Peter Goodrich Tax Manager
Cryptocurrency Tax Compliance
The COVID-19 pandemic has induced a shift toward the digitization of currency. There has been an abandonment of physical cash by many individuals and businesses, some due to fear of possible transmission of the virus by legal tender. And there is also fear caused by the accelerated devaluation of the U.S. dollar due to the hyperinflationary monetary policy known as a quantitative easing. Witness gold currently trading at $1,800 an ounce. A path for cryptocurrency mass adoption is being paved.
U.S. regulatory clarity regarding cryptocurrencies is on the horizon. Many blue-chip companies are racing to develop mainstream technology built on blockchain and cryptocurrency to provide utility and to solve real-world problems. This is reminiscent of the dot-com tech boom and it has attracted financial institutions, retail investors, and the government.
The last major cryptocurrency bull run took place in late 2017 in early 2018. Since then, the crypto market has been extremely volatile, and it currently appears to be consolidating around key support and resistance levels. We are at a point in history where great “financial reset” may occur and eyes are on cryptocurrency.
As an investor, it is important to note that respective tax implications are depending on the type of cryptocurrency transaction involved (trading, staking, mining, etc.). For federal income tax purposes, the Internal Revenue Service treats cryptocurrency as property and applies similar tax principles. In the very popular case of swing trading, regardless of whether it is an individual or especially a fund, it is critical to account for the realized and unrealized capital gains or losses incurred as well as the fair market value of the crypto holdings throughout the year. There is an added complexity to these calculations since exchanging one cryptocurrency for another is also considered a taxable event yielding a capital gain or loss.1
There are at least 6,000 known cryptocurrencies that are offered throughout various exchanges and over-the-counter markets many of which are not located in the United States. It is necessary to have a strong accounting foundation using software that integrates with therespectiveplatforms’application programming interfaces (API) and communicates with the internal accounting system.
Since many exchanges and OTC markets are not located in the United States, the Financial Crimes Enforcement Network (FinCEN)has not yet mandated disclosure of crypto holdings held abroad on the Report of Foreign Bank and Financial Accounts (FBAR). It is a conservative approach to proactively disclose all crypto holdings held abroad on the FBAR. Nonetheless, the income from all these accounts should be disclosed and all taxes owed must be paid.2
The IRS has its own compliance requirements related to foreign financial assets with Form 8938 under the Foreign Account Tax Compliance Act (FATCA). Investors with crypto holdings abroad should give this equal consideration and look to take the approach of full disclosure.2
There may be a need to amend prior-year tax returns regarding inadvertently omitted taxable transactions in cryptocurrency. It is best to be proactive in remedying non-compliance since the IRS has been in communication with various exchanges regarding this matter and failure to disclose and pay all taxes owed will result in potential penalties and interest assessed. In addition, if you have received a
1099-K from an exchange, please note the IRS has a copy and you should determine the respective tax implications.
The bottom line is that it is critical to work with a tax professional well-versed in this area to determine the tax planning, exposures, and any related compliance and disclosures.