Crypto Tax Prep Business Booms as Trading Surges and IRS Tightens Screws

Startups that help Americans calculate their crypto taxes have been raising hundreds of millions, hitting unicorn valuations. Even traditional tax-prep firms are rolling out crypto services. This piece is part of CoinDesk's Tax Week.

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Crypto tax preparation is big business in the U.S. as cryptocurrency investing has mushroomed into a $1.9 trillion global market.

Startups that help Americans calculate their crypto gains and resulting tax bills have been raising hundreds of millions and achieving billion-dollar valuations. Even traditional tax-prep services have been rolling out offerings for this blooming niche. And perhaps not a moment too soon, with valuations near last year’s all-time highs, a proliferation of novel ways to profit on digital assets and the IRS on the hunt for crypto tax cheats.

This article is part of CoinDesk’s Tax Week

It’s hard to gauge the size of this niche. "If I were to put out an estimate, I'd estimate that the U.S. crypto tax prep market is currently worth $400 million, but that number is growing exponentially year-over-year as regulators clamp down." said David Kemmerer, co-founder and CEO of CryptoTrader.Tax.

The IRS started looking into cryptocurrency closely in the summer of 2019, when it sent thousands of letters to taxpayers whom the agency suspected of not reporting their crypto-related taxes properly.

“What I've seen in the past few years was consumers started to realize they have to pay taxes, but it was so overwhelming that they just ignored it,” said Michelle O’Connor, vice president of marketing at TaxBit. But then they started receiving “scary IRS letters.”

In October 2019, the IRS published its first detailed guidance on how taxpayers should declare crypto-related income. The same year, the agency included a question about cryptocurrency transactions in the Schedule A of individual 1040 forms. In 2020, the question became obligatory for all U.S. taxpayers.

Investors are getting the message, tax pros say.

“We will see the highest compliance rates among consumers and enterprises filing their crypto taxes for 2021 and expect to see the compliance rates grow exponentially year-on-year moving forward,” said Dan Hannum, chief operating officer of ZenLedger.

Down the road, technology will become increasingly complex, with decentralized finance (DeFi) and non-fungible tokens (NFTs) gaining adoption, and with the taxman looking over their shoulders, more people will need help managing their tax liabilities.

The IRS differentiates between various kinds of transactions, so cryptocurrency accounting might be tricky, and the safest way for consumers often appears to be asking for professional help – or using specialized software.

Hard to measure

Estimates of the crypto tax prep market’s size vary.

“We believe that due to the massive uptake in crypto last year especially, that the crypto user base could be sitting close to 16% of the U.S. population, bringing us to 53 million potential crypto taxpayers,” said Robin Singh, founder of Koinly, citing last year’s Pew Research report about crypto adoption in the U.S.

Mark Steber, chief tax officer at Jackson Hewitt, the country’s second-largest tax prep firm with storefront offices nationwide, cited a more modest estimate by the consulting firm Chappuis Halder: about 15.3 million account holders, or about 9% of taxpayers in the U.S., and 35 million to 68 million globally.

The available official numbers are not that impressive, points out Shehan Chandrasekera, head of strategy at CoinTracker: the IRS has so far released stats for the 2019 tax season, and according to the report, only about 928,000 taxpayers said they did crypto transactions during the 2019 fiscal year (fresher data is not available yet).

However, this is likely to change.

“Based on trends and market insights, we believe at least half of the U.S. tax-filing population (~75 million) has something to do with crypto,” Chandrasekera said.

“Some may have taxable transactions where they have to file forms with the IRS. Some may be HODLers with no reporting requirement until they sell assets,” he added, using crypto slang for long-term holders.

The tax-prep companies wouldn’t share their client numbers. But they’ve been attracting significant investment.

Last August, TaxBit, which calculates crypto taxes both for consumers and the IRS, ​​raised $300 million in a Series B round at a $1.33 billion valuation. CoinTracker raised $100 million in January and is now valued at $1.3 billion. The company also announced an exclusive deal with Coinbase to help the Nasdaq-listed exchange’s users to properly report their crypto taxes.

Koinly, another firm in this category, is “seeing a significant uptick in our user numbers,” said Singh. The reason underscores the relative immaturity of the crypto industry.

The uptick “is fueled by the 1099 forms that exchanges are sending out to their users,” Singh said. “These forms are completely inaccurate in most cases since crypto traders have a number of wallets and exchange accounts, and no one exchange can produce an accurate report of the entire crypto activity.”

This problem is also what led two years ago to the “scary IRS letters” O’Connor mentioned. Cryptocurrency exchanges sent generated tax reports for their users, but those forms turned out to be incorrect, she said: Data about users’ transactions and gains was not balanced by the information on their initial purchases, making the IRS think they underreported their taxes.

Niches within niches

In this vast market, companies are picking different spots. Some catered to retail consumers first, some focused on enterprises and others also chose to provide technology to regulators.

TaxBit is concentrating on catering to crypto enterprises first of all: According to O’Connor, the initial mess with the tax forms mistakenly sent out by exchanges made her company’s founder think of how the situation can be fixed at its core. So in TaxBit’s model, exchanges using TaxBit’s service, or just joining its TaxBit Network, can offer free tax accounting for all of their users.

As for retail clients, O’Connor declined to reveal any concrete numbers but said that last year TaxBit generated “millions of tax forms” for consumers. “This year, we’re on pace to do 10x what we did last year,” she said.

TaxBit offers its service free to users of its enterprise clients. CoinTracker charges $59 for "hobbyists" (under 100 transactions per year), $199 for "premium" customers (under $1,000) and customizes pricing for bigger clients.

ZenLedger is a smaller competitor to TaxBit and CoinTracker and raised $6 million in a Series A last August. It chose an opposite approach: focus on retail users and create as many different blockchain integrations as they demand – and the enterprises will follow, said Hannum.

This year, ZenLedger is looking to serve 400,000 customers, which would represent 8x growth from the previous year, Hannum told CoinDesk. In terms of revenue, the company grew 12x – all of it driven by retail.

With the infrastructure bill passed by the Congress last year, stipulating that the U.S. will collect $30 billion in cryptocurrency-related taxes over the next 10 years, the IRS is now busy ramping up its technological and human resources, Hannum said. Over the next 10 years, the IRS is getting $80 billion of federal funding to invest in tech and people – “a large percentage of that will be used for cryptocurrency,” Hannum said.

That’s another opportunity for crypto accounting companies: to provide forensic solutions to government agencies to help them find crypto traders failing to report their taxes properly. ZenLedger has been providing this kind of technology to the IRS, as well as to the state governments and other countries’ authorities, too, according to Hannum. This global market for taxation regulatory technology is a “multibillion dollar industry,” growing exponentially, he said.

Retail users don’t need to worry about the IRS contract, Hannum says: “ZenLedger and our government contracting arm are two separate entities. ZenLedger will never give customers' information to the IRS. Instead, the IRS provides our government entity data completely independent from ZenLedger's client base. Our customers use our software to report their own activity directly to the IRS.”

Household names enter

Mainstream tax filing companies, like software provider TurboTax or storefront chain H&R Block, will likely acquire startups specializing in crypto rather than build their own tech from scratch, Hannum predicted.

ZenLedger is getting acquisition offers, he claimed, but for now, his company sees “a big green field ahead” and would rather keep building than sell.

However, some incumbents are building rather than buying: “At Jackson Hewitt, we train our tax pros on tax preparation using our internally sourced training materials (which includes what cryptocurrency is and how to handle it on a tax return) and create our own tax software that can handle cryptocurrency, whether it is payment for a business, payment to a client or investing,” Steber said. The company does not have “an account management or crypto support for portfolio issues,” he said.

TurboTax’s parent company Intuit did not respond to CoinDesk’s request for comment. But TurboTax is definitely looking to get a piece of the crypto tax pie, with its recent ad targeting cryptocurrency traders.

H&R Block, another household name in the tax filing industry, said it “has prioritized enhancing and expanding the cryptocurrency guidance” this year. “H&R Block is also engaging with leading crypto tax calculator providers to identify solutions that may help our clients navigate the complexities of reporting crypto transactions,” the firm’s media representative said.

Lots of luck, says Kemmerer of CryptoTrader.Tax.

“Traditional tax companies like TurboTax, H&R Block and Jackson Hewitt are going to have extremely difficult times keeping up with the demand for crypto tax services in the future because this is a fundamentally new asset class that requires a completely different tech stack to effectively serve clients (blockchains, wallets, etc.),” he said.

Just as mainstream stock exchanges like Nasdaq and NYSE haven’t built competitors to Coinbase and Gemini, old-school tax accounting firms are struggling to keep up with the nascent market, Kemmerer said. “As history shows, building brand new technologies from the ground up is extremely difficult for large incumbents who don't have expertise in the space.”

As more jurisdictions adopt cryptocurrency-specific taxation rules, the U.S.-based startups are looking to expand overseas. TaxBit is looking to serve taxpayers in the U.K., Canada and “most likely, Australia,” O’Connor said, adding the company is talking to potential enterprise clients in Europe and Latin America.

CoinTracker supports clients in the U.K., Canada and Australia, Chandrasekera said, and “planning to expand services into more countries as well.”

ZenLedger is eyeing Canada, Australia and various countries in Europe and Asia, Hannum said.

(Kevin Ross/CoinDesk)
(Kevin Ross/CoinDesk)


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Anna Baydakova

Anna Baydakova was CoinDesk's investigative reporter with a special focus on Eastern Europe and Russia. Anna owns BTC and an NFT.

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