(Behind? Check out why the purchase of goods and services are cryptotax -able crypto events in Part 3.)

The (Very) Weird World Of Crypto

Crypto can be swapped for other crypto. This is something the financial world has never seen before. Which brings us to our next cryptotax -able event: the swap.

Imagine for a moment that you purchased some shares in Tesla. You then went and found an exchange where you could swap some of your Tesla holdings for Twitter (i.e. Tesla/Twitter trading pair). You then continued the suspension of your disbelief as you noticed the trading fee was issued in the form of Amazon shares! Well, it's a good thing you’ve been keeping track of fair values and cost basis in U.S. dollars throughout all this, right... Right?! Cryptotax requires it.

And that is just the beginning of the weird and wonderful world of crypto that is unlike anything the financial world has seen before. And, no matter how wonderful for the user, it's creating a world of questions around cryptotax for professionals.

Crypto exchanges can offer many compelling advantages over traditional exchanges such as the Nasdaq or New York Stock Exchange. For example, crypto exchanges are open for trading 24/7 (crypto literally never sleeps), generally offer low and simple fee structures, fractional purchasing for small retail investors, and immediate or at least same-day trade settlement.

Waiting two days for stock to settle once you’ve had a taste of the blazing speed of crypto… Well, stinks. Two business days equates to roughly two weeks in Gen-Z interwebs time. It’s a hard sell. Which is one of the reasons the IRS knows it's here to stay.

Of course, there are also many disadvantages when it comes to startup or early-stage crypto exchanges. Thin order books resulting in slippage, weak internal controls, no standardization in ticker symbols across exchanges, and weak reporting functionality to name a few. But don’t let the details get in the way of a great exchange!

(And, at what point in the cryptotax filing process do professionals "value" the gain or loss?)

Swap, Change & Switch

Swapping one type of crypto for another has been commonplace for a long time in the crypto space. That’s why there is a litany of “crypto swap” exchange providers. ShapeShift, Changelly, and CoinSwitch are some of the most popular ones.

Crypto exchanges in the U.S. in general, have come a long way since the early cowboy “it’s not regulated” days. 

Take Gemini, for example. According to their website, they are SOC 1 Type 1 and SOC 2 Type 1 and Type 2 compliant which was performed by Deloitte. The exchange is a fiduciary and subject to the capital reserve requirements, cybersecurity requirements, and banking compliance standards set forth by the New York State Department of Financial Services (NYSDFS). Also, they offer insurance to cover both online “hot” wallet and offline “cold” storage. Gemini made headlines back in 2018 when they announced they have partnered with Nasdaq to leverage its SMARTS Market Surveillance technology to monitor its marketplace. 

One may argue that these steps towards the institutionalization of crypto should (eventually) get us to better cryptotax reporting for crypto users in the U.S.

So, is swapping one crypto for another considered a taxable event? Yes!

Crypto Taxable Event: The Swap

Nope, you don’t have to cash out to USD fiat currency to trigger a cryptotax -able event.

In terms of cryptotax the exchange one cryptocurrency for another is a taxable event. Swapping one cryptocurrency for another is treated the same way as if you sold for USD and purchased the new crypto with USD.

The challenge for the taxpayer or tax preparer is that many of these exchanges offer very little in the form of reporting. Generally, if you have more than $20,000 in proceeds and 200 transactions during a tax year with a crypto exchange you should receive a 1099-K form. The exchange will also have reported the same to the IRS. The problem is that a 1099-K reports on gross proceeds and not the cost basis and gains and losses derived from your transactions. You know... the actual gains and losses which the IRS requires you to report. 

Some crypto users received a 1099-B which unlike the 1099-K provides taxpayers with information regarding their cost basis (if available) and proceeds from the sale of capital assets. The problem is the “if available” part. It's no easy task for a crypto exchange to track cost basis and therefore will generally not provide a complete 1099-B as it simply does not track the data.

So you can start to see a picture here of just a sliver of the challenges and complexities of financial reporting in the crypto space.

That is where software solutions like Ledgible Tax come in. On the Ledgible Tax platform, the taxpayer or preparer can connect the various crypto exchanges the taxpayer used during the tax year or even bulk upload the transactions from the exchanges and wallets. From there, Ledgible’s powerful SOC certified cryptotax software does all the heavy lifting for you so you can have the peace of mind of filing crypto taxes accurately with a complete audit trail as a backup.

Now let's move on to Part 5 where we'll learn about hard forks and airdrops.

This post is informational only and is not intended as tax or investment advice. For tax or investment advice, please consult a professional.

Purchasing with Crypto

Click here to read CryptoTax: Events Professionals Ought to Know Part 2

Overstock.com is heralded as the first major retailer to start accepting bitcoin purchases back in January of 2014. Since then several leading e-commerce platforms have followed suit such as Expedia, Shopify, Twitch, and even telecom giant AT&T. Typically these companies will accept cryptocurrency through payment providers such as BitPay, Coinbase Commerce, and others. Amazon does not (yet) offer crypto as a payment option, however, many e-commerce sites will allow you to buy Amazon and other gift cards with crypto which can then be redeemed at your favorite retailer. Paypal has been a payment and withdrawal option for several crypto exchanges for years, but recently rumors have been circulating that the fintech giant may “allow buys and sells of crypto directly from PayPal and Venmo”. (On October 22, 2020 those rumors were confirmed.) Virtual currency such as bitcoin and ether as a means of payment is slowly gaining wider acceptance, but what are the tax ramifications of using crypto as a means of payment for goods and services?

Taxable Event: The Purchase (of goods/services)

According to IRS Notice 2014-21 “A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.” Since crypto is treated as property for federal tax purposes, exchanging crypto for a good or service results in a disposal of the crypto, and consequently a short or long term gain or loss would need to be calculated and reported. According to the October 9, 2019, virtual currency FAQs, First-In, First-Out (FIFO) and Specific Identification are acceptable cost basis methods. Consider this example. You purchased $100 worth of bitcoin with cash on Monday from a popular exchange such as Coinbase. A few days later (let’s say Thursday), you decide to settle your AT&T bill with said bitcoin. Yup, you would need to compute and record the gain or loss derived from the difference between the price you paid to purchase the bitcoin on Monday and the fair value of bitcoin at the time you settled your phone bill. Ouch!

Dude, It Was Just A Coffee

Wait, that’s crazy? I’ll stick with cash and card, thank you very much! I mean, isn’t there some sort of microtransaction threshold exclusion? As it stands now all gains or losses regardless, of size, will need to be reported.  There was an effort back in 2017 by US lawmakers to push through legislation that would essentially allow consumers to make smaller purchases below a $600 threshold, without the related burdensome reporting requirements. However, the bill did not even make it past the House Floor.  In January of 2020, two members of Congress continued their efforts to make it simpler for the people to use virtual currency in their daily lives. They introduced a bill entitled the “Virtual Currency Tax Fairness Act of 2020”. The bill would provide for a de minimis exemption for personal transactions where the gains are less than or equal to $200. The AICPA also submitted their recommendation in a comment letter to the IRS, “Treasury and the IRS should offer administrative relief by allowing a de minimis exclusion for virtual currency, similar to the exclusion allowed for foreign currency transactions. Tracking small amounts of gain or loss on transactions of low value creates a situation where the administrative costs outweigh any possible tax on the immaterial transactions.” Unfortunately, there is not that much we can do to expedite the crypto tax regulatory processes. Fortunately, however, what we can do is make it easier than ever before to calculate and track crypto gains, losses, and cost basis across all your crypto wallet and exchange activity. AICPA SOC Certified Ledgible Tax solution can do the heavy lifting for you while giving tax professionals the ability to manage their clients’ virtual currency tax from a portal that integrates directly with the clients’ wallets and exchanges.  Now let's move on to another taxable crypto event: The Swap.

Disclaimer: This post is informational only and is not intended as tax or investment advice. For tax or investment advice, please consult a professional.

Read Part 1 here.

Crypto Tax Series - Part 2

What Every Tax Professional Ought To Know

Crypto Is Booming (Again)

Payments company Square, Inc. first allowed Cash App users to purchase and sell bitcoin during the rampant crypto boom of 2017. Since then it has continued to invest in its bitcoin offering, a move that seems to have yielded profitable results!

According to Square’s 2020 Q2 SEC filing, for the six months ended June 30, 2020 and 2019, bitcoin revenue amounted to $1.2 billion and $191 million respectively. The financials indicated that the primary driver behind the soaring 520% increase “was due to growth in the number of active bitcoin customers, as well as growth in customer demand”.

Of course Square is just one of the myriad options available for users to trade crypto today. Coinbase for example, one of the largest and most popular crypto exchanges in the U.S. boasts over 35 million users and over $7 billion in custody.  

Yes, Crypto Tax Is A Priority For The IRS

The majority of crypto users are uninformed when it comes to the potential tax consequences surrounding crypto. Some think that the IRS will not be able to track or trace their trades back to their identity (ouch!). 

During 2019 we saw the IRS sending out over 10,000 warning letters to cryptocurrency users to file amended returns if appropriate and pay back taxes. The IRS recently also released the 2020, 1040 draft form, where we can see the virtual currency question has moved from Schedule 1 to near the top of the main form, right under the name and address, asking, “At any time during 2020, did you receive, sell, exchange, or otherwise acquire any financial interest in any virtual currency?”. “Virtual currency” was also included in the 2019–2020 IRS Priority Guidance Plan. These are all unmistakable signals that the IRS is prioritizing crypto. 

Taxable Event: The Sale

So, let’s begin with the basics. Selling crypto for fiat (e.g. USD) is a taxable event.  The character of the gain or loss depends on whether the crypto is a capital asset (e.g. stocks, bonds, and investment property) in the hands of the taxpayer and the length of time the position was held. 

For example, “hodling” (slang in the crypto community for holding the crypto rather than selling it) crypto as a capital asset for longer than a year before selling it will generally result in a long-term capital gain or loss. If the crypto was not held as a capital asset, but rather as inventory for sale in a trade or business, the resulting gain or loss recognized will generally be ordinary in character.

Tools like Ledgible Tax exist to help tax preparers segregate and correctly classify crypto gains and losses. In the world of crypto tax there are many more taxable events than simply selling their crypto for cash. Let’s take a look at some of the other most common transactions in crypto that may result in taxable events.

Disclaimer: This post is informational only and is not intended as tax or investment advice. For tax or investment advice, please consult a professional.

A Secret Message On A Blockchain

A covert message can be found inscribed into the first block of the bitcoin blockchain, “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks,” referring to the London newspaper’s lead story of the day. This edition of the newspaper is now one of the most valuable crypto collectibles to date with asking prices over a million dollars! And since those early days in 2009, crypto has steadily increased in prominence, adoption, and mainstream conversation despite naysayers predicting its demise. Accounting firms in the US have increasingly entered the space launching their crypto tax, accounting, and blockchain practices. The AICPA released a practice aid covering both the accounting and auditing of digital assets. The OCC announced in July 2020 that national banks in the USA now have the authority to provide cryptocurrency custody services. Crypto is simply an area that tax professionals can no longer ignore. In fact, there's tremendous opportunity for accounting service providers to grow their business by offering tax services to cryptocurrency users and crypto investment holders.

https://www.youtube.com/watch?v=13PGZrMKpb8

Wanted: Crypto Tax Savvy Professional

Crypto-savvy tax professionals are now needed more than ever given the significant confusion around crypto tax compliance. It also provides tremendous thought leadership and business development opportunity. Back in March of 2014, the IRS issued Notice 2014-21, stating that virtual currencies are to be treated as property, rather than currency (that could generate foreign currency gains or losses) for US federal income tax purposes. Thus general tax principles applicable to property transactions apply to transactions using cryptocurrency. The 2014 IRS notice left much to be desired and a litany of open questions lingered, given the unique make-up of this novel and emerging financial assets class.  Fast forward to now and the updated guidance received from the IRS in October of 2019 in the form of a Revenue Ruling 2019-24 and updated FAQs, sought to provide more clarity. The updated guidance, however, still left many questions unanswered and created confusion around more nuanced and complex areas (such as air drop and chain forks) that we'll get into later. The AICPA issued another comment letter (a “must-read” if you’re a tax professional) to the IRS in February 2020 to submit their recommendations relating to the updated guidance dealing with the following five areas:

• Revenue Ruling 2019-24 
• New Question on the 2019 Form 1040, Schedule 1
• Frequently Asked Questions
• Form of Guidance
• Prior AICPA Recommendations Not Included in New IRS Guidance

What’s Holding Tax Pros Back?

In speaking with numerous leaders across the accounting, legal and tech community there still seems to be very few crypto tax professionals that understand how crypto works, the complexities, and the related potential tax implications. Primary reasons that were given for this shortage in crypto-savvy tax professionals included regulatory ambiguity, lack of client demand, and uncertainty whether this is an area worth pursuing in the long run.  In this crypto tax series, we’ll explore some of the most common crypto taxable events that every tax professional ought to know and how tools, like Ledgible Tax, can empower professionals to provide a premium crypto tax service to their clients. In Part 2 we’ll learn about the significant priority the IRS has placed on crypto and kick off with our first taxable event. 

Disclaimer: This post is informational only and is not intended as tax or investment advice. For tax or investment advice, please consult a professional