Part One in a Series on U.S. and International Cryptocurrency Taxation
Will the coming months finally bring guidance from the IRS and U.S. lawmakers when it comes to cryptocurrency?
Crypto assets are currently lacking coordinated standards—but that may be about to change. Both the Internal Revenue Service (IRS) and Washington policymakers are busy amending guidance.
New Tax Guidance on Digital Assets
Are they currencies? Or are they investments? Since 2014, the IRS has treated digital assets as property for tax purposes. In other words, transactions in these virtual currencies (which include NFTs) need to be reported on a tax return, just as holdings of stocks or other assets are treated. If crypto coins are bought and then sold in less than 12 months, then it is considered a short-term gain, while if they are held longer than 12 months, they are taxed at the lower long-term capital gains rate.
The IRS updated guidance in 2019, requesting a response if virtual currencies were received as income. No matter how much is received, the amount must be reported on the appropriate tax form and is subject to the same taxes as ordinary or self-employment income. Crypto miners need to include the fair market value of the asset and include it in their gross income.
This guidance also addressed “hard forks”—when a single cryptocurrency is split into two separate currencies, as well as “airdrops” pertaining to these hard forks, which are considered ordinary, taxable income. The IRS established that taxpayers could use LIFO, FIFO or specific identification accounting methodologies to figure crypto gains and losses.
Required Reporting Ramps Up
While the 1040 for tax year 2020 asked filers about cryptocurrency activity, the 2021 version saw that question moved front and center—to the top of page one, to be exact. The question was also slightly altered to read, “At any time during 2021, did you receive, sell, send, exchange, or otherwise dispose of any financial interest in any virtual currency?”
Even more changes are in store for 2022 returns. In the draft Form 1040 for 2022, the IRS has created a bold category, “Digital Assets,” that inquires if taxpayers sent or received crypto assets as income or gifts in addition to the categories from the 2021 form. While taxpayers need to check whether or not they are gifted, a gift is taxable only if it goes over the USD16,000 annual threshold or the lifetime threshold, which is $12.06 million as of this year.
Keeping track of crypto assets is no easy task, and while securities firms provide gains and losses on 1099s for sales of mutual funds or stocks, crypto exchanges such as Coinbase have historically only provided the income received, leaving it to the investor to figure out their cost basis.
However, that may be about to change. While the 2021 Infrastructure Investment & Jobs Act did not include tax increases, it did include a tax-related source of revenue to the government—through broker reporting of digital assets. Crypto-brokers will now be required to provide investors with tax documents similar to those that are provided for traditional assets in Form 1099-B. The agency is apparently working on a separate document, Form 1099-DA, that will include the number and kind of assets, cost basis, fair market value, and holding period. The provision applies to returns required to be filed and statements required to be furnished after December 31, 2023.
While the IRS is making amendments to how investors report crypto transactions, there are other big changes in store as well. The possibility that crypto will generally be under the oversight of the Commodity Futures Trading Commission (CFTC)—aligned with crypto industry preferences—is growing. In early June, a landmark bill was introduced by the bipartisan team of Cynthia Lummis (Republican Senator from Wyoming) and Kirsten Gillibrand (Democratic Senator from New York). The Responsible Financial Innovation Act tries to establish a regulatory framework for digital assets and proposes that the CFTC be the main overseer for cryptocoins.
And just last month, The Digital Commodities Consumer Protection Act was proposed, identifying Bitcoin, Ethereum, and other “fungible forms of digital property,” as digital commodities under the guise of the CFTC. Securities and Exchange Commission (SEC) Chair Gary Gensler is putting his support behind this initiative as well, at least for non-security tokens.
While this would include Bitcoin, the world’s largest cryptocoin by market capitalization, the SEC would remain overseer of most other tokens, which are considered “security” tokens in alignment with enforcement actions of the agency. The SEC would have jurisdiction over transactions involving digital commodities that are used only for the purchase or sale of a good or service.
As U.S. policymakers attempt to regulate and standardize the “Wild West” of crypto, taxpayers should expect new rules and amended regulations, as well as increased scrutiny. Estimates suggest that the IRS is undercollecting over $50 billion per year in unpaid crypto taxes. Therefore, it is vital to keep abreast of these trends and changes and seek the advice of a trusted international tax advisor to help prevent any unnecessary surprises.