The impact of cryptocurrency (“crypto”) will certainly continue to grow as our world becomes more virtual and fast-paced. As its use and popularity grows, there will also be more challenges in terms of accounting for gains or losses properly and in the U.S. taxation of crypto investments.
Below are some accounting issues which must be addressed from crypto investments:
- Knowing and understanding unique features of blockchain such as Proof of Work (mining), Proof of Stake (staking), Air Drops, and Hard Forks.
- Difficulty in creating and maintaining proper crypto investment schedules. Accounting issues increase as more exchanges are used for trading and different unique features occur, such as the ones noted above.
- Properly recognizing realized gains and losses and unrealized gains and losses due to difficulty in tracking cost basis.
- Difficulty understanding how the exchange trading system works and understanding and reading the exchange trade reports. Trades are denominated in cryptocurrency, usually Bitcoin, and when coupled with the mechanics of buy and sell trades, creates issues for some of the topics noted above such as efficiently and accurately creating and maintaining a proper crypto investment schedule as well as being able to accurately determine realized gains and losses as well as unrealized gains and losses.
- Another tracking issue is due to a unique feature for crypto that allows trading of partial whole units. Pressing the buy or sell button once when trading crypto, even for a small amount, may create large numbers of transactions that are small in amount.
- Difficulty obtaining FMV due to the volatility of the markets (potentially over 100% gains in one day) and potentially large price variances between different exchanges and countries. At the beginning of 2018, crypto prices in Korean exchanges were approximately 43% higher on average than the rest of the world.
From a U.S. tax perspective, there are equally daunting challenges in ensuring proper reporting of crypto investments, such as:
- Whether gains from crypto investments are considered ordinary or capital in nature. About 2-3 years ago, the Treasury issued guidance that cryptocurrency is considered “property” rather than “currency”. This means that U.S. taxpayers must determine whether gains or losses are ordinary or capital in nature. This determination often depends on each taxpayer’s specific facts, so this must be analyzed on a case-by-case basis.
- For most individuals who are investors, the crypto investment activity may be analogous to trading in securities, such as stocks, bonds, and mutual funds. In such cases, tracking the holding periods for each crypto investment and determining cost basis is crucial for tax reporting on Schedule D and Form 8949 of their U.S. individual returns.
- Taxpayers need to keep in mind that the recognition of gains or losses for U.S. tax purposes is not necessarily when they receive cash, but when there is “constructive receipt” of money or property. This can be from receiving additional crypto investments through some of the unique features above, such as the ones mentioned above. For instance, receiving additional Bitcoin units through an AirDrop would likely be considered a taxable income, similar to when a stock investor receives additional shares through a stock dividend. Even though the investor received no cash, he would still be subject to U.S. taxation on the stock dividend received, as though it were a cash dividend. It would appear that receiving additional crypto would be treated in a similar manner.
- U.S. tax residents are individuals who are U.S. citizens, legal permanent residents (i.e., “green card” holders) or who nonimmigrants who meet the “Substantial Presence” Test under U.S. tax law. U.S. citizens and green card holders are generally subject to U.S. taxation on worldwide income, no matter whether they reside within or outside of the U.S. It does not matter, from a U.S. tax perspective, whether a foreign country taxes income from crypto investments. U.S. taxation and reporting is not affected by what other countries do or do not do; rather, it would only determine the extent of relief possible from double taxation through claiming U.S. foreign tax credits in cases where crypto investments are double taxed by the U.S. and a foreign jurisdiction.
- Even in cases where crypto investments are conducted through a foreign corporation, a U.S. shareholder of a foreign corporation will likely be subject to current U.S. taxation on crypto investments under the recent reforms passed in the new Tax Cuts and Jobs Act (TCJA). Even under prior law before the TCJA, there would still be deemed income inclusion for U.S. tax purposes on crypto investment activity. Nonetheless, there are complex tax compliance and reporting issues to consider related to crypto investments.
- Recently, the IRS reported that only 0.04% of U.S. taxpayers reported income from crypto on prior year federal income tax returns. While the percentage of overall taxpayers investing in crypto is not high, it is probably higher than the 0.04%. With the IRS forcing Coinbase and other U.S. exchanges to report U.S. taxpayer activities from crypto, the level of reporting to the IRS will continue to grow. Also, it would not be surprising if the IRS plans to use the inter-governmental information exchange agreements under FATCA (Foreign Account Tax Compliance Act) to require foreign crypto exchanges to report their investment activities related to U.S. persons, similar to how foreign banks and financial institutions must do so under FATCA.
The above are just a preliminary list or sampling of possible accounting and tax issues related to cryto investments. Because of the complexity involved with crypto investments, U.S. persons should consider seeking advice from accounting and tax professionals experienced with such investments.