As the popularity of cryptocurrency continues to grow, more and more donors are making cryptocurrency donations. As a result, cryptocurrency donations can provide significant tax benefits to philanthropic donors. Additionally, embracing cryptocurrency donations could enable charitable organizations to reach an entirely new class of donors who prefer to give in non-traditional ways. A basic understanding of cryptocurrency and the current rules that apply to accepting cryptocurrency donations can help nonprofit organizations prepare to capitalize on this new form of donation.
What is cryptocurrency and how does it work?
The underlying infrastructure behind a cryptocurrency is a blockchain. The blockchain is a shared database that functions as a digital ledger. Each transaction that occurs is recorded on a “block” of data. This tracks the asset as it is traded. Even though the database can be accessed by anyone at any time, it is extremely secure because each transaction is encrypted.
The Internal Revenue Service (IRS) defines cryptocurrency as a “type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger.” It functions like any other medium of exchange that can be used to purchase, sell, and store value. Unlike a traditional currency like the U.S. dollar, cryptocurrencies are exclusively digital and are not backed by a sovereign government. Some of the better-known cryptocurrencies include Bitcoin, Ethereum, and Litecoin.
The Pros of cryptocurrency donations
- Transparency – Since the blockchain is public, anyone can see how the currency is being traded. Cryptocurrencies are among one of the most transparent ways of exchanging value.
- Cost and Time Efficient – For most transactions that occur on the blockchain, they go through quickly and can be seen on the blockchain within the next day. Without a conventional third party to monitor each transaction, this can save organizations a substantial amount of processing fees.
- Avoids Capital Gains Tax –The IRS has confirmed that when a donor gifts cryptocurrency to a charity, the taxpayer does not have to pay any capital gains tax as a result of the donation.
The Cons of using cryptocurrency donations
- Stability: Cryptocurrencies are still fairly new and the market volatile. The value of the currency can rise and fall dramatically, making it more risky and unpredictable than traditional currencies. Furthermore, the laws surrounding cryptocurrency are inconsistent among jurisdictions which raises uncertainty about the cost of future regulatory compliance.
- Security: As a purely digital technology, cryptocurrencies are subject to numerous cybersecurity issues. Keeping up with enhanced cybersecurity measures to protect cryptocurrency can potentially be costly for an organization to maintain.
- Environmental and Social Costs: As climate change and social justice issues come into focus, the environmental and social costs of doing business have become increasingly important to many businesses and consumers. In accepting cryptocurrency donations, nonprofits should keep in mind that cryptocurrency mining and processing of transactions can consume enormous quantities of energy and that the efforts of digital “miners” also undergird the process of validating cryptocurrency.
How is cryptocurrency regulated?
The popular appeal of cryptocurrency is that it is less regulated than traditional financial markets. IRS guidance says that it will treat virtual currency as “property” for tax purposes. IRS guidance also addresses frequently asked questions regarding how existing tax rules apply to virtual currency transactions. However, this will likely soon change, as the U.S. and other jurisdictions more aggressively seek to thwart its misuse and impose new regulatory regimes governing cryptocurrencies. Nonprofit managers and philanthropic donors utilizing cryptocurrency as a medium for charitable giving should stay on top of regulatory developments for this new form of exchange.
Best practices for cryptocurrency charitable donations
Documentation Requirements for Cryptocurrency Donations.
To receive a charitable deduction that reduces the donor’s federal income tax, the donor must do the following:
- Cryptocurrency donation of $250 or less: The donor should obtain and maintain a receipt from the charity that includes the name and address of the charity, the date of the contribution, and the type/amount of cryptocurrency and the fair statement regarding whether goods or services were received in exchange for the donation.
- Cryptocurrency donation of $500 or more: The charitable organization receiving the cryptocurrency donation must provide the donor with a contemporaneous written acknowledgment so that the donor may properly claim the tax deduction.
- Cryptocurrency donation of $5,000 or more: The charitable organization may be asked by the donor to acknowledge receipt of the gift by signing Form 8283. This does not represent an agreement on the value of the property.
Regardless of the value of the donation, the donation receipt must state whether any benefits were provided in exchange for the gift and if so, the fair market value of the benefits provided.
Donation Valuation and Appraisal Requirements.
The amount the donor can deduct depends on how long the donor has held the currency. If the donor has held the currency for over a year, the contribution is equal to the fair market value of the currency at the time of the donation. If the currency has been held for less than a year, the contribution is the lesser of the donor’s basis (cost plus adjustments) in the currency or the currency’s fair market value at the time of the contribution.
Tax Reporting Requirements.
A charitable organization should treat a cryptocurrency donation as a non-cash contribution. These are reported on its annual return in Form 990. If the organization sells, exchanges, or otherwise disposes of the cryptocurrency within three years of receiving it, it must file a Donee Information Return, Form 8282.
Cryptocurrency Gift Acceptance Policy.
Due to the lack of federal guidelines, charities should implement their own gift acceptance policies that will describe how they will handle crypto-based donations. Because cryptocurrency is highly volatile, most nonprofits will want to liquidate the cryptocurrency gift upon receipt. There are several companies that provide this service including Coinbase and Bitpay.
As the use of cryptocurrencies increases and the regulatory scheme evolves, the nature of how nonprofits and charitable donors utilize it will inevitably change. In the meantime, organizations and donors must be aware of both the risks and rewards that are involved in accepting a non-traditional currency like cryptocurrency.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.