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The ‘taxing’ complication of cryptocurrency

Investors who were lucky enough to hop on the cryptocurrency bandwagon ahead of its sharp rise in popularity were also fortunate enough to avoid taxation for a time. Cryptocurrency, an alternative payment system started in 2008, caught on for many reasons. One major draw of this new form of financial exchange was that it cut out the middleman and was cashless. It was also advertised as hack and forgery-proof. The fact that it allowed two entities to conduct business across the globe anonymously only further fueled its use.

What changed with crypto

In the span of a few years, the Internal Revenue Service (IRS) and state tax preparers noticed that this peer-to-peer fund exchange created a loophole leading to tax evasion, money laundering schemes, and dark-web abuses. As a result, the IRS released a notice in 2014 declaring that cryptocurrencies (like Bitcoin, Ethereum, Litecoin, Dogecoin, etc.) were considered property, as opposed to currency, and would be taxed as a capital gain or loss depending on the values when purchased and then traded or sold.

In 2019, the IRS sent letters to around 10,000 persons suspected of owing taxes on the buying and selling of alternative currencies. The letters were “educational” warnings of impending interest, penalties, and even prosecution.

What this means for CPAs

As a CPA, you may feel caught in the confusion. With crypto transactions and investments still in their infancy, you may find yourself fielding calls and questions from clients wondering what to do with their tax returns. No doubt, you’ll ruffle some feathers once an unsuspecting “crypto-keeper” finds out that their investment or payment is subject to a capital gains tax as with the trading of stocks.

Federal and state taxes

Your clients may have already received their aforementioned educational letters. In addition, they may receive a 1099-K or other 1099 forms. This is a source of confusion because, as of this writing, there is no uniform guideline as to what crypto exchanges are required to send out to their customer base.

Some exchanges send out a 1099 form. Some send a 1099-K for customers with over 200 transactions or $20,000 in volume. Some send nothing at all.

Crypto maneuvers such as hard forks (where keepers, a.k.a. “miners,” of the blockchain used in crypto-security decide to split the chain to insert an improvement) and airdrops (cryptocurrency gifted at random, usually for promotional purposes) cause state tax issues. Such issues include how to appoint or source taxable income, apply sales and use taxes, and conform to state and federal tax guidelines.

Current 2022 IRS guidelines

To sum up, the guidelines, if you buy and sell crypto, you are an investor and taxed according to capital gains tax policies. Any profit made from trading the cryptocurrency or using it to purchase goods or services is taxable as a capital gain.

If you get paid in crypto, that is income, and you are taxed according to income tax guidelines. Take miners, for instance, who perform duties in the blockchain of cryptocurrency. That is a job, and they are paid for it in crypto. Their earnings would be subject to income tax. As with any job duty performed from home, there may be ways they can deduct job expenses from their taxable income. (It takes a lot of computer power and uses up a lot of energy.)

In any case, cryptocurrency values are based on U.S. dollar values at the time of the transaction, and this is where documentation is vital.

Document everything

The best advice for yourself and your clients is to document everything regarding cryptocurrency. Even a soda bought with traded crypto could be subject to a capital gains tax if purchased with a coin (and with crypto, we’re probably talking about fractions of a coin) that gained in value while in a person’s virtually-held wallet.

Thankfully, software exists that makes tracking and recording crypto exchange transactions easy. Encourage your clients to invest in cryptocurrency-friendly technology to make their tax returns more manageable and less risky.

The Ever-evolving Dance Between Crypto and the IRS

As cryptocurrency has evolved and changed, IRS guidelines have had to keep up. What started as secure, cashless transfers evolved into an investment angle but has switched again to a focus on tax significance. Since this new digital currency system is still relatively new, expect it to continue to change and government bodies to continue releasing more instructions with those changes.

As it stands now, crypto exchanges will be required to issue 1099-B forms stating capital gains and losses starting in 2023. In 2022, exchanges are currently sending out 1099-K forms for all entities with over 200 transactions and $20,000 in volume, or other 1099 forms, if any. Your clients may require reassurance and education that the 1099-K forms do not declare their taxable amounts of gains or losses in cryptocurrency.

For clients who dabble in cryptocurrency, aren’t aware of the tax implications, and have not received an educational letter or 1099 form, there’s a chance they might not tell you about their digital currency. It will be up to you to know the right questions to ask about your investments.

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