin.
