Proposal to Establish U.S. Tax Regime for Digital Assets Draws 120K Comments

It's tax week at Coindesk. Over 120,000 comments have come in on an IRS proposal that maps out how crypto brokers and investors would report transactions to the agency joining us. Now to discuss is the founder of the educational site, crypto bullseye zone Kirk. Welcome to the show, Kirk. Hey, thanks for having me. Glad to be here. Yeah, we're glad to have you. Now you have a new opinion piece coming out on coin desk about this topic and you think that it could greatly increase the cost of filing crypto taxes. Talk to us about your thesis. Sure, absolutely. So basically these new proposed regulations are saying that you can use both FI O or you can use specific identification for your cost basis, right? But however, what you have to do now is there's two things you have to do to qualify for specific specific identification number one is you have to uh notify your broker, which would be in this case, your centralized exchange. What specific lot or tranche of Bitcoin or E or whatever it is that you want to sell. So, uh so you have to do that ahead of time. And in addition, you also have to identify in your own personal records, the particular lot or the tranche of your crypto that you wanna sell. So the issue with the broker is that there's really no mechanism right now to notify a broker, it's just that the exchange is not these exchanges don't, don't have these type of mechanisms in place. So now you could uh theoretically you could send a email to support at Coinbase or whatever that is. However, the it doesn't mean the exchange is actually gonna take that information and use it to prepare uh your, your 1099 D A which is the report that's supposedly gonna be issued by the IRS with all your trades. And so uh it, they, they, the exchange is not gonna bake that into the reporting. So that's, that's the issue there, which means that they can't, if the model doesn't support specific identification, that means that these 1099 das are essentially gonna all be issued on a fi fo basis, like I said, meanwhile, it's, you know, because basically preparing crypto taxes is, is impossible to do without crypto tax software. And the software is limited in the sense that uh generally speaking, was not designed to have an interface that allows you to identify a specific lot that you want to sell ahead of time that you can't therefore calculate your taxes based on true specific identification based on how the Irs wants you to do it. So the key takeaway here is that basically the way this uh the way crypto taxes was done previously was on an after the fact basis, which means you gather all your transactions together, connect all your exchanges, add in all your addresses and then you calculate your taxes. Well, this new uh this new methodology is basically saying it's, it's an after, I'm sorry, it's a before the fact game that you have to now play, you have to identify all these things before the fact before you make the trade. Whereas the way we used to do it, it was after the fact. And so basically because that you can't do it that way, it essentially makes the compliance impossible. So that, that's one of the main challenges here. I, I sort of want to translate this because people might not know the difference between FIFO and Lifo. We're talking here first in first out. So if you don't identify the, the coins that you're going to sell prior to selling what you're saying here, and this is the new IRS rule, automatically, it's going to go by the first coin that you bought. And because the price of Bitcoin and skyrocketed over the past year, it's doubled in price, chances are, if you bought Bitcoin over a year ago, you're going to pay a lot more in taxes than if you let's say, have been buying uh repeatedly over the past year and you decide to sell some, for whatever reason, it's not by the last one that you bought, but by the first one you bought, which might have been half the price of where you sold it at, which means you have a huge tax liability. So you're saying that none of, or, or I, I assume most of the centralized exchanges operating in the United States do not give you the ability to say I want to sell these coins from 2015 or 2012 or whatever it is, or, or, or actually sell it uh from uh May May 2023. They're gonna go back all the way to your first purchase and that could stick you with a huge bill. So you're gonna go uh FIFO which is first in, first out and if you don't do that, it's gonna be fa o That's correct. Thanks for the analysis there. That's right. Yeah, that basically what it boils down to is at the end of the day. If you don't comply the way it stands right now with specific identification, what could happen is upon audit, it would be recalculated into FIFO and as you explained those, the DJ S and ogs out there, whoever may have really high built in gains, you could go the, the difference in uh the gains and losses could be significant. You could have a gigantic tax liability from a recalculation. So you, you explained it very well, there something else, you know, is that taxpayers are responsible for specifically identifying the units of digital assets sold no later than the date and time of the sale disposition or transfer, regardless of whether a broker is used. Why is this significant? Well, that's as I was explaining before, is basically the way that we do it now is, is uh the, the calculations are typically done with the software, you know, much, you know, at a point in time. That's, that's, that's after the fact that the all the trades happen, you know, you connect all your exchanges, you connect your addresses and stuff like that and then you go and make the calculation. So now you've got to identify it, you know, at the point in time before these things actually happen. So they, you know, like I said, the software and the tooling is not sophisticated enough yet to do that. So that's, that's really one of the main challenges here. And what software is typically used are you talking about specific uh specific brands? Yeah. Well, there's, there's actually, there's actually dozens of software providers that are out there right now. So there's, there's actually, there's actually some enterprise grade software, there's also retail based products that are out there, I guess for a retail user who's dabbled in crypto who's maybe interacted with the centralized exchange, what software would you point them to? Well, I don't know if I specifically wanna point out any, uh, specific vendors. I just, I just like to talk about this generally because I, I think they all have, uh, by the way, like I said, uh, uh, this tax software does amazing things. Like I said, you couldn't, you couldn't, uh, you couldn't do these calculations unless you have, you know, crypto tax software. But at the same time there's limitations, there's all, I think they all have different limitations depending upon which one you're using. How does this, how does this differ from other securities and other assets that are bought and sold uh using a brokerage account? Uh How is this situation any different? That's, that's, that's a great question. And so basically the, what's proposed here with uh where the taxpayer can choose either FIFO or specific, specific identification. That's basically the same thing that happens with security sales. You have those two choices. So everything defaults and starts off as fifo. However, if you notify your broker and say, hey, I want to use specific identification, they're not gonna make any trades if you, until you instruct, you know, the particular tax lot that you want to sell. So that's really the same thing again. But the issue here is that like a lot of things in crypto, it's, you know, crypto is the square peg that doesn't fit into the round hole. You know, it's also, it's also because in many ways, a lot of these, a lot of these uh, centralized exchanges never really thought this out there. There was a, there was a time when this wasn't a problem for them. So why bother? That's, that's exactly right. I think it's both the exchanges in the software. It was, you know, basically the taxpayer was relegated to have 100% responsibility for calculating their own taxes. So now the issue is that you now have, say 37 hands in the pie. If you know Bob taxpayer, Bob is doing his own taxes and he gets 3037 of these 1099 das, he's got his, his himself to do the crypto calculation and he's got all these 1090 nines, every broker, every wallet, you know, assuming that if you know, depending upon whether the regulations that actually, you know, whether the D five platforms get roped into it and are classified as a broker or not. But just for illustration purpose, I actually asked, talked about this with, I was at two conferences recently just in the past couple of months CPA conferences doing presentations. And I said, hey, what do you, what do you think is the average number of 1099 BS that a taxpayer gets now? OK. Outside of crypto, just broker 1099 BS. And I'd say, let's just say it's five because that's what I would have said. 2 to 4 or somewhere in there. Five. OK. It's, you get, so the CPA S or the taxpayer. They get the 1099 Bs and they're basically transferring the information on to the end of the tax software, not crypto tax software. I'm talking about tax returns software and they, they just basically take it from the form into the software without any thinking and that's it. You just make sure they match and it's good for the most part. There's rarely an issue. Sometimes there is, but there rarely is. So, what I'm saying here is that the issues are gonna be the norm, not the exception. And when you go from 5 29 1099 BS to in the world of crypto 3750 like whatever the number is, especially when they're cons when right now, uh they're talking about the uh uh payment processors being brokers, payment processors are not brokers. That's just gonna make this thing a mess. So that means every retail, so every place where you shop and you have a payment processor and they're considered brokers. You're gonna, that's just gonna pile on the number of not a problem for central for uh people using their own uh keys and crypto and decentralized software, correct? Decentralized exchanges don't have this same kind of problem. This is, this is a very, oh, we, we, we're right out of time. This is a yes or no question. Oh, yeah. Well, it depends on whether it depends on whether be I ends up being considered a broker or not. So it's, it's gonna be a headache one way or the other. All right, Kirk, we are all out of time, so we're going to have to leave it there. Thanks so much for joining us this morning. That was Crypto Bull's Eye zone founder Kirk Phillips and don't forget to check out more on coindesk dot com. We have a lot of analysis and insights on taxes for crypto this week.