Uncle Sam doesn’t care how you report crypto tax gains — just do it

Uncle Sam doesn’t care how you report crypto tax gains — just do it
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If you haven’t heard about a company called Coinbase in the past 12 months, you’ve either been living under a rock or deliberately avoiding the bitcoin hype train.

I’ll make it quick. Coinbase is a San Francisco based cryptocurrency brokerage and exchange; its the blockchain industry’s first unicorn, and has accrued over 13 million customers in less than six years. The exchange lets people link bank accounts to buy and sell four digital currencies, including Bitcoin, Bitcoin Cash, Litecoin and Ethereum. The reason for the background is because the millions of Coinbase users across the country who made gains in their cryptocurrency portfolio (or digital “wallet”’) in 2017, must report their gains to Uncle Sam. Now that we are in the midst of tax season, crypto enthusiasts are scrambling to do the right thing before the April 15 deadline. And it is extremely important they know a few things.

First, while it’s has been a legal requirement since 2014 (digital currency is currently identified as a form of property), very few Americans actually disclose their capital gains to the IRS. Some deliberately avoid it because they think blockchain is synonymous with anonymity and therefore won’t get caught. Bad move. The government is already working with blockchain analytics companies like Chainalysis so they can uncover large USD sells that go unreported.

Some simply forget about cryptocurrency tax compliance, because they only have experimental stakes in the asset class. Also a bad move. Every digital currency transaction incurs a gain or loss and therefore triggers taxable event, no matter how small.

Still others undergo a painstaking manual process with their regular accountant. Yet again, a bad move. Filing with your standard tax professional typically causes over reporting (leaving money on the table) or under reporting (risking government intervention). The most common problem however, is that digital currency investors and traders simply don’t know how to report their gains.

Since disruptive technology typically outpaces the implementation of regulatory guidelines and/or formation of government policy, there’s currently no national standard for Americans meeting their cryptocurrency tax liability. Further, companies can’t keep up with new tax reporting obligations (there’s a reason TurboTax doesn’t integrate crypto transactions yet). In lieu of all this, exchanges, brokers, and digital wallet providers are all trying to provide their best advice to customers, or at least refer them to third party Software as a Service (SaaS) providers, but the system is largely broken.

Customers need better guidance on all of this because of several recent factors; they’ve seen the Senate Hearing from Tuesday, indicating a need for better regulation, they’ve seen the Cyber Unit shutdown of several ICOs, and they’ve seen the increasingly stringent crackdown on cryptocurrency malpractice. Despite their recent sums of digital wealth, cryptocurrency users will be doing all they can to avoid the prospect of an authority knocking on their door, or even worse, five years in jail and a fine of $100,000 USD, a maximum tax evasion penalty for misrepresenting or concealing financial information.  

Additionally, the complexity and confusion surrounding cryptocurrency tax reporting is vast, especially when you take into consideration individuals versus business accounts, financial limits, as well as the transfer of cryptocurrency funds across multiple blockchains, multiple wallets and multiple currencies. Just a few days ago, Coinbase issued IRS form 1099-K to customers that appeared to qualify as business accounts. The form, used for reporting Payment Card and Third Party Network Transactions, was limited to qualifying Coinbase customers who received cryptocurrency into their accounts covering 200 transactions totaling more than $20,000 USD during the calendar year.

While this may have caught some account holders with business activity by surprise, it is standard practice for third-party payment processors to make this form available to their customers. Any business using a traditional payment processor (e.g. Stripe or Paypal), should be familiar with the form. What complicates matters for customers who use Coinbase as a payment processor is the myriad of other activities for which Coinbase does not have insight to. These providers cannot present an entire picture because they simply don’t have access to transactions outside Coinbase, nor should they need to. Coinbase can provide the gain/loss for the transaction, but if the cryptocurrency is simply moved from one wallet to another, a gain or loss may not have been realized.

Only when the cryptocurrency is exchanged for another cryptocurrency, used for payment, or converted to fiat currency (US Dollar or other legal tender) should the business realize a gain or loss. Reportedly, Gemini, the New York exchange owned by the Winklevoss twins has also issued this form. However, Form 8949 is being increasingly used as a more simple and accurate tool, especially by SaaS providers, to report cryptocurrency gains and losses.

Finally, depending on the term held, a cryptocurrency user in the highest income tax bracket could pay capital gains tax upwards of 28 percent. This results in a massive financial windfall for the government, particularly given the extraordinary growth of value in bitcoin across 2017 (with a 1540 percent increase from January 1 to December 31). But it also results in a heavy hit to the wallet of a cryptocurrency investor, an annoying set of paperwork, accountant phone calls, and various options to consider.

But at the end of the day, it is an important legal requirement. The government needs its slice of the pie, just like any form of income, because they provide the services and institutions needed to keep society running. At the moment, whilst a national standard is lacking, I imagine they are not too concerned about how they receive the documentation — or in what form —  just that they do.

Perry Woodin is the founder of NODE40 and chief strategy officer of HashChain.