08.23.21 | Client Alert
The massive infrastructure bill still working its way through Congress, if and when passed, may include new tax reporting requirements in an attempt to put a bit of a lasso on the wild west of the crypto world. The effect would be to give the government greater scrutiny on the movement of crypto assets and, of course, generate more tax revenue.
Under consideration are proposals that would require cryptocurrency exchanges, and potentially other service providers such as miners and stakers, to file information returns to report transactions to the IRS. The proposal essentially targets these cryptocurrency participants as brokers, defined as “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” “Cryptocurrency,” “virtual currency,” or similar words are not specified in the bill. Instead, the bill describes the trading of digital assets as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.” Presumably, the reason for the definition is to include any other representation of value that may be created. Currently, the target date for this to become law is 2023.
For federal income tax purposes, cryptocurrency is considered to be property. From this perspective, the IRS generally treats crypto as a capital asset to be taxed in the same way as any other gain realized on the sale or exchange of such asset.
Should the proposal pass, the IRS will be notified when an investor sells or trades crypto, just like when an investor sells stock. There are many uncertainties, such as how this reporting requirement applies to crypto stored in, for example, wallets and not on any exchanges. The current legislation would require all transactions to be reported.
Coinbase president and COO Emilie Choi says these regulations, if not developed with input from crypto innovators and investors, could result in business moving outside the United States2. If that occurs, income tax compliance for crypto transactions could potentially become even more complicated, with international regulations and reporting requirements also affecting investors.
Under current law, brokers (such as stock or real estate brokers) are subject to penalties for failure to file required information returns to the government and to the payee, respectively, under IRC Sections 67211 and 6722, each of which impose a $250 penalty per required return. In large volume cases, the penalties may reach up to $3,000,000 per reporter per tax year with a combined $6,000,000 per year cap under IRC Sections 6721 and 6722. Potentially, the penalties may not be capped if the IRS believes that the rules were intentionally ignored. Cryptocurrency participants deemed brokers would be subject to this penalty regime as well.
With all this uncertainty, the most important thing crypto investors can do is to ensure they are tracking, and reporting when required, all their activity – buying, selling, trading, mining, etc. This can be daunting and time-consuming, especially as many retailers now accept cryptocurrencies such as Bitcoin as a method of payment. Just using a small amount of Bitcoin to pay for a latte at Starbucks creates a taxable transaction that should be reported on an income tax return.
Luckily, there are several apps, such as Cointracker, that can help in tracking crypto transactions. Many of these apps include integration with major exchanges and wallets to automatically track all activity and give access to your tax advisor to calculate gains and losses for tax purposes accurately. In addition, investors in cryptocurrency should look to prior years to find any potential unreported transactions. Again, apps like Cointracker can assist in retroactively tracking crypto investment activity.
While much remains unclear and is not final, legislation in some form will likely be enacted. It is more than prudent for cryptocurrency exchanges, buyers, and sellers to prepare ahead of what is expected to be demanding information reporting requirements and strict non-compliance penalties.
Questions? Contact Ben Westbrook at 212.331.7474 | email@example.com or reach out to your Berdon advisor.
Berdon LLP New York Accountants