The current impact of crypto tax reporting
Tax season is breathing down our necks! When it comes to cryptocurrency, blockchain, non-fungible tokens (NFTs), etc., be aware; the IRS is watching. There are many people making obscene amounts of money right now in crypto and digital currencies, while the vast majority of people are sitting on the sidelines watching, expecting this ‘fad’ to end.
Like it or not, the ‘fad’ is here and does not appear to be going away anytime soon. The State of Colorado recently announced that it will accept cryptocurrency as a form of payment of state tax liability. While the government has been slow to address various aspects of the business, the IRS has clearly acknowledged that cryptocurrency is to be treated like property and that gains and losses are subject to tax reporting (see IRS Notice 2014-21). Many investors in this arena hope that there is no tax to pay and seek to keep their investments away from the government radar screens, because crypto and blockchain transactions have not been subject to typical bank and brokerage reporting requirements.
At least, that has been the case historically. Unfortunately, for those investors, those days are gone. For 2021, right on page one of the federal tax return, Form 1040, near the top, the form asks the question of whether or not you received, sold, exchanged or otherwise disposed of any financial interest in any virtual currency. The IRS is quite serious about having taxpayers disclose their digital and virtual currency activity.
As disclosure is required, how are transactions taxed? Just like other property, if held for one year or more, gains will be treated as long-term capital gains and will be subject to more favorable tax rates. Many investors of digital currencies, however, do not hold their investment for that length of time and will be subject to short-term capital gains treatment, which is at higher ordinary tax rates. This may be disappointing for those who have been looking to lock in gains that occurred in a very short time period.
To the extent that brokers are involved, there are typical reporting requirements. Brokers are obligated to report transactions in securities to both the IRS and the investor. Under legislation passed in 2021, the reporting requirements will apply to any transactions in 2023 and subsequent years. The 2021 legislation applies to typical brokers and agents, as well as cryptocurrency exchanges, custodians or platforms (e.g., Coinbase, Gemini or Binance), and to digital assets such as cryptocurrency (e.g., Bitcoin, Ether or Dogecoin).
Many people are aware that banks are required to report cash transactions of $10,000 or more. The same 2021 legislation also extends those cash reporting rules to cryptocurrency. Any business that accepts payments of $10,000 or more in cryptocurrency will have to report that to the IRS (on IRS Form 8300).
All of the broker reporting rules that apply currently to stocks, bonds, mutual funds, exchange-traded funds (ETFs), etc., are extended to apply to digital and crypto investments and funds. For this reporting to occur, cryptocurrency exchanges will have to get the customer's name, address and phone number and report the gross proceeds from the sale of digital assets and capital gains or losses and whether these were short-term (held for one year or less) or long-term (held for more than one year). Information gathering by agents will become the norm.
Under current rules, if you have a stock brokerage account, then whenever you sell stock or other securities, you receive a Form 1099-B at the end of the year. On that form, your broker reports details of transactions, such as sale proceeds, relevant dates, your tax basis for the sale and the character of gains or losses. We do not yet know if crypto transactions will be reported on this form, or some other, yet to be created, form.
The legislation defines digital assets as any digital representation of value recorded on a cryptographically secured distributed ledger or any similar technology. Recognizing that this area continues to evolve, the IRS is allowed to modify this definition. The purpose of modifying the definition would seemingly be to adapt to new technologies and allow the IRS to capture anything that is new but might not fit within the definition. To the extent that NFTs may not fit within the definition of digital assets for this purpose, we would expect the definition might be expanded and refined to intentionally capture NFTs.
The bottom line is that full reporting in this arena is here. If you use a cryptocurrency exchange or platform and the exchange or platform has not already collected a Form W-9 from you (seeking your taxpayer identification number), expect it to do so. The initial reporting year will likely be a challenge, as information is gathered and the platforms get up to speed.
This is an area that continues to evolve and adapt. We are here to help in any way that we can. Please feel free to call upon a Chuhak & Tecson business and tax attorney with any questions or concerns you may have about the reporting rules.
Client alert authored by Mitchell Weinstein (312 855 4608), President and Principal.
This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.