Crypto Investors Need To Follow These IRS New Reporting Requirements
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New Tax Form
According Bitcoin.com, 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?|
What will the IRS do with this information?
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.
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 Focussing 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.
|SAYS THE IRS: “IN JUST 18-MONTHS WE ALREADY SEE THE BENEFITS – IN THE DEVELOPMENT OF NEW TOOLS AND THE NUMBER OF REAL CASES.”|
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.|
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.
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.
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 9th of October 2019, it reaffirmed the above guidance and expanded guidance on various forms of virtual currency that emerged in the meantime.
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.
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.
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
- 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.
|PLEASE ANSWER YES OR NO|
|At any time during 2019, did you:|
|ANY FINANCIAL INTEREST IN ANY VIRTUAL CURRENCY?|
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).
|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.|
|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.
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 intended 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.
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