The basics to keep in mind when filing your tax returns involving cryptocurrencies this year.
From the CMC Editorial Desk: It’s… taaaax season. Before you panic, what do you need to know as you’re filing returns on your crypto? Find out more about the current landscape, trends and to-dos in this article.
With all the excitement and opportunities around cryptocurrencies, it might be easy to forget about crypto taxation. According to Uncle Sam, cryptocurrencies are classified as property. This means just about every virtual currency transaction from mining, spending to trading and exchanging cryptocurrencies, are taxable events for U.S. tax purposes.
With cryptocurrencies’ value constantly changing, keeping track of all that data could be a nightmare come tax time.
From 2013 to 2015, less than 900 people each year reported Bitcoin transactions to the IRS. That’s out of millions just counting the number of users on Coinbase alone.
While paying taxes can at times be painful, it is very important that you include your crypto-trading activity with your tax return. A lot of traders are convinced that because of the anonymous, decentralized nature of Blockchain and cryptocurrency transactions, that there is no way for the government to know about their cryptocurrency transactions.
Unfortunately for these people, this is just not true. The Blockchain is a distributed public ledger, meaning anyone can view the ledger at any time. Documenting and understanding an individual’s activities on that ledger comes down to associating a wallet address with a name.
If you choose not to file your gains and losses, you will be committing blatant tax fraud to which the IRS can enforce several penalties, including criminal prosecution, five years in prison, along with a fine of up to $250,000. Below are charts for both long-term & short term capital gains for your reference:
Requests for Regulatory Clarification
The first IRS tax guidance for cryptocurrencies was introduced March 2014. Various professional, regulatory and governmental bodies have expressed needs and concerns to the IRS related to clarification regarding the existing tax regulations for cryptocurrency.
The AICPA, which is the world’s largest association of accounting professionals, asked the IRS to issue immediate, updated guidance regarding the tax treatment of cryptocurrency transactions early in 2017.
The American Bar Association of Taxation has also formally asked the US Internal Revenue Service to create a safe harbor for investment gains realized from cryptocurrency hard forks.
Even members of the Senate Finance Committee and the House Ways and Means Committee sent a letter to the IRS requesting that it clarify the rules on cryptocurrency taxes and clarification as to why it issued a broad summons for Coinbase user data in 2016.
Rather than release any further guidance, the IRS has focused on enforcement actions around the preliminary rules released during 2014.
1099-Ks and John Doe Audits
The IRS has demonstrated it intends to enforce existing 1099 reporting rules on cryptocurrency exchanges, but it has not followed up by providing clarity regarding those rules.
The IRS has already forced Coinbase and Gemini to report users on form 1099-K.
The 1099-K lacks the cost basis details required to capture an accurate capital gain and loss calculation that would determine taxable income for the IRS. This is because 1099-K’s do not report the relevant cost basis data necessary to accurately calculate capital gains and losses. Additionally, this form does not reconcile trades across multiple exchanges.
This is why investors are turning to experienced cryptocurrency CPAs for assistance for accurate portfolio calculations, tax filings and advisory related to documentation and future tax code developments.
Gearing Up For Tax Enforcement
Late last year, America, the U.K., Canada, Australia, and the Netherlands formed an International Task Force called the Joint Chiefs of Global Tax Enforcement with the goal of sharing intelligence to track down tax evaders. Their specific targets include offshore accounts and cryptocurrencies.
The Australian Tax Office has also recently warned Australians to declare their annual returns from virtual currencies. This is something like what other regulatory agencies are doing around the world.
The tax-collection agency of Israel isalready actively targeting cryptocurrency traders and investors in in order to reduce tax evasion. Some of the measures taken include sending notice letters to individuals suspected of not reporting their earnings from cryptocurrency trading.
It is clear that cryptocurrency has been on the radar of governments around the world.
With that in mind, a document has been signed by those in attendance at the most recent G-20 conference agreeing that the member countries will come together on the issue of cryptocurrency taxation with final plans set to be revealed in 2020.
Future Crypto Tax Trends
It is clear that both the United States and international tax agencies have prepared for enforcement against non-compliant cryptocurrency investors and in some cases, this has already been implemented. We expect to see this trend increase in the future. There have been indications that countries will attempt to work together to internationally enforce compliance across exchanges and investors.
In the future we may also see social media increasingly used to catch tax evaders. According to the IRS’s National Office of Procurement, the agency is planning to analyze social media platforms to catch tax evaders.
It is highly likely that soon the IRS will include a question on form 1040 like the questions regarding offshore financial accounts. This would require taxpayers each year to check a box denoting whether they traded or owned cryptocurrencies during the taxable year. This would also require people to certify on their tax return explicitly whether they owned cryptocurrency.
Eventually we may see court cases that can dictate future treatment of certain scenarios such as like-kind exchanges. A like-kind exchange under United States tax law, also known as a 1031 exchange, is a transaction or series of transactions that allows for the disposal of an asset and the acquisition of another replacement asset without generating a current tax liability from the sale of the first asset. As a result of future enforcement actions and clarification of reporting requirements, we also expect a higher level of compliance across investors in the future.
What Investors Need To Do To Protect Their Assets
Learn The Rules Before You Play The Game
According to the IRS, like-kind exchange rules have not been explicitly permitted for cryptocurrency trades. Since cryptocurrency was designated as property in 2014 by the IRS with no stipulations for like-kind exchanges every crypto transaction is taxable.
All too often, I meet new potential clients at Camuso CPA that are actively investing in cryptocurrency who are not aware of the tax implications as they relate to their portfolio. This can lead to negative results such as not planning properly for tax liabilities.
Investors may be forced to liquidate a large portion of their portfolio in a bear market to cover tax liabilities imposed on large volumes of active trades made during a bull market. Investors may also, leave money on the table by not optimizing their portfolio for taxes during bear markets. Be sure to deeply consider the tax implications to any investment, trading or business decision.
Record-keeping is Key
Due to the tax implications surrounding cryptocurrency, the nascency of the asset class along with the general nature of cryptocurrency, proper record-keeping is of the highest priority when preparing documentation for tax purposes.
Most cryptocurrency exchanges are currently operating in a regulatory gray area. We recommend that taxpayers download their transaction histories from every exchange that they had activity on for the applicable tax years.
Unfortunately, it is very common to see new clients who do not have access to all their relevant exchange and non-exchange data due to various circumstances such as exchange shut downs, lack of data reported by exchanges or other related scenarios. For these reasons, I recommend downloading all the relevant data outlined on a quarterly basis.
Work With An Experienced Crypto CPA
The IRS established a broad tax policy that includes extensive reporting requirements for taxpayers. Many cryptocurrency traders, investors and miners are facing some of the most challenging tax seasons of their lives.
When it comes right down to it, there is nothing that can replace good professional advice. Any CPA firm that a cryptocurrency investor chooses should be able to demonstrate that they are knowledgeable in cryptocurrencies and financial services, not just hopping on the latest trend like many CPA firms and franchise organizations.
A professional cryptocurrency CPA can ensure you protect your crypto assets from Uncle Sam, can put your mind at ease during tax season, and even save you some money. While there are some helpful online tools that you can use to help you prepare this tax season, they don’t provide everything you need to accurately file your cryptocurrency taxes.
Make sure you stay up to date on the latest changes
The cryptocurrency tax landscape is rapidly developing much like the overall industry, and the pace of that change is faster now than at any time in previous years.
Tax planning and compliance for cryptocurrency are evolving, and increased tax authority scrutiny will cause a jump in the number and size of cryptocurrency tax audits and assessments in the future.
Investors and businesses who work to make sense of the shifting cryptocurrency tax landscape must remain diligent in staying up to date on the latest developments in IRS legislation and tax treatments surrounding various forms of cryptocurrency transactions.
About The Author
Patrick Camuso, CPA is founder and owner of Camuso CPA, a CPA firm serving cryptocurrency investors, miners and businesses nationwide. Camuso CPA was the first CPA firm in the country to accept cryptocurrency as a form of payment for professional services. Camuso CPA works with investors and businesses on cryptocurrency portfolio tax analysis, tax preparation and tax planning.