Cryptocurrency Tax Reporting Guide For U.S. Investors (2024)

The IRS published a brand new Schedule 1 form. It is part of the 1040 tax form for US taxpayers to declare “Additional Income and Adjustments to Income,” and it contains a question about your crypto activities.

Almost 152 million US tax filers will use this form for their 2019 tax returns, and the very first question is:

⇒ At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?

Pundits are not sure and some find the question vague. Some point out that the vagueness is cause for caution. The safe approach for taxpayers would be to consider any interaction with virtual currency that can fall under this broad list of engagements reportable. What will the IRS do with this information?

Others feel sure that the IRS has a reason for asking, and worry that you could unwittingly increase your odds of being audited by checking the “yes” response.

The IRS is notoriously vague on cryptocurrency in general and after the latest guidance, more questions were raised in respect of hard forks and airdrops.

The IRS Is Focusing On Crypto, Very Much

The IRS is expanding its efforts to find and tax crypto owners. The IRS says that “cryptocurrencies are undermining the financial and tax system.”

For the IRS, cryptocurrencies are problematic. Companies are increasingly paying employees in crypto, and trade their goods for crypto. They do not pay any taxes. Often, income is shifted to foreign exchanges where there are no reporting requirements and where no AML practices exist. For the IRS, this is the focal point of their current criminal investigations.

Even the IRS does not have unlimited resources. Nevertheless, the IRS does have the tools required to catch the crypto evaders. Cybercriminals now use cryptocurrency. They want to remain anonymous, but they won’t, according to the IRS. In its fight against evasion, the IRS collaborates with international partners. The Joint Chiefs of Global Tax Enforcement or J5, for example, comprises of the IRS Criminal Investigation Unit and counterparts in the UK, Australia, Canada and the Netherlands. Its focus is international tax evasion, which includes the use of cryptocurrency used to evade international tax obligations.

Compliance On Virtual Currency Transactions

Virtual Currencies

⇒ Include digital currencies and any virtual currency that has an equivalent value in or acting as a substitute for real currency, defined as the official and legal currency of a country.

Cryptocurrency

⇒ A type of virtual currency that uses encryption to secure transactions digitally recorded on a distributed ledger.

According to the IRS, only a few hundred taxpayers reported virtual currency transactions despite the collection by the IRS of information on more than 10,000 taxpayers that seem to have engaged in virtual transactions. It is the age of virtual currency. People are using cryptocurrency for payments more frequently and even the blue-chip companies are coming out of the woodwork to accept payment of the same. Evermore, taxpayers, seem to be unaware of their tax reporting obligations in respect of virtual currencies.

No wonder that this area is fast becoming an IRS focus point. Taxpayers and advisors must review their virtual currency tax requirements before IRS enforcement becomes more prolific.

In 2014, IRS guidance indicated that virtual currency will be treated as property and not as currency. Transactions in virtual currency became taxable.

Revenue Ruling 2019-24

Issued on the 9^th of October 2019, it reaffirmed the above guidance and expanded guidance on various forms of virtual currency that emerged in the meantime.

Hard Fork

The IRS defined a ‘hard fork,’ as a change to a distributed ledger that underlies a cryptocurrency. If the change results in a split from the original ledger, and this results in a new cryptocurrency on the ledger, a hard fork is created.

Soft Fork

When a distributed ledger undergoes a protocol change that does not result in a diversion of the ledger and does not result in the creation of new cryptocurrency.

Airdrop

A manner of distribution of cryptocurrency following a ‘hard fork’ to the distributed ledger addresses of multiple taxpayers.

Tax Implications Of The Above

When a fork or an airdrop provides the taxpayer with:

⇒ A new cryptocurrency over which he or she has control and ownership that is – if the taxpayer can:

⇒ Transfer

⇒ Sell

⇒ Exchange or dispose of it, then it becomes taxable.

In terms of Revenue Ruling 2019-24, the income recognized will be ordinary income, and the basis will be the fair market value at the time of their receipt.

Gifts, Charitable Contribution, Soft Forks & FIFO

Virtual currency transactions that involve gifts or charitable contributions and soft forks will as a rule, not be subject to tax. If the taxpayer cannot accurately identify the units of a cryptocurrency involved in a particular transaction, the default treatment for the transaction must be first-in, first-out.

Ten Thousand Letters

The IRS obtained information on 10,000 taxpayers involved in virtual currency transactions from one or more virtual currency exchanges. The agency sent out three types of letters to the 10,000.

⇒ Those who may not have met their US filing requirements for virtual currency transactions.

⇒ Those who may not know the reporting requirements for reporting virtual currency transactions.

⇒ Those who may not have adequately reported their virtual currency transactions.

For the IRS, these are “soft letters” aimed at voluntary compliance from taxpayers before enforcement actions are initiated. According to the agency, it already has the information required to start enforcement.

FORM 1040 SCHEDULE 1

Now the IRS has added a question about virtual currency on its new tax return to Form 1040 Schedule 1.

Ostensibly, all taxpayers must now file a Schedule 1 to respond to this question.

Cryptocurrency regulation in the US and the world at large remain an ocean of uncertainty and this is made worse by the lagging uncertainty over cryptocurrency taxation. There are many reasons for this. Some regulators do no even have a clear grasp of what cryptocurrency is, nor how the crypto-universe functions. As to how cryptocurrency evolves value, regulators with a clear understanding can probably be counted on the fingers of one hand.

Internationally, many countries are yet to provide any taxation rules. Notable exceptions are the United States and South Korea, where inroads are being made, among others by imposing taxes on crypto-gains however, vague these rules might still be. The US issued more guidance in October of 2019 – the first in five years, but it also raised more questions in the cryptocurrency world. One of the significant problems that arose is to understand how the IRS plans to tax airdrops.

The initial guidance (2014) was a mere ‘a paragraph long. In it, the agency classified virtual currency as property, grouping it with real-estate, bonds, and equities. As a result, one had to draw an analogy between say, equities, and cryptocurrency. The guidance that was issued in October 2019 provided much-needed clarification of aspects the industry was analogizing but still felt unsure about, like cost basis assignment methods and the use of first-in first-out (FIFO).

FIFO

⇒ You have a basis in every asset you acquired. When you dispose of any of these assets, you have to pick one out of the pool of assets. Your choice of which has massive tax ramifications.

⇒ The IRS approved the use of FIFO as the default method for cryptocurrencies. However, specific identification is also allowed if you meet the criteria – by proving transaction IDs, blockchain hashing, and supporting records.

⇒ This way you can pick which specific lot you want to sell. This is highly advantageous from a taxation point of view if you select assets with the highest cost basis to sell first.

Example

⇒ Amy buys Bitcoin three times per year with the prices rising. Her third purchase was for the highest price Bitcoin.

⇒ When the market turns downward, she incurs a loss of 50% for the last Bitcoin she bought, selling it at the end of the year. Now she can book a 50% loss instead of gain on the initial purchase, given she meets the IRS criteria.

This allows Bitcoin investors to optimize a lot more because you can be more accurate, while the tax profile of what you own or not, is dramatically changed.

Crypto Firms Must Follow GAAP For Financial Reporting

The chief accountant for the Securities and Exchange Commission, NAME LASTNAME, has said that companies have a responsibility to follow accounting standards when working with blockchain and digital assets.

Bricker opened by stressing it was crucial for the accounting profession to keep abreast of emerging technologies to ensure it can adequately fulfil its role as gatekeeper for “issuer compliance related to financial reporting.”

He went on to emphasize that innovations in technology can in fact be “the ally of a company’s business and financial reporting activities, not their opponent”.

Bricker emphasized that for firms and their auditors alike, the existing parameters of auditing standards and federal securities laws, with their attendant reporting obligations – where they apply – should continue to be closely adhered to.

Blockchain applications were one of the major focuses in Bricker’s speech, coming less than a year after he advocated that accountants in the U.S.get up to speedon information about cryptocurrencies and other digital assets. At the time, he spoke directly about companies or people that conduct initial coin offerings (ICOs).

Bricker’s focus on Monday was, once again, directed at American companies and the accountants responsible for keeping their books. He told event attendees that it is “critical that we keep ourselves informed about emerging technologies so that the accounting profession can continue to perform the essential gatekeeper function for issuer compliance related to financial reporting.”

“It follows that changes in technology need not work against investors and the public capital markets,” Bricker went on to say, explaining:

“Moreover, companies must continue to maintain appropriate books and records – regardless of whether distributed ledger technology (such as blockchain) smart contracts, and other technology-driven applications are (or are not) used.”

The SEC official exhorted corporate accountants to “take what is learned and then act appropriately” within U.S. securities statutes, whether or not their work involves keeping records related to digital assets.

“Distributed ledger technology and digital assets, despite their exciting possibilities, do not alter this fundamental responsibility,” he remarked.

Recent high-profile developments on the crypto regulatory landscape in the U.S. have seen the SECextendits purview to oversee crypto hedge funds, FINRAmuscle inon a case of alleged securities fraud, and a New York federal judgerulingthat securities laws are applicable for dealing with crypto fraud allegations.

The Financial Accounting Standards Board (FASB), a financial accounting standards body in the US, is reportedly consideringwhether to undertake a new initiative on digital currencies.

The FASB – which sets accounting standards for publicly traded US firms – hasn’t yet decided if it will develop new guidelines for companies dealing with bitcoin and other cryptocurrencies. However, the non-profit is apparently assessing whether it should begin that process following a request from the Washington, DC-based Chamber of Digital Commerce (CDC) – a trade organization for companies and groups working in the digital currency and blockchain space. If it does undertake the initiative, the FASB would not bealone among the world’s accounting standards groups who have begun developing new frameworks. Among those is the Australian Accounting Standards Board, whichin Novemberargued for globalaction in this area.

Further, a group of accounting firms including PwC, Deloitte and EY, among others, formed a new coalition last year aimed atpromoting new standardsfor digital currency. The CDC, too, has previously launched an advocacy effort, dubbedtheDigital Assets Accounting Coalition.

Why You Must Report Bitcoin and Cryptocurrencies Gains to the IRS

It is reported that over 14,000 U.S. taxpayers have used Coinbase to buy, sell, send or receive Bitcoins and other cryptocurrencies from 2013 to 2015. Their accounts register transfers of at least $20,000. Very few of those people, however, have reported any gains to the IRS from their Bitcoin investment. The Agency is now taking crypto tax evasion really seriously and making the necessary moves to ensure no one goes under the radar. So if you were considering skipping the part about cryptocurrency gains on your tax return, just know that this is a very bad idea.

What is IRS doing to Catch Cryptocurrency Tax Evaders?

The IRS has set up a new team of specially trained agents who focus on international crimes, including those involving cryptocurrencies. This is important because the Blockchain technology is new, complex and unfamiliar to most people. Therefore, it creates a huge backdoor for tax evaders and other criminals to make billions of dollars illegally.

The work of the agents also helps criminal investigators who work on capturing drug dealers and malware ransoms. Over the past few years there have been numerous cases of big organizations falling victims to such criminals. Surely, you wouldn’t want to fall in the same category as them, so make sure you report your crypto gains.

Is There Any Way to Keep my Bitcoin Investment a Secret?

No. And if you do, it is illegal. Coinbase was required to release information on all accounts that had at least $20,000 at any point over the last year. The IRS will eventually find out if you haven’t declared your Bitcoin investment or transactions deliberately. If they do, you will be treated as other tax evaders who do not report foreign or domestic financial assets. This means you will receive substantial penalty and face criminal prosecution.

Is it Too Late to Amend my Previous Tax Returns if I have Bitcoins?

You can still amend your previous tax returns if you haven’t declared your cryptocurrencies., bur note that penalties and interest will be charged.

Take out

⇒ The IRS has recruited more staff to investigate tax evaders.

⇒ Not reporting your Bitcoin and cryptocurrency gains is a crime.

⇒ You will be caught and penalized (potentially prosecuted) as more data is shared with the IRS.

⇒ You can amend your previous tax returns if you haven’t declared your crypto assets.

How U.S. Cryptocurrency Investors Can Profit From Unclaimed Property Rules Tax Reporting

As the deadline for businesses to file their reports on unclaimed property approaches, many businesses are considering including information on misplaced cryptocurrency passwords or lost cryptocurrencies.

Unclaimed funds, of which unused gift cards may be an example, are often reported on by institutions such as retailers, banks, state government agencies, and insurers. Cryptocurrencies such as Bitcoin and Ethereum, being virtual in nature and growing in use and popularity. The downside to these currencies is that the keys, passwords and digital wallets used to access them can be lost, which renders the currencies unclaimable. This presents accountants with a distinct challenge in the businesses they serve.

According to Robert Peters, director of Duff & Phelps Unclaimed Property and Tax Risk Advisory, some states have adopted rules where unused Bitcoin, as an example, could be included as a form of unclaimed property. He goes on to say that more and more states are broadening their definition of unclaimed property to include unused or lost cryptocurrencies.

Many businesses are working towards completing their fall filings of accounts before November. All financial instruments that have gone dormant for the specified period of time, typically three to five years, would be valid for this type of reporting, but this may vary from one state to another.

As a result of these laws differing between states, the upcoming reporting season may entail re-organizing dollar thresholds, due diligence mailing dates, as well as the completion of electronic paper filing and payment requirements.

Scott Regan, another director of Duff & Phelps Unclaimed Property and Tax Risk Advisory, cautions that the upcoming reporting deadline dates, being October 31 and November 1, apply to 40 states. The lack of uniformity between these states and the subtle differences in their application of the filing rules presents corporate accountants with a strong challenge.

Adding to these challenges is that there are different dormancy periods for different types of property, where dormancy is the amount of time before the property is considered abandoned. It only becomes possible, after this lapsed time, to report it or remit it to the state. The notification requirements may differ from state to state, from requiring certified mailings, minimum threshold limits, or issuing of letters within 60 or 120 days prior to filing, depending on the specified requirement.

Dates, dormancy periods, due diligence requirements and deadlines are all aspects that need to be taken into consideration, and this presents accountants with a mammoth task ahead of them before the filing season closes.

In 2016, the Uniform Law Commission passed the Revised Uniform Unclaimed Property Act, but it has not, as yet, been integrated and fully adopted by many states. This lag in switching to a more uniform system is causing a significant amount of confusion for corporations affected by it. Tennessee, for example, has recently switched from being a spring reporting state to a fall reporting state, which has made reporting a moving target for all the affected entities.

Businesses or individuals that would like to report on misplaced cryptocurrency keys or wallets, will be challenged by this lack of consistency between states. Currencies deemed to be dormant as defined by the state they are owned in, may be claimed by the state from the issuing company, and it would seem these companies are specifically being targeted.

Even if the cryptocurrency exchanges that hold the currencies are located abroad, the rules regarding dormancy may still apply if the owner is resident in the U.S. Technically, the rules apply in the owner’s location, but subtleties in the rules and how they are applied in the various states, need to be taken into consideration.

Even though cryptocurrencies are reasonably new, unclaimed property rules have been challenging accountants in the more traditional aspects for many years. Gift cards and loyalty programs are just two such challenges.

Where rewards are earned by customers from dollars they have spent, these rewards may have the potential to be converted into a form of cash or something with a cash value. If these rewards remain unused, they may be deemed to be unclaimed property. Illinois is just one state that applies the rule in this manner.

Peters cautions retailers to pay careful attention to the changes under the Revised Uniform Unclaimed Property Act. Gift cards that may not have needed to be reported as unclaimed property in the past, may need to be reported as such now.

Some states pursue unclaimed property quite aggressively, because it could mean significant revenues for them. In a Supreme Court case, something as simple as not having a known address for the customer or vendor results in the state of incorporation becoming entitled to that property. Delaware is the state of incorporation for most of corporate America, and this state has claimed billions of dollars in unclaimed property over the past several years. The audit campaigns launched by the state of Delaware are distinctly focused on unclaimed property, because, in their estimation, as much as 95% of companies are non-compliant in this area of tax assessment. Tax audits can go back as far as 15 years if a company has not kept adequate records. This, naturally, has a huge impact on the affected companies.

Other states are increasing their focus in this area of interest. Bands of third-party contingent-fee auditors are hired to conduct audits across multiple states, with their primary aim being to recover the unclaimed property. As little as only 2% of what is investigated will find its way back to the actual owners.

Companies need to educate themselves on the changes in these rules, and the differing deadlines for unclaimed property. Compliance reporting is a fall deadline for most states. The rules in these states are specific regarding what and how property gets reported on. The vast changes in unclaimed property reporting rule over the past several years may even be missed by sophisticated entities. Companies that prove to be non-compliant tend to be first in line for audits, placing a significant compliance burden on them.

States have honed their ability to identify potentially non-compliant companies, which usually results in large penalties and fees levied against these companies. The most likely entities to be found to be non-compliant are companies owned by foreign parent companies. The states have learned to target these entities, as it is common that the foreign entities do not understand the U.S. tax requirements in enough detail to ensure they are compliant when reporting season is upon them.

Companies that tend to claim expenses as a cost of conducting their business, need to be aware of the tax implications of doing so. As an example, issuing a credit to a customer results in an expense to the business because sales revenue has already been reduced by the credit amount extended to the customer. Uncashed checks issued to vendors would create the same type of effect. A whole series of new accounting rules have come about regarding more complex situations such as gift cards. Companies that issue gift cards essentially end up needing to maintain three sets of financial records: one for tax, one for unclaimed property and the third for the reporting of their financial statements.

So, in summary, any organizations preparing for the fall reporting season need to pay particular attention to the unclaimed property aspects of their financials and ensure the requirements for their particular state have been met in this regard.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.