With the Internal Revenue Service (IRS) increasing tax enforcement for cryptocurrencies, it grows ever more important for you to understand the reporting requirements for ownership and exchange of cryptocurrency, and to become aware of potential valuation issues that may arise from its transactions.
On February 15, 2018, tax attorneys Steven Toscher and Michel R. Stein, principals at Hochman Salkin Rettig Toscher & Perez P.C., delivered a presentation entitled “New IRS Scrutiny on Cryptocurrency Reporting: Filing Requirements and Exchange Treatment.” Earlier this month, President Trump nominated Charles Rettig, one of Toscher and Stein’s colleagues, to serve as commissioner of the Internal Revenue Service (IRS). Perhaps their insights will shed some light on what informs Rettig’s regulatory approach to virtual currency.
If you’re not enthralled by the subject of cryptocurrency taxation, I’ll simply provide Toscher and Stein’s tips for virtual currency investors. They suggest:
- Create a record-keeping system
- Keep track of acquisition dates, sell dates and cost basis information.
- Report dispositions on Schedule D and Form 8949.
- Identify your exchange rate.
- Use regular capital gains strategies: offset gains with losses, time dispositions to qualify for long-term treatment.
- Watch tax rates: short-term v. long-term capital rates; gains subject to the 3.8% net investment income tax.
- Be aware of tax treatment for virtual currency received by “mining” them – may be business income subject to the income tax and self-employment tax.
- Deduct any investment-related expenses (Schedule A) (Pre-Tax Cuts and Jobs Act of 2017).
- For a deeper exploration of cryptocurrency taxation, please read on.
Establishing the urgency of such discussions, Toscher and Stein’s presentation explains, “Cryptocurrency is drawing increased attention from government regulators.” They note that in November 2017, Coinbase was ordered to release information on approximately 14,000 customers.
- Exchanging virtual currency (“VC”) for Sovereign (fiat) currency
- Exchanging VC for property (i.e. Barter)
- Exchanging VC for VC
- Hard fork / Airdrops
- Initial Coin Offerings (ICOs)
Problems Posed By “Fair Market Value”
In 2014, the IRS Notice 2014-21 designated cryptocurrency as property, but since then, the agency has not issued further guidance, creating what Toscher and Stein call “challenging tax reporting issues.”
Income derived from the exchange of virtual currency for goods or services is calculated at the fair market value (in USD) of the virtual currency on the date the property was received. As the price of cryptocurrency varies dramatically across exchanges and throughout the course of a day, it’s not immediately clear how “fair market value” would be determined.
While timestamps are typically available on exchanges, how would the IRS or an individual cryptocurrency investor know the price of bitcoin (or another cryptocurrency) that was acquired or distributed without an exchange as a middleman? Matching up blocks on a blockchain and cryptocurrency prices seems like a real challenge. Another issue is this: would the price of the cryptocurrency be calculated at the time the transaction was submitted or at the time that the transaction was verified?
The 2014 IRS notice also provided that salaries paid in virtual currency are subject to normal reporting requirements (i.e. W-2, 1099 etc.) Still, there’s an inherent problem due to the anonymity of cryptocurrency wallets.