The following article is an exclusive contribution to CoinDesk's Crypto and Taxes 2018 series.
2017 was a banner year for cryptocurrency—an expansive bull market, exciting new coins, and an explosion of crypto-related services.
As cryptocurrencies finally reached the mainstream, regulators and governments have stepped up their oversight. While some nations banned (and rapidly un-banned) cryptocurrency marketplaces and services, the United States moved towards more stringent IRS enforcement by establishing a dedicated cryptocurrency team and forcing major exchanges like Coinbase to turn over user information on trades.
Some may view any governmental activity as anathema to the ethos of cryptocurrency. However, increased IRS scrutiny does have a positive benefit: it adds a layer of legitimacy to the cryptocurrency world as, instead of banning cryptocurrencies, the US government is tentatively acknowledging it as a financial asset.
This is a powerful step forward in the growth of this new industry. I want the U.S. regulatory bodies to embrace and celebrate the transformative potential of cryptocurrency, rather than be mired in an antagonistic battle against the movement.
The current crypto-tax landscape is so chock full of “gray areas” that it would make winter-time Chicago blush. Are you allowed to defer taxes by claiming a 1031 Exchange on your coin-to-coin transactions? Which accounting methods can be used? Do wash sale rules apply? Are forks and airdrops taxable?
As a result, tax professionals in the cryptocurrency space are applying a hodgepodge of rules that historically have been applied to stocks, bonds and other tradable securities, real property, intangible property, and so on. Having spent the last several months helping people calculate their cryptocurrency tax liabilities has often felt like driving while staring straight into the rear view mirror.
Without clear guidance from the IRS, the resulting non-consensus amongst cryptocurrency tax professionals has led to an environment where it seems even most accountants are hesitant to handle crypto taxes.
In fact, the majority of my firm’s clients are actually calculating their own capital gains not to file on their own, but in order to make life easier for their accountant. This is especially surprising given the asset class ended the year worth more than $600 billion, and many investors had capital gains much larger than their annual salary, and minimal to no experience calculating capitals gains in the past.
Notably, no tax rules are being drawn from crypto’s namesake – currencies.
That is because the most recent meaningful statement from the IRS about cryptocurrency taxation came in 2014 when the agency specified that crypto was not actually a currency, and therefore even tiny gains were taxable and needed to be reported, unlike with actual foreign currency that has a de minimis exclusion for gains under $200.
What is the IRS going to do when another government adopts a cryptocurrency as its national currency? The Marshall Islands intends to issue the Sovereign, or SOV, to supplement the USD as local tender. Venezuela is also heading in that direction and many more nations will surely follow.
Crypto tax reform
Here are a few foundational ideas I would propose for cryptocurrency tax reform:
- De minimis exclusions (e.g. spending less than $200 for a good or service should be exempt from reporting and capital gains tax)
- Designate cryptocurrencies as a new asset class, complete with common sense rules that are customized for cryptocurrencies’ unique use cases, as opposed to strained comparisons to semi-related asset classes
- Last in, first out (LIFO) or specific-shares should be the default accounting methods, as they more closely track the economic realities of investors buying fresh bitcoin or ethereum in order to transfer it to other exchanges and invest it in other cryptocurrencies
- Exempt bitcoin and ethereum from wash sale rules. As currencies often traded for others they should be exempt from rules about not buying back a currency you’ve recently sold. Those same rules should apply to other currencies to prevent selling and buying back just to harvest tax losses
- Safe harbor for reporting back taxes: Once guidance is given, offer investors a chance to pay back taxes or amend prior returns given the uncertainty of the current environment
- Safe harbor for regulations around reporting foreign assets via the FBAR and/or FACTA forms – most people do not even know where in the world an exchange is located, unless it’s Bitmex or Coinbase
- Explicit tax deferral on cryptocurrency capital held within one exchange: When an investor trades cryptocurrency only for other cryptocurrencies without transferring it out of an exchange and being able to convert it to USD, for example, it seems a bit unfair that he or she would be expected to pay paper gains in USD that have not been realized
- Aggregate reporting of gains and losses at exchanges that do not offer exchange to USD or other fiat – as opposed to the burdensome task of requiring billions of trades made in “Satoshi’s” (e.g. units of bitcoin) to be converted to USD when no consensus market price exists for most currencies at any time. Instead, a user would report the USD values of cryptocurrency transferred in (effectively a “buy” from a capital gains perspective), and the USD value of cryptocurrencies transferred out of an exchange (a “sell”)
I am sure the IRS would love nothing more than to give clear guidance on all of this– but the truth is if there were easy answers we would already have them.
While the dust settles on this tax season, my hope is that the new IRS cryptocurrency group will gather together a working group of industry practitioners tasked with building consensus around these topics and writing sensible regulations.
I think it is unfair to expect the IRS to do all of the hard work of making these decisions on its own. Progress is neither automatic nor inevitable.
It is much easier for us in the industry to hide behind the caveat of “well, the IRS hasn’t said anything about it yet…” than to try and drive the space forward with meaningful thought leadership. I sincerely hope I get the chance to participate in a group like this someday.
Happy tax filing day everyone!
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