-By Donovan Thiessen, CPA
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There are now daily headlines about the rise and fall of cryptocurrency prices. Upon release in 2009 and through 2010 Bitcoin was trading for pennies and trading volume was 5,000 transactions per month. By 2013, trading volume exceeded 1,000,000 per month and the unit price went from $13 to $1,200 before settling around $700. Then, in spring 2017, with May flowers and huge momentum in the market, with the Bitcoin unit price rose to almost $20,000 by year’s end and trading volume exceeded 10,000,000 transactions per day. Bitcoin led the way for thousands of cryptocurrency “altcoins” and the rising tide lifted all boats. It did not go unnoticed by the IRS that many millionaires were spawned over the last few years. This article is an update on IRS reporting compliance issues for investors and traders of these digital assets.
The IRS issued its only guidance on this topic in 2014 (Notice 2014-21) and remained silent until November 2017, when it summoned the popular cryptocurrency exchange Coinbase to disclose information on more than 14,000 users. Even more recently, Coinbase is complying with issuing Form 1099-K for customers who have received more than 200 receipt transactions or greater than $20,000 during the year. This primarily relates to accounts being used for business. The IRS knows people are generating massive wealth in this market and it is expected that it will not only be coming for its tax revenue but also issuing more guidance for tax reporting. The following is what you generally need to know to comply for income tax purposes.
You must be diligent in your record keeping. IRS Notice 2014-21 classified virtual currency, aka cryptocurrency, as property subject to capital gains and losses. This means that a taxable event occurs any time you buy, sell, exchange or use these assets to purchase products or services. Specifically, if you purchased 1 bitcoin for $300 and you sell it for $500, you have a taxable gain of $200. If you traded it for a $1,300 bicycle, you have a taxable gain of $1,000. If you traded it for 75 units of Litecoin valued at $5,500, you have taxable gain of $5,300. And, for individuals who bought in recent months, it is possible that losses were incurred.
If you sat down in front of an accountant today, he or she would ask you to provide your current inventory and cost basis for each type of asset that you own. That data is used to prepare an accounting report that is used to calculate your gain or loss. In my experience, traders have hundreds or even thousands of trades and scant workpapers as support. With that said, an entire history is needed; every single transaction to determine your gain or loss.
Many traders are also sitting on massive wealth that hasn’t yet been converted to US dollars. For example, some traders may have a resulting tax of $30,000 due for the 2017 tax return, but they don’t have $30,000 cash, prompting a cryptocurrency sale now to pay for the tax. That $30,000 sale is a taxable event itself, generating even more tax for 2018 that requires planning for an estimated tax payment. So, you may need to sell $35,000 to cover tax payments for both years. Only with accurate record keeping can you plan effectively.
There may also be a foreign asset disclosure requirement depending on which exchange you’re using. If the exchange you’re trading on is in a foreign country and your account balance exceeds $10,000 at any point in a tax year, you may be required to disclose detailed account information on your income tax return. Failure to report this information can result in a hefty penalty of 50% of the account balance.
The IRS summons of Coinbase customers who transferred Bitcoin from 2013 to 2015 is considered an active investigation. According to Coinbase and the IRS this customer pool exceeds 14,000 and only 800 to 900 taxpayers reported gains related to bitcoin in each of the aforementioned tax years. The suggestion here is that many Coinbase users may not be reporting their Bitcoin gains. There may be reprieve of penalties associated with noncompliance for these taxpayers by filing “Qualifed Amended Returns.” This is hoped to be addressed in future IRS guidance but it is wise to at least look into the use of the IRS voluntary disclosure policy to get yourself into compliance for prior and current periods.
This article is necessarily brief and doesn’t cover concepts like forking (like a stock split), digital wallets, mining activities, initial coin offerings, theft and casualty losses suffered from online theft. The immediate concern is income tax enforcement and guidance to be issued by the IRS. In general, the IRS has increased third party reporting requirements in recent years and I believe that this is on the horizon for digital asset transactions. In other words, expect the exchanges to eventually be required to report cost and sale information on 1099’s. Never forget that all income is taxable unless the IRS says otherwise.
**This information is of a general nature and based on authorities that are subject to change. Your specific situation should be determined by consulting a tax advisor. Nothing in this article should be construed as investment advice, and any tax advice is not intended to be used to avoid tax penalties in any way.
Donovan Thiessen, CPA has worked for Gerety & Associates, CPAs in Las Vegas, Nevada for 10 years, focusing on trust and estate, and individual and business income taxation. The firm has substantial experience in estate planning and can handle complex transactions. You may reach Donovan at email@example.com and 702.933.2213.