Crypto Tax Archives - Page 3 of 8

CRYPTO TAX ALERT: IRS Starts Sending New Virtual Currency Education Letters

Crypto Tax Expert writes about crypto client experience and perspective on the new round of Virtual Currency Education Letters from the IRS.

The IRS has officially resumed mailing out virtual currency education letters to taxpayers suspected of inaccurately reporting all their crypto income.

The IRS first mailed the Virtual Currency Education Letters in July and August of 2019 to about 10,000 taxpayers.

Dozens of crypto owners contacted me having received the first round of virtual currency education letters, and all of them had crypto holdings in 2017 above $900,000.

The first round of virtual currency education letters showed that the IRS knew who the crypto whale traders were.

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IRS Sends a New Round of Virtual Currency Education Letters

This week (August 24, 2020), a crypto owner contacted me, having just received a virtual currency education letter.

However, his 2017 maximum crypto holdings were less than $150,000.

“The recent virtual currency education letter suggests that the IRS now uses much looser criteria for determining whom to send letters.”

- Clinton Donnelly Tweet

What is the significance of this development with the new round of virtual currency education letters?

The federal income tax is a voluntary system in that taxpayers voluntarily report their income to the IRS. The IRS uses audits to find and punish tax evaders. The IRS cultivates a healthy fear in the public to encourage broad voluntary compliance. It is easier for the IRS to send out these education letters to motivate taxpayers to fix their mistakes, then to commit valuable IRS time and resources doing actual audits.

Restarting the education letter campaign again shows the IRS is increasing their focus on non-reporters of crypto income.

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“Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest, and penalties,” said IRS Commissioner Chuck Rettig. “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”

What are these virtual currency education letters?

There are three different virtual currency educational letters: 6173, 6174, and 6174-A.

Directly receiving any of these virtual currency education letters identifies you as a person of interest to the IRS.

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Letter 6173 is sent to those whom the IRS suspects of having possibly engaged in tax misreporting of a criminal level.

I strongly encourage you to amend your tax returns quickly to avoid legal complications if you have received Letter 6173. Also, engage a criminal tax lawyer.

Letter 6174 and 6174-A are similar and sent to taxpayers suspected of misreporting their crypto income at a non-criminal level.

Letter 6174-A is a little more verbose than in 6174. I’ve not identified any difference between the situations of those receiving either letter. These are the most common letters.

What do the virtual currency education letters say?

The letters state, “We have information that you have or have had one or more accounts containing virtual currency but may not have properly reported your transactions involving virtual currency, which include cryptocurrency and non-crypto virtual currencies.”

The taxpayer is encouraged to amend or file tax returns accurately, reporting crypto income.

The warning is added, “If you do not accurately report your virtual currency transactions, you may be subject to future civil and criminal enforcement activity.”

Trust me, that’s not a good thing for anyone.

Specific instructions are given to mark a crypto return and provide a particular mailing address for sending the returns.

These instructions are important because it allows the IRS to track that you acted on the letter.

Recipients who don’t act when receiving a virtual currency education letter will be more likely to get audited.

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If you prepared your return, I recommend engaging a professional to assist in the review and amendment of returns, to be safe.

Should you call the IRS telephone hotline information?

The letters offer a telephone hotline number. The IRS will only provide general advice.

Be aware, the IRS records all phone calls and keeps a log of the phone numbers of who calls the IRS.

These call logs and recordings can be used by an auditor or revenue officer if you disclose any clues about your situation.

What can be done about the virtual currency education letters?

For most people, the odds of getting audited are low. But if you have received a letter, your odds are high of an audit.

Getting a professional recalculation of your crypto income and amending 1-3 years of returns is not inexpensive, but getting audited will be several times more expensive.

Undergoing an IRS audit can also significantly impact a person’s emotional, marital, and financial strain.

At Donnelly Tax Law, we recommend:

– Amending your crypto tax returns using our bulletproof crypto return methodology

– Consulting with an experienced crypto tax return preparation professional about your risks.

How can Donnelly Tax Law help?

We believe every crypto taxpayer can have a “Bulletproof Crypto Tax Return.”

Our website offers powerful do-it-yourself resources and full-service crypto tax preparation services.

We’ve helped taxpayers owning cryptocurrencies:

Avoid over $40 million in gains by using Like-Kind Exchange calculations.
We have prepared over 850 anti-money laundering reports required for many crypto traders.
We have prepared over 1025 tax amnesty returns needed by crypto traders correcting back filings. Our acceptance rate is 100% success.
Moreover, we’re one of the few firms with experience defending crypto returns at an IRS audit.

We are experts at filing returns for expats and foreign corporations.

We have clients in 48 countries.

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Crypto Tax Reporting Becomes IRS Top Priority – The New 1040 For 2020

Discover what the IRS is doing with crypto tax reporting by understanding the upcoming changes to the form 1040.

What is the IRS doing with crypto tax reporting?

The IRS has just released draft versions of the new Form 1040 for reporting personal income taxes. In the form, the IRS has moved their enforcement of cryptocurrency taxation to the most prominent position possible.

In 2019, the IRS had added a cryptocurrency question to an optional form called Schedule 1. The question asks, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency? YES or NO.”

For 2020, this question moved to just after the address. The question occurs before listing your kids in the dependents block. Cryptos before kids! Cryptos before wages!

Highlighted in yellow below is the new question on the 1040 form.

What is the significance of this for crypto tax reporting?

This prominent placement forces every taxpayer to admit whether they dealt in virtual currencies. It is a simple Yes or No question. No taxpayer can claim they never saw the question.

Why is this question important?

Because when you sign a tax return, you are swearing to the following statement from page 2 of the form, “Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete.” Under U.S. law, perjury is a felony punishable by three years in prison.

Why are crypto owners concerned?

2019 was the first year this question appeared on the tax form. Many crypto traders who had never reported their crypto income before became nervous. Here’s why. When you report the sale of property like cryptocurrencies, you must report the purchase price and date. That purchase date might be in a previous year. That could expose a taxpayer to an audit unless you go back and correct all previous returns.

Why should non-crypto owners be concerned?

The question asks about virtual currencies. What are virtual currencies? The IRS says, “Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Cryptocurrencies are only one type of virtual currency.

Other types of possible virtual currencies include frequent flyer miles, store loyalty card points which can be used like cash to buy store products, even purchase cards where you prove you bought nine pizzas, then the tenth one is free. In short, virtually everyone has an interest in some virtual currency. Perhaps everyone should answer yes to this question?

What is the legal issue for crypto tax reporting?

The term virtual currency is not a part of the law or tax regulations. The IRS notice defining virtual currency and the 2019 FAQ on virtual currency are non-binding. The National Taxpayer Advocate has called out the IRS for publishing non-binding FAQ, stating that they are a trap for the unwary.

The U.S. Government Accounting Office (GAO) published a report GAO-20-188 stating the IRS guidance in 2014 & 2019 was not clear as to which parts are authoritative and which parts were subject to change. IRS and the Financial Crimes Enforcement Network (FinCEN) have not clearly and publicly explained when, if at all, requirements for reporting financial assets held in foreign countries apply to virtual currencies (Forms 8938 and FBAR).

Will the statute of limitations protect me from IRS audits?

The statute of limitations protects taxpayers by limiting how much time the IRS has to audit returns. The IRS has three years from the due date for filing the return or two years from when the debt was paid whichever is longer. However, if there is a false return or tax evasion, there is no limitation. If the unreported income relates to financial assets where the counterparty is not a U.S. person, then the statute is extended to six years. (This pretty much describes all exchanges with anonymous persons on a crypto exchange, U.S. or foreign.)

The IRS has already begun audits of non-criminal crypto returns fro 2017. I am currently defending two clients from IRS audits of their cryptocurrency income.

Is the IRS question even lawful?

Many have asked if this question represents a substantial and unconstitutional overreach on the part of the Internal Revenue Service, and it should be withdrawn. It is excessive for the IRS to require a taxpayer to declare on the new Schedule 1 if he has “any financial interest” in cryptocurrency. This question violates many of the taxpayer’s constitutional rights. Mandating that taxpayers declare whether they received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency subjects taxpayers to an abridgment of numerous constitutional protections.

Is the question overly broad?

The First Amendment overbreadth doctrine allows a challenge to the validity of a statute on its face only if the law is substantially overbroad. City Council of Los Angeles v. Taxpayers for Vincent, 466 U.S. 789, 799-801, 104 S. Ct. 2118, 80 L. Ed. 2d 772 (1984). A law is overbroad when, although it constitutionally regulates some conduct, it sweeps so broadly that it also covers a substantial amount of constitutionally protected conduct. MDK, Inc. v. Vill. of Grafton, 277 F. Supp. 2d 943, 948 (E.D. Wis. 2003).

The United States Supreme Court has stated that “[a] statute may be deemed unconstitutional only if it is ‘substantially’ overbroad ‘judged in relation to the statute’s plainly legitimate sweep.’” Broadrick v. Oklahoma, 413 U.S. 601, 615, 93 S. Ct. 2908, 37 L. Ed. 2d 830 (1973). A finding of substantial overbreadth “requires the court to find ‘a realistic danger that the [policies] will significantly compromise recognized First Amendment protections of parties not before the Court.’” N.Y. State Club Ass’n v. City of N.Y., 487 U.S. 1, 11, 108 S. Ct. 2225, 101 L. Ed. 2d 1 (1988) (quoting Taxpayers for Vincent, at 801).

In analyzing an overbreadth challenge, a court must first construe the challenged statute—or in this case, the question on IRS Form 1040 Schedule 1—because “it is impossible to determine whether a statute reaches too far without first knowing what the statute covers.” United States v. Williams, 553 U.S. 285, 293, 128 S. Ct. 1830, 170 L. Ed. 2d 650 (2008). Next, the court determines whether the statute, as construed, “criminalizes a substantial amount of protected expressive activity.” Williams, 553 U.S. at 297. If so, the Court must determine “whether the statute is ‘readily susceptible’ to a limiting construction which would render it constitutional.” Snider v. City of Cape Girardeau, 752 F.3d 1149, 1158 (8th Cir. 2014) (quoting Virginia v. Am. Booksellers Ass’n, 484 U.S. 383, 397, 108 S. Ct. 636, 98 L. Ed. 2d 782 (1988)).

Likewise, a governmental directive may be held unconstitutional if “it seeks to prohibit such a broad range of protected conduct that it is unconstitutionally overbroad.” Taxpayers for Vincent, at 796.

Holding property—in this case, cryptocurrency—is not a taxable event. Reporting the fact that your own cryptocurrency is not a taxable event. As a result, the question is overbroad and should be withdrawn.

Does this crypto tax reporting question have a chilling effect on First Amendment Rights?

“The aim of facial overbreadth analysis is to eliminate the deterrent or ‘chilling’ effect an overbroad law may have on those contemplating conduct protected by the First Amendment.” Turchick v. United States, 561 F.2d 719, 721 (8th Cir. 1977) (footnote omitted).

The Supreme Court stated that “[a] statute may be unconstitutional if it is so overbroad as to “chill[] . . . individual thought and expression,” such that it would “effectively preclude or punish the expression of particular views.” Nat’l Endowment for the Arts v. Finley, 524 U.S. 569, 583, 118 S. Ct. 2168, 141 L. Ed. 2d 500 (1998) (citations omitted).

In 1968, the Supreme Court reasoned that “a government regulation is sufficiently justified if it is within the constitutional power of the Government; if it furthers an important or substantial governmental interest; if the governmental interest is unrelated to the suppression of free expression; and if the incidental restriction on alleged First Amendment freedoms is no greater than is essential to the furtherance of that interest.” United States v. O’Brien, 391 U.S. 367, 377 (1968).

The question on the proposed Schedule 1 does not survive intermediate scrutiny, as the Supreme Court has held that it must “further[] an important or substantial governmental interest; if the governmental interest is unrelated to the suppression of free expression; and if the incidental restriction on alleged First Amendment freedoms is no greater than is essential to the furtherance of that interest.” United States v. O’Brien, 391 U.S. 367, 376-77, 88 S. Ct. 1673, 20 L. Ed. 2d 672 (1968). This overbroad question chills free speech and should not be included in the tax form.

Does the IRS question violate taxpayers’ legal protections?

Mandating that taxpayers declare whether they received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency subjects taxpayers to an excessive fine.

What is the Excessive Fines Clause of the Eighth Amendment?

“Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.” U.S. Const. amend. VIII. In analyzing an excessive fines claim, the court must first decide whether a penalty is a fine before determining if it is unconstitutionally excessive. Dewees v. United States, 272 F. Supp. 3d 96, 100-01 (D.D.C. 2017).

The Supreme Court has stated that a payment to the government is only considered a “fine” under the Eighth Amendment if it is “punishment for some offense.” Austin v. United States, 509 U.S. 602, 609-10, 113 S. Ct. 2801, 125 L. Ed. 2d 488 (1993). The purpose of the penalty must be primarily retributive or deterrent rather than remedial. Id. In the context of forfeiture, for example, a penalty that is solely “designed to punish the offender” is considered punishment and is thus limited by the Excessive Fines Clause. Id. at 333-34.

The question in which a taxpayer must declare whether he receives, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency is primarily retributive or deterrent. It is not remedial. Taypayers will experience this situation regularly. The mandate will not deter them from doing so. While tax penalties have in the past been held to fulfill a remedial purpose are not subject to the Excessive Fines Clause, cryptocurrency was not contemplated by the Court by the Supreme Court 80 years ago when the standard was announced in Helvering v. Mitchell, 303 U.S. 391, 58 S. Ct. 630, 82 L. Ed. 917, 1938-1 C.B. 317 (1938). The Supreme Court reasoned that tax penalties are remedial because they exist as “a safeguard for the protection of the revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from the taxpayer’s fraud.” Id. at 401. There is no fraud in this circumstance where income is not realized. The question does not create a loss of revenue for the government.

What is the Due Process Clause of the Fifth Amendment?

A due process means that a person has been afforded an adequate “opportunity to be heard at a meaningful time and in a meaningful manner.” Mathews v. Eldridge, 424 U.S. 319, 333, 96 S. Ct. 893, 47 L. Ed. 2d 18 (1976), quoting Armstrong v. Manzo, 380 U.S. 545, 552, 85 S. Ct. 1187, 14 L. Ed. 2d 62 (1965). Courts judge procedural due process challenges to property deprivations by weighing (1) “the private interest that will be affected by the official action;” (2) “the risk of an erroneous deprivation of such interest through the procedures used, and the probable value, if any, of additional or substitute procedural safeguards;” and (3) “the Government’s interest, including the function involved and the fiscal and administrative burdens that the additional or substitute procedural requirement would entail.” Id. at 335.

Arguably due process is violated when this property right is deprived of a taxpayer, especially when there is no value recognized, that is, the cryptocurrency is not converted to a fiat currency or exchanged for another service or product of value. The fact that a taxpayer has cryptocurrency impacted a taxpayer’s privacy interest; there is significant the risk of an erroneous deprivation of the taxpayer’s property right; and it creates an undue burden in light of any governmental interest.

What is the Equal Protection Clause of the Fifth Amendment?

The threshold element of an equal protection claim is disparate treatment. Tippins v. Parish, 2019 U.S. Dist. LEXIS 177875, at *23 (W.D. Mich. Oct. 15, 2019), citing Scarbrough v. Morgan Cty. Bd. of Educ., 470 F.3d 250, 260 (6th Cir. 2006); Center for Bio-Ethical Reform, Inc. v. Napolitano, 648 F.3d 365, 379 (6th Cir. 2011) (“To state an equal protection claim, a plaintiff must adequately plead that the government treated the plaintiff ‘disparately as compared to similarly situated persons and that such disparate treatment either burdens a fundamental right, targets a suspect class, or has no rational basis.’”).

An equal protection plaintiff must be similarly situated to his comparators “in all relevant respects…” Nordlinger v. Hahn, 505 U.S. 1, 10, 112 S. Ct. 2326, 120 L. Ed. 2d 1 (1992). Further, a sufficient injury in fact is concrete and particularized, and actual or imminent as opposed to merely hypothetical. Lujan v. Defenders of Wildlife, 504 U.S. 555, 560, 112 S. Ct. 2130, 119 L. Ed. 2d 351 (1992)). It is the plaintiff’s burden to demonstrate that his claim satisfies all of these elements. Id. at 561.

Here, it is clear that the owners of cryptocurrency are being treated differently than other taxpayers. As such, an equal protection claim can be argued as the government treats these taxpayers “disparately as compared to similarly situated persons and that such disparate treatment either burdens a fundamental right, targets a suspect class, or has no rational basis.” Ctr. for Bio-Ethical Reform, Inc. v. Napolitano, 648 F.3d 365, 379 (6th Cir. 2011), quoting Club Italia Soccer & Sports Org. v. Charter Twp. of Shelby, 470 F.3d 286, 298 (6th Cir. 2006), overruled on other grounds as recognized by Davis v. Prison Health Servs., 679 F.3d 433, 442 n.3 (6th Cir. 2012). Answering the question affirmatively singles out cryptocurrency owners for treatment unlike other taxpayers.

Does this crypto tax reporting question discriminate against commerce?

The question is also discriminatory on a cryptocurrency owner’s commerce. “If a restriction on commerce is discriminatory, it is virtually per se invalid.” Oregon Waste Systems, Inc. v. Department of Environmental Quality of State of Or., 511 U.S. 93, 99, 114 S. Ct. 1345, 128 L. Ed. 2d 13 (1994).

Under Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279, 97 S. Ct. 1076, 51 L. Ed. 2d 326 (1977), a state tax will be sustained against a Commerce Clause challenge as long as the tax (1) is applied to an activity with a substantial nexus with the taxing state; (2) is fairly apportioned; (3) does not discriminate against interstate commerce; and (4) is fairly related to the services provided by the state. Id. The Complete Auto test emphasizes the importance of looking past the formal language of a tax statue to its practical effect. Direct Mktg. Ass’n v. Huber, 2011 U.S. Dist. LEXIS 9589, at *14 (D. Colo. Jan. 26, 2011), citing Quill, 504 U.S. at 310.

Applying this test to cryptocurrency, there is no substantial nexus, the action is not fairly apportioned, discriminates against interstate commerce; and is not fairly related to the services provided.

Further, it is clear that the practical effect is to create a discriminatory environment for cryptocurrency owners.

Summary On The Latest Crypto Tax Reporting

The question on virtual currencies represents a substantial and unconstitutional overreach on the part of the Internal Revenue Service; it should be removed—especially until the laws and regulation of cryptocurrency is more definite and the courts have had an opportunity to determine the validity and constitutionality of these laws.

Although IRS Commissioner Chuck Rettig has noted, “The IRS is committed to helping taxpayers understand their tax obligations in this emerging area,” and that the new guidance “will help taxpayers and tax professionals better understand how longstanding tax principles apply in this rapidly changing environment,” this question runs afoul of constitutional protections and should be withdrawn.

The choice by the IRS to elevate the importance of their question after significant legal issues have been raised, is troubling.

Given the overly broad definition of virtual currency, if all taxpayers answered YES, then the question becomes trivialized and useless for data mining purposes.

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Bitcoin Tax Recordkeeping – Stephan Livera Podcast: Part Two

Learn about Bitcoin tax recordkeeping with tax experts Clinton Donnelly and Dennis Wohlfarth on Stephan Livera’s podcast, episode 183.

Dennis Wohlfarth of Accointing and Clinton Donnelly of Donnelly Tax Law join Stephan Livera to talk about Bitcoin tax recordkeeping, and strategies to employ to minimize tax. In the full podcast, we chat about:

Current Bitcoin tax treatment
Capital gains Bitcoin tax treatment
Bitcoin tax recordkeeping
Bitcoin tax strategies locally
Bitcoin tax strategies for those willing to go overseas
International crypto competition

In part one, we talked about Bitcoin tax treatment and Austrian economics on Stephan Livera Podcast, episode 183, and our guests were from the company Accointing and Donnelly Tax Law.

We talked about Bitcoin and tax strategy.

Today, our podcast show notes are about Bitcoin tax recordkeeping with our two crypto tax experts.

In part one, we left off curious about how people typically deal with having multiple wallets or multiple exchange accounts.

Bitcoin Tax Recordkeeping: Dealing With Multiple Wallets Or Exchange Accounts

What’s the typical way that you and your customers usually deal with multiple wallets or multiple exchange accounts?

Dennis Wohlfarth:
At Accointing, we allow our customers to directly connect their exchanges with either an API or a direct connection if the exchange offers that. For Bitcoin and auto blockchains, we import all the historical data through an xPub and yPub, or standard Bitcoin addresses.

You can then combine all that into one portfolio, and we keep track of the entire money flow in your system.

That means if you send something from your first exchange to your Bitcoin wallet, Accointing handles that connection through the transaction ID, and we create a so-called “internal transaction.” These internal transactions are not a taxable event. They even create a fee because of the transfer fee that you can use later as a cost that you spend to transfer those Bitcoin.

Tracking Your Money Flow

Use the internal transaction through Accointing to transfer the cost basis from the first wallet to your second wallet, and it is always kept with that Bitcoin. This internal transaction is excellent because you can go back and dive into your money flow, and you have everything completely tracked.

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It’s nice to have for tax purposes and to prove to your bank where you got the funds. If you trade with higher amounts, banks want to know where you got that investment from because it could be some money laundering activity. If you can track the entire history, it makes it more accessible.

Bitcoin Tax Recordkeeping: Self-Spending Is Not Taxed

Stephan Livera:
I see. Yeah. That’s one way to aggregate across all of your wallets and all of your exchanges into one thing.

The other part is when you sell. That’s a capital gains event, typically, and you want to have the record to say this wasn’t a sale, this wasn’t me spending. It was me, self-spending. And so that’s not treated as a capital gain, etc., and therefore not taxed.

Bitcoin Tax Recordkeeping: Taxable Events

Dennis Wohlfarth:
Exactly. Or you even use it when you send a gift or did some other activity with it so you can prove where.

For example, in Germany, we are currently suing the government, and are in court because we don’t agree with the government on the tax regulations.

We don’t agree that payment should be a taxable event. We believe that people who report their taxes in Germany are being truthful. These truthful people report some gains and, in theory, have to pay taxes, but it’s unfair. The government can’t prove that other people don’t report taxes or are guilty of tax fraud. They don’t have a way to go into the blockchain point or different exchanges because they are all over the world.

Therefore, they cannot prove that you traded, but they want forthright people to pay taxes, which is not legal in Germany. That’s why we’re currently suing the government there and fighting the tax regulation. To make it clear to them that they can do that for everyone, which is highly unlikely, or they’re not allowed to file taxes on crypto investments or crypto trading.

That’s one part that we try to do for the German community. Clinton knows more about the US part. Some inspiring things are happening in the future. I mean, a few exciting discussions are starting where they are trying not to treat payments as a taxable event, which would be nice. Considering everything happening in the market regarding Lightning and Defi coming in, I don’t know how they want to do it.

Bitcoin Tax Recordkeeping: Taxation From A Capital Gains Point Of View

Stephan Livera:
Let’s talk a bit about that. This idea of payments and the taxation that occurs on them, theoretically from the capital gains tax point of view.

So I guess what you’re getting here is for example’s sake, let’s say you buy $100 worth of Bitcoin, and then it’s $200 worth of Bitcoin. If you spent a portion of that, the point you’re getting out there is theoretically a capital gain on which the government wants their pound of flesh.

What are some different ways those situations are treated from a taxation law perspective?

You can find out more about how different situations are treated from a tax law perspective in our upcoming post along with Bitcoin tax strategies locally and overseas.

Stay tuned for Part Three of the Bitcoin Tax Strategies Podcast with our host Stephan Livera.

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Bitcoin Tax Treatment – Stephan Livera Podcast: Part One

Learn about Bitcoin tax treatment strategies with tax experts Clinton Donnelly and Dennis Wohlfarth on Stephan Livera’s podcast, episode 183.

Dennis Wohlfarth of Accointing and Clinton Donnelly of Donnelly Tax Law join Stephan Livera to talk about Bitcoin tax treatment, and strategies to employ to minimize tax. In the full podcast, we chat about:

Current Bitcoin tax treatment
Capital gains Bitcoin tax treatment
Bitcoin tax record keeping
Bitcoin tax strategies locally
Bitcoin tax strategies for those willing to go overseas
International crypto competition

These podcast show notes are about Bitcoin tax treatment and Austrian economics today for episode 183, and Stephan Livera’s guests are from the company Accointing and Donnelly Tax Law.

We’re going to talk about Bitcoin and tax strategy.

Tax is not something people want to discuss. At the same time, it’s one of those things where a lot of listeners may be interested in understanding some of these different issues and some tax strategies they could employ.

Introducing Bitcoin Tax Strategy Experts: Dennis Wohlfarth and Clinton Donnelly

Dennis Wohlfarth:
My name is Dennis. I officially co-founded Accointing in 2018. We had a system running before that as a group of investors in the market for many years. At some point, we faced the problem of keeping track of all our investments. Especially back in the days of (Initial Coin Offerings) ICOs and all the things that were happening back then. So we decided to build a tracking tool for ourselves, as a backend tool. In 2018, we went public to support the crypto market in keeping track of everything and creating tax reports for different countries. And we’re now at the point where we support the US, Austria, Switzerland, UK, and Germany for specific tax reports and other countries with general health performance.

Clinton Donnelly:
My name is Clinton Donnelly, with Donnelly tax law. We do tax preparation and defend people with tax audits of their cryptos. I do tax preparation in the United States, but I have a very international experience. I have an advanced law degree in international financial regulation, including taxation, from the University of Liverpool in the UK.

I have clients in 48 different countries who are mainly:

Americans exploring crypto tax implications of doing business with the US
Americans living outside the US.

I have a practice focusing on cryptocurrencies, cryptocurrency return preparation, and tax amnesty (related to crypto).

I have authored four books in cryptocurrency, and I do a lot of speaking about it.

Stephan Livera:
That’s fantastic. Let’s get started. I think the naive person is first thinking about Bitcoin, but depending on how they’ve acquired that Bitcoin, they might think I am super private.

What are some things people need to be thinking about in the world of Bitcoin taxation?

Current Bitcoin Tax Treatment

What’s the reality in terms of Bitcoin tax treatment?

Clinton Donnelly:
The international community has decided that Bitcoin is considered a virtual asset. It’s property. It’s not currency, and it’s not a cryptocurrency from a global perspective.

Taxation occurs when you sell or exchange that Bitcoin. So merely buying a Bitcoin is not going to be a taxable event. If you're hodling that Bitcoin, for a couple of years, there are no taxes involved. When you sell it or exchange it, you are going to incur taxes on the gain.

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If Bitcoin hits the moon this year, what sort of thinking would your listeners want to have in terms of taxes?

The one thing about taxes, it’s usually a percentage of your income.

On the one hand, I’d wish all your listeners to have incredible tax bills, which means they made incredible amounts of money.

That said, how do we minimize what we have to pay and not give the government or any government more than they need to get legally?

Depending on your jurisdiction, they're going to take 25 to 50% of your hard-earned money toward taxes. So your tax strategy is just as important as your investment strategy.

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Stephan Livera:
It’s almost like the tax agents and the tax law of the land encourage people to hodl, right? That’s kind of the encouraged position because it’s only when you sell or spend that Bitcoin that you have to even think about these taxes, right?

Clinton Donnelly:
That’s exactly right. Most countries in the world want to encourage investment.

Capital Gains Bitcoin Tax Treatment

When does investing happen?

Investing can happen:

when you buy it and hold it for a long time or
when you’re a day trader, you’re in and out, in and out

But corporations cannot grow a business if they are just day traders investing in their company. They want somebody to invest and leave that money for a year, two years, or “whatever amount” of time. That way, the corporation knows that they can bank on that investment.

Governments incentivize that by having one or having extra tax tiers for capital gains. Capital gains are what you call selling property.

Which countries have long-term capital gains incentives?

Most countries have long-term capital gains incentives. In the US, your tax rate goes down to 15%. It goes down to zero or some minimal amount or after so many years at zero in certain countries. This holding is an incentive, and that is a significant reward for the hodlr to be aware of and ask if they hit that long-term capital gains mark.

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In most countries, the most natural and most legal thing to do is to go for the long-term capital gains incentive on your taxes.

How is crypto income treated from an Australian position?

Stephan Livera:
At least from the Australian position, my understanding is that it matters whether your income is treated as if your business is one of “trading,” or your business is one of “investing and speculating.”

So if you’re in the trading world, it is seen as if you are trading income like you had one hundred thousand dollars, and that’s your income for the year. But for most people, it’s in the capital gains world of being an asset. And when you made a gain, you’re taxed on the gain.

Is that mostly a fair way to think about it?

Bitcoin Tax Strategies Vary Country-To-Country

Dennis Wohlfarth:
Yeah, it is. Like Clinton already said, it’s a bit different in every country. For example, after holding it for one year in Germany, you have zero taxable gains, or you don’t have to pay taxes on it because it becomes long-term. So, you need to be careful.

If you are margin trading or similar trading activities, you need to be careful not to be treated as an investment company because it changes the rules a bit.

You have to open a business for that, but most investors who may trade a few times per month don’t typically have a problem with that. And based on that holding period, there are also a few good parts that you can use.

If you buy Bitcoin or any other crypto assets at a high price, and the price drops, you can use that and tax plus harvest or sell the loss and use it as a loss for the coming years when you create some gains. It depends on how and when you invested in crypto.

Bitcoin Tax With Accointing

Importing Transactions With Crypto Tax Tool Accointing

One big part that we offer to our clients at Accointing is allowing everyone to import all the transactions and all the trades (for free). We also have different tools to monitor and display holding periods or assets.

Imagine that you trade on various exchanges, and hold in different Bitcoin wallets, you’d never know which Bitcoin is long-term. That means there is a lower tax rate on the Bitcoin in the short-term gains.

So you need to be careful here, and Accointing has a way of displaying that.

There’s also a little more for the optimization part. You can go deep into that, and there are different ways of tracking.

You can keep track of your investments in one single day depot.

That means you buy Bitcoin, and in most countries, they use a first-in-first-out (FIFO) method to calculate which Bitcoin or cost basis you have to use when you sell something.

There’s a single day depot where you put everything into one Excel file. You use the oldest one, like the oldest Bitcoin cost basis that you have and sell that. But in most cases, that’s not what you want to do, especially if you do more day trading.

A good way of optimizing a bit more of a micro field here is to track everything with multiple depot tracking. That means if you buy something in one exchange and you send it to your wallet. The cost basis gets transferred to the wallet, and when you buy something else, on another exchange in your day trade there with Bitcoin, you just sell the Bitcoin that is really on this exchange, and you don’t touch long-term investments.

With that strategy, you can trade a few percentages of your portfolio, and the rest you can keep separate and go for the long-term gains.

If in 2017, you had had an investment of say, ten Bitcoin, and at just six months, you hadn’t sold them, but Bitcoin price crashed, there would be a trade-off.

Would it be better to sell at that high price, or is it better to hold?

The answer is, it depends on what you expect the market to do in the future.

It’s good to optimize for taxes, but not all the time when you trade. So that’s the trade-off that you have to use in that situation.

For example, there are countries like Switzerland where you don’t pay any gains on your crypto trades, and it’s just a wealth tax at the end of the year. So, if you’re lucky to live in a country like this and want to day trade, it’s a little easier. But you can make that happen anywhere in the world.

Bitcoin Tax Practices

Tax-Loss Harvesting

Stephan Livera:
So the first point you mentioned was regarding tax-loss harvesting. My understanding of that is you purchase at a specific price, but now the price has fallen. And people sell and re-buy to lower their cost basis so that they’ll have a loss that they will be able to use against their future gains in the future. Is that right?

Dennis Wohlfarth:
Yes, that’s correct.

And if you do that, you always want to sell them in under a year, because you can use more losses for future gains since the tax rate is higher.

For example, in Germany, if you sell after one year, the tax rate for long-term holdings is zero. You don’t have any losses that you can subtract from your future gains because it’s no longer taxable.

Stephan Livera:
So the other point was regarding what you might call segregation.

For those people who are traders, they might have a holding amount created, and it is their long-term holding that’s going to get taxed as an asset at a capital gains tax (CGT) sort of style.

Whereas if they’re trading, that’s a separate portion of their Bitcoins. Let’s say they are a trader, then that is what gets assessed on a different basis because that’s more like regular income, right?

Dennis Wohlfarth:
Yes, exactly. You don’t want to mix those two depots up, and you can use different strategies.

If you buy Bitcoin every month, you can use different addresses and put the Bitcoin there from the beginning.

If you mixed them up and traded them over the past few years, you want to use this method.

You can use a tool that we offer at Accointing, where we tell you which day depot has long-term holdings and which has short-term holdings, and what the trade-off is between them.

You can go deep into that and analyze it. Then use the correct Bitcoin, maybe from your wallet, number 10, to sell because this would create a loss.

On the other hand, the Bitcoin that you hold in Coinbase would generate a gain, right? So, in the end, you sell one Bitcoin, but you can sell the correct one to create a loss with that trade.

Stephan Livera:
I’m also curious about how people typically deal with it when they have multiple wallets or multiple exchange accounts.

For More Bitcoin Tax Help

Stay tuned for part two of the Bitcoin Tax Strategies Podcast with our host Stephan Livera.

You can find out more about multiple wallets and exchange accounts and more in our upcoming post.

Subscribe to our newsletter and get our free download This Deadly Crypto Mistake Could Cost You $10K!.

Watch The Full Webinar

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Crypto Tax Tool With A Crypto Tax Expert – The Crypto Tax Webinar: Part Three

Learn how to estimate your taxes with an excellent crypto tax tool and tips on how to estimate how much you will be paying in taxes.

Learn about how to estimate your taxes with an excellent crypto tax tool called Accointing in this transcribed Crypto Tax Webinar. Presented by Clinton Donnelly and sponsored by Accointing.

In the full live webinar, we covered:

How to deal with COVID 19: Paying Crypto Taxes On An Installment Plan
The current on-going policies regarding crypto-taxation
What are taxable events and how to handle them
The sent IRS letters and the different implications for each of them
The next steps in order to conduct your crypto tax submission
Some opinions from a top Crypto CPA in the market and average estimate of how much you will be paying in taxes
An idea on how to estimate your taxes with a crypto tax tool

In Part One, we discussed the tax guidance the IRS has created to report cryptocurrencies and breakdown what those IRS activities have been in the history with crypto.

We looked at what type of enforcement the IRS is doing and reviewed how they’re slowly increasing the implementation level in how they’re going after people. We also explored some IRS letters that they sent out.

In Part Two, we discussed how to report cryptocurrencies on your crypto tax return. We looked at the mechanics and tax aspects of that.

PART THREE: Crypto Tax Tool With A Crypto Tax Expert

In Part Three, we will discuss how to prepare a tax return and what sort of help you can get. We’re also going to discuss how to use Accointing, an excellent crypto tax tool.

Accointing is a beneficial tool, particularly for reconciliation, one of the biggest challenges when using a tool.

You can report internal transactions using the crypto tax tool Accointing. These are transactions within the actual platform.

You need to tell the platform that those transactions were transactions recognized as being equal and the movement from one point to another. Then you can classify transfers within Accointing.

The idea here is that you can state what should be classified as income, an airdrop, a margin fee, a margin loss, and so forth to classify them based on their depot.

What happens if I don’t disclose all my positions?

Now we’re on the slide about what happens if I don’t disclose all my positions. This slide is a bit of a misnomer.

You don’t disclose your positions to the IRS, only your transactions and the penalties listed here are really for criminal tax evasion.

What do you have to worry about if you didn’t report your crypto activities in 2017?

The IRS is going to spend their time going after the big fish. They've demonstrated the ability to determine who the big fish are with 10,000 letters.

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If you're what I'd call a small fish and you had less than a hundred thousand in 2017, you may not be the type of person the IRS will focus on.

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I mentioned that because many of the smallest traders that call me are super conscientious and want to report everything and be above board.

The IRS is going to focus on the most prominent players: large and middle-sized players.

What happens if the IRS identifies that you didn’t report some income in 2017, and then you reported some gains, and they hit you with penalties?

There could be an understatement of taxes, that’s a penalty, and a late payment because you didn’t pay this.

Those two penalties themselves would typically add 50% to whatever you owed.

If it were over $5,000 in taxes, you would be looking at another 50% more in terms of penalties and interest.

If they felt you had engaged in tax evasion, there is a civil tax evasion penalty of 75% of whatever taxes weren’t paid.

Generally, they’re only going to use that when they’re coming after someone who is pretty egregious.

The critical thing is you want to be clean because when you suddenly start reporting in 2020 that you made trades, and when you list the buy date as 2017, that is a logical jump for an auditor to ask, ‘why didn’t you report any cryptos in 2017 or 2018?’.

You bought some, and you probably traded some.

So it’s the dates that are going to force you to come clean on past filing issues. That should be a concern of yours. You can schedule a consultation with me and we can talk through the situation.

What method can I use for crypto tax calculation in the US?

This question is related to the words FIFO and LIFO (first-in-first-out) or (last-in-first-out).

These reporting methods determine which coin it is that you sold when you sell a coin.

We know the price when we sell a coin because that’s in the transaction records, but what was the price of that coin?

You may have had coins at five different price points, and which one was it that sold?

The one you choose determines how much gain or loss occurred on a particular transaction, and that affects your taxes.

The tax laws said, FIFO.

They currently refer to revenue section 1012 which says, you have to do FIFO.

However, the IRS in the most recent FAQ in October 2019 said, you can use any method you want.

You can choose the best reporting method after the coin has sold as long as you use what they called a specific identification approach, which is being able to show that all your coins are accounted for. You just can’t make it up. Accointing’s crypto tax tool does that.

Accointing allows you to use FIFO, LIFO, or any method that you’d like.

I recommend that people use whatever method generates the lowest taxes for you to pay that year. And you can change this method every single year. You might do LIFO one year FIFO another year, and then, maybe an optimized method a third year.

How do you get started with an excellent crypto tax tool?

You have to decide how much you’re going to do for yourself on your taxes and how much you want someone to help you.

Our company does full-service tax calculation, but you’re going to be paying a couple of thousands of dollars to do all that per year. Larger traders can afford that, but smaller traders have to do that in a bit more of a budget manner.

I recommend a crypto tax tool like Accointing to generate your crypto tax records. That’ll generate a form called form 8949, the IRS form where you list the buy and sell dates and the cost and sale prices. Everyone is on the list, meaning the gain for every transaction.

Accointing will generate that record, and they can create it in a TurboTax format.

If you use TurboTax, it can be automatically uploaded, and Accointing makes it very convenient.

Most of those software packages will lease with TurboTax, but Tax Act or H & R Block will be the largest one. They all have the tools to generate a tax return. However, they aren’t literate about cryptocurrency reporting.

You’ll find instructions on the Accointing web page, which tells you exactly how to load it into TurboTax. It’s straightforward and effortless to do with the instructions. You only have to upload it to the software. So that’d be one approach.

What if your tax life is complicated or you are using an accountant, but your accountant doesn't know cryptos?

Your accountant is not interested in learning cryptos, so it may fall on you to use a crypto tax tool like Accointing to generate the tax records that you then turn over to your accountant.

And your accountant will then know what to do with form 8949. He or she can plug it into the tax software.

Or you can go to a full-service firm that can do everything for you if doing your crypto calculations is too overwhelming.

How do you find the right crypto tax accountant?

The best thing is to ask your accountant, bluntly, “Do you do cryptocurrency tax returns?” Ask them, “How many have you done and do you calculate the capital gains, or do you expect me to do that?”

I had one client who, in 2018, had a CPA who said, “Yeah, I know how to do this.”

And that CPA was only learning how to do crypto returns.

My client gave this CPA her taxes and five months later she still didn’t have it done. She gave up on it. So, she took it to another CPA who said, “Yeah, yeah, yeah, I can do this”.

He prepared the entire tax return for her, but he didn’t sign it. And my client dug into it and found out that this guy had lost his CPA license.

So it was just a fake return that he had made.

My client met me, and we did her tax return after the others failed. We got the whole thing solved and saved her a fortune. She paid zero taxes that year.

You want to ask your tax preparer, how many crypto tax returns they’ve done. You don’t want them to learn on you.

You can tell your tax preparer that you’ll do the Accointing work yourself and bring it to them. Your tax preparer will say yes to that and know what to do with the Accointing results.

Suppose you cannot do the calculation yourself, and using Accointing is overwhelming for you. Then, you need to get a professional to help, which can be done on an hourly basis.

Or you can turn the entire work over for a higher amount and have someone do the whole thing.

That is how you get started and get a tax return prepared.

How much will it cost me to pay my crypto taxes?

The complexity of your trading environment will have a bearing on how much you pay when you use a tool like Accointing.

Some people like to dabble in everything and used a bit of everything. Say, they did shape shifting, margin trading, and futures. They also used Binance, Defi, and did all sorts of things.

The more complicated your environment was, the more complicated it can be to calculate your gains. So, you have to look at the crypto tax tool and see what their pricing is.

Power Tricks For Medium To Large Fish (Crypto Whales)

I have a handful of tricks for you.

Suppose you’re a medium and large fish.

Note: These tricks probably aren’t for smaller fish.

My big six tools would be for reporting your capital gains before 2018, when the law was changed. We could use a method called like-kind exchange for 2015, 2016, and particularly 2017. This is a way of not having to pay taxes on the crypto to crypto trades. That gain is passed along to the subsequent transactions.

Starting in 2018, you couldn’t do like-kind exchange anymore, but I’ve saved people millions in this area.

For tax harvesting, as we come into the end of the year, around October, November, you want to start thinking about how you are poised from a capital gains point of view.

Around October/November would be a great time if you have a lot of gains to do tax harvesting, this would be to take coins that are losers, and sell them for a loss and take that loss and it offsets your gain so that your taxes at the end of the year will be lower.

There are two methods of tax harvesting:

One is just selling worthless coins.
Another one is doing a wash where you take a coin, sell it to lock in the loss, and then the next day buy it right back because you still want to have a position for that coin. You have a long term expectation for it.

If you’re a large fish, the third idea is to move to Puerto Rico, but you genuinely have to move there. You can’t just visit. They offer a 0% capital gains tax on capital gains from cryptocurrencies.

There are a lot of complexities and a severe thing to do. You seriously have to move to Puerto Rico. You have to uproot your life, but if you’re a large fish, this might be a meaningful thing to do, to make a lot of money to reduce your taxes.

So what are we talking about here?

You’re going from 15% tax bracket down to a 0% tax bracket.

So if you had $100,000 in gains, you’re looking at $15,000 in taxes.

To save $15,000 and go to Puerto Rico, probably not the right move for you, but if you have millions, this would be something to consider.

If you have old returns between 2017 and 2018 and you need to fix them because you didn’t report anything, especially if you’re a medium and large fish. Then you would need to look at tax amnesty solutions to minimize your tax liability.

What is your anti-money laundering liability?

If you traded on foreign exchanges, you had over $10,000 in foreign exchanges, you become liable to report those on the two anti-money laundering forms, FBAR and form 8938.

You can bulletproof your tax return. Just go to my website.

We have lots of do-it-yourself tools like books and an increasing number of videos we’re starting to make available online on how you can calculate your taxes using TurboTax, and how to do your anti-money laundering form filings.

We have lots of great crypto tax tools.

Responding To IRS Communications

Donnelly Tax Law offers a crypto tax audit for an annual fee.

Suppose the IRS contacts you about your crypto activity on your tax return. For any tax return you have exposed, and if you get contacted by the IRS, we will provide you with an analysis. You’ll be getting your A-team in place to respond to that crypto tax return.

This audit assist is critical. You can go to CryptoTaxAudit.com to learn more about that.

Dealing With COVID-19 Installment Payments

A lot of people are concerned about paying taxes. They realize if they pay their taxes, it’s going to be a big tax bill, and they might not have the money. People are worried about that.

One of the things you have available to you is installment agreements from the IRS. People who owe a lot of money can set up an installment agreement and spread the payments out over seven years.

You can pay it month by month until your cryptos go up and start to make some money, and then pay off that tax debt in a lump sum. The IRS is excellent about lump sums. They’re remarkable about interest rates, but they do want you to pay them monthly.

If you’re concerned about that big tax bill and what you’re going to do about it, there are many ways to do it.

See the chart above that explains some things, and if you have concerns, contact us.

Utilizing A Good Crypto Tax Tool

I invite you to go to the Accointing.com website and try their crypto tax tool. Dabble with it. There are several free features you can use.

If you require professional advice, you can contact us.

We have clients all over the world doing crypto calculations for US clients.

You can schedule a consultation on our website.

We can talk about your particular situation, or if you need help preparing your tax return.

Thank you for your time, and I hope you have a great weekend.

If you have a more complex situation, you can talk to the people at Accointing on their chat web page.

You can also contact me on my web page DonnellyTaxLaw.com and schedule a consultation for a fee; we can go over whatever your particular situation is.

You can also visit our website for Do-it-Yourself resources for doing your taxes.

Watch The Full Webinar

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How to Report Cryptocurrencies – The Crypto Tax Webinar: Part Two

Learn about the mechanics of how to report cryptocurrencies on your tax return and the help you can get to prepare your crypto tax return.

Learn about how to report cryptocurrencies and prepare your crypto tax return in this transcribed Crypto Tax Webinar. Presented by Clinton Donnelly and sponsored by Accointing.

In the full live webinar, we covered:

How to deal with COVID 19: Paying Crypto Taxes On An Installment Plan
The current on-going policies regarding crypto-taxation
What are taxable events and how to handle them
The sent IRS letters and the different implications for each of them
The next steps in order to conduct your crypto tax submission
Some opinions from a top Crypto CPA in the market and average estimate of how much you will be paying in taxes
An idea on how to estimate your taxes with a crypto tax tool

In Part One, IRS History With Crypto, we discussed the tax guidance the IRS has created to report cryptocurrencies and breakdown what those IRS activities have been in the history with crypto.

We also looked at what type of enforcement the IRS is doing and reviewed how they’re slowly increasing the implementation level in how they’re going after people. We also explored some IRS letters that they sent out.

PART TWO: How to Report Cryptocurrencies

In Part Two, we are going to discuss how to report cryptocurrencies on your crypto tax return. We’ll look at the mechanics and tax aspects of that.

When to report cryptocurrencies as a taxable event?

Cryptocurrencies are treated as property.

You only make income from property when you sell it. So buying cryptocurrencies is not a taxable event.

A taxable event is something that has to be reported on your income tax return.

You can buy cryptos all day long, and you don’t have to report them.

However, when you sell one, you have made a profit because you will hopefully sell it for a gain. That gain is what you have to report on your tax return.

I want to address a critical point that many people don’t understand who are new to taxes, called capital gains.

When you trade one crypto for another crypto or have a crypto-to-crypto trade, is that a taxable event?

It’s taxable for the crypto that you gave up because you have already achieved some gain or loss for that crypto.

You have to report that even though you didn’t take or receive US dollars from the transaction.

From a tax law point of view, you’ve made a gain when It moves from this coin to that coin.

Every transaction has to be reported on Form 8949. And that’s what services like Accointing do exceptionally well.

You plug in all your transaction records from your exchanges and wallets.

Accointing’s tool will go through and match it up and generate the forms you need to do a tax return. It can create the reports and forms that you need to give to an accountant to prepare or to do it yourself with TurboTax or Tax Act.

So if you decide to pay somebody, $2,000 in Bitcoin, because they’re going to do some service for you, is that a taxable event?

When you sell Bitcoin, You give up ownership of it. The value of that Bitcoin is going to be $2000 because that’s what you agreed to in this scenario. That is equivalent to a sale event or an exchange, and giving up that Bitcoin would be a taxable event.

The person who received that Bitcoin sale, got income. So on their tax return, they have to report that they received income.

Suppose you’re someone who got paid in crypto for doing work or selling a product that is income. These are reported like a wage or on your business income statement.

I want to hit that home: Every trade crypto-to-crypto is a taxable event. This concept is essential. Many new traders don’t realize that a gain can be a positive gain or a negative gain.

We call negative gains losses, but they’re all important.

Even though you had some gains, if you have other ones that are losses, you can use those losses to offset your gains, and you only pay tax on the net. Gain the winners, minus the losers.

You pay a tax on the collective gain, if it’s a positive number.

I’ve had so many people who bought Alt coins in 2017, and the prices went down, down, down, and became worthless.

I’ve had to tell clients that all those worthless coins they bought are hidden gems.

You can claim those as tax losses, and because they are worthless you can offset the gains that you’ve made, and you’d save a bundle of money on your taxes.

I want to stress the importance of both of those.

When you buy crypto with Fiat, the first time is not a taxable event, but when you get the crypto back and get a fee outback from selling crypto, that is a taxable event.

How To Compute Your Crypto Taxes In The US To Report Cryptocurrencies

We use the word basis, or you might’ve heard of a cost-basis; both words mean the same thing.

The basis is the cost. It’s the collective cost that you’ve had in owning something before you sell it. The price you bought it for, that’s your cost basis. And when you sell it, that’s your list of use and equivalent to the word proceeds.

The proceeds of a sale are whether you sold it for cash or whether you sold it in any swap for some other coins.

You subtract those proceeds and you get the gain even if it’s a negative amount. Proceeds are always expressed in US dollars.

Taking Advantage Of Long-Term Capital Gains To Save Money

I’m going to tell you about one of the most significant ways to save money on your crypto taxes: by taking advantage of long-term capital gains.

When you sell a coin in a unit treated as regular income, the gain is taxed like a regular income (like a dollar of salary), and you pay taxes on it.

But if you have held that coin for more than a year, you get a lower tax rate; it’s called the long-term capital gains rate.

For most people, that’s 15% versus your regular tax rate, your tax bracket. The marginal tax bracket of most people is in the 20% to 30% range. So, long term capital gains is a great way to reduce your taxes.

Another thing is the transaction fees, especially if you’re a high-frequency trader, your transaction fees are quite significant compared to your total gains. So, you can claim those transaction fees. They’re part of the cost basis for your trades. You need to use a tool that captures the transaction costs as well as the trade values. I will mention Accointing for this, but most of them will do this for you.

Next, we’ll talk about the holding period. It lays out the principle of a long-term versus the short-term capital gains. The IRS fully approves this. Congress likes long-term capital gains and is encouraging people to do it. It’s part of Congress’s strategy for creating investment in the United States.

How are tokens considered for tax purposes?

Tokens, ERC-20 tokens, or ERC-721 tokens, are ultimately still treated as property. There is a US dollar term for the purchase price, and then there’s a sale price. You’re going to subtract those to calculate what the gain might be or the loss. So it doesn’t matter what the token was doing.

A lot of these tokens may be stable value coins. They’re worth a dollar, but a lot of stable value coins fluctuate up and down a bit.

You can calculate the gain and loss of those, but should expect that to be pretty close to zero in most situations.

Still, all tokens in all cryptocurrencies are treated as property and taxed as property.

Now we’ve identified two different ways that can happen.

We have capital gains, which comes from investments, and then you have income.

For example, if my employer paid me, or if I did some work for somebody out of a contract basis, that coin that came in is income. A hundred percent of it is income.

Now, I hold on to that coin and I hold it for a year, and then I sell – now that’s an investment. The cost basis of that coin is how much I declared as income when I received it.

That’s how you determine the cost basis.

What about some other characteristics?

What if you have done mining, how do you treat that income to report cryptocurrencies?

Mining income is business income because it also has an expense.

You have the cost of equipment, which can be depreciated and usually written off in the same year, the cost of electricity, and the other utilities involved.

You do have costs with mining, which can offset the income, and you don’t have to pay as much as a staking income.

Not having the expense side; you just have staking income. If you had income like interest from lending your coins to someone, these would be treated as interest.

If someone gave you some cryptocurrencies, that would be a gift. Gifts are not taxed as income. People can give you all the coins in the world as gifts, but it’s not taxable to you. It is an exchange and is a taxable event to them.

However, if it’s a charitable gift, they would report it as a charity.

If it were a gift to a friend, the value of that coin on the date it was given is considered the sale price, and there’s a taxable aspect.

Airdrops are a controversial point, because the IRS came out with an FAQ, here in October of last year, which angered a lot of people.

The IRS said airdrops are treated as income on the day that they’re received. But as many people found out, the coins that you received by airdrops were sometimes not solicited, and it was dubious whether they were worth anything at the time that they were received or not.

We talk about the fair market value of coins and fair market value is what an informed buyer and an informed seller would agree to for the price.

When the airdrops that people have come out, there’s no market for some of these coins. So, the IRS had backpedaled on that. The advice they gave, you can treat two different ways.

One, is to treat an airdrop as income on the time it’s received, or you could classify it as $0, as a gift to you at $0. Then you won’t pay taxes on it when you sell it sometime in the future, that would be two different tax treatments that are out there.

The difference has to do with the convenience of tax reporting.

Although the first approach I told you about, treating it as income, would be the more appropriate way to manage them.

When you transfer coins from your wallet to an exchange or back and forth, the act of moving is not a taxable event. There’s no gain. It’s still your coin after you transfer it. Although you might have been putting it into the custody of an exchange for that time, it’s still your coin.

Those are some broader characteristics.

Report Cryptocurrencies With Reliable Resources

If you have a more complex situation, you can talk to the people at Accointing on their chat web page.

You can also contact me on my website DonnellyTaxLaw.com and schedule a consultation for a fee; we can go over whatever your particular situation is.

You can also visit our website for do-it-yourself resources for doing your taxes.

Stay Tuned For Part Three Of The Crypto Tax Webinar

Subscribe to our newsletter to be notified and to get our free download, This Deadly Crypto Mistake Could Cost You $10K.

Watch The Full Webinar Video

Follow Me On Twitter

IRS History With Crypto – The Crypto Tax Webinar: Part One

Learn about IRS history with crypto, the current policies regarding crypto-taxation, and review the IRS crypto letters and their different implications.

Learn about IRS history with crypto in this transcribed Crypto Tax Webinar. Presented by Clinton Donnelly and sponsored by Accointing.

We will talk about where the current state of cryptocurrency reporting is for taxes and break down the IRS history with crypto.

In the full live webinar, we covered:

How to deal with COVID 19: Paying Crypto Taxes On An Installment Plan
The current on-going policies regarding crypto-taxation
What are taxable events and how to handle them
The sent IRS letters and the different implications for each of them
The next steps in order to conduct your crypto tax submission
Some opinions from a top Crypto CPA in the market and average estimate of how much you will be paying in taxes
An idea on how to estimate your taxes with a crypto tax tool

PART ONE: IRS History With Crypto

In Part One, we’re going to discuss the tax guidance the IRS has created to report cryptocurrencies and breakdown what those activities have been in the IRS history with crypto.

We will look at what type of enforcement the IRS is doing and review how they’re slowly increasing the level of implementation in how they’re going after people. We’ll also explore some IRS letters that they sent out.

About The Presenter

I’ll tell you a bit about myself. My name is Clinton Donnelly. I’m an enrolled agent, but I have an advanced law degree specializing in international financial regulation and taxation. I specialized in foreign reporting and crypto reporting for many years.

I have some of the largest clients out there, with tens of millions in crypto investments, complex reporting obligations, and anti-money laundering reporting needs.

And at this point, we’ve helped people reduce their capital gains by over $40 million using like-kind exchange calculations for pre-2018 gains.

Donnelly Tax Law has done over 850 anti-money laundering forms for crypto traders.

We’ve also done over a thousand tax amnesty filings to help people avoid penalties for failing to do previous filings with a 100% success rate. We’re very proud of that.

More importantly, my firm not only prepares tax returns, but we have also created a whole slew of do-it-yourself tools and books, and we now have video courses coming out to help the average person do their taxes and save a lot of money.

We are one of the few firms that have genuinely defended a crypto investor in a formal IRS audit of their crypto investments. Our background creates some unique insights in terms of what the IRS is doing and how they’re looking at things.

So I hope to share this with you and that you’ll find it helpful.

About Accointing

Accointing is a tax software package for helping you calculate your income and capital gains. It is tremendously easy to use. It does use APIs and CSV files from crypto exchanges and works with all of the major exchanges.

It’s an exciting tool found at Accointing.com. It has a lot of free features, and it supports over 300 wallets and exchanges. So it’s fully functioning and very affordable. I think it has a powerful reconciliation tool to help you get onboarded and get your transactions loaded, so you can start getting your tax results right away.

What’s the IRS history with crypto so far?

IRS Issued Initial Guidance In April 2014

The IRS has issued initial guidance in 2014 about cryptocurrency reporting of a tax sale. The IRS came out with what they called a notice that defined “what they referred to as virtual currency.” It’s cryptocurrency.

In this notice, the IRS stated cryptocurrencies are to be treated as property.

We’re going to dig into what their guidance means regarding property.

It’s not called currency; the IRS called it virtual currency. When, in fact, the IRS doesn’t treat it like that.

The IRS Commissioner Made A Statement In February 2018

In February 2018, the IRS commissioner, Charles Retting said that the IRS has, and will continue to have more information about you than you could ever possibly imagine, referring to crypto traders. So they’re working very hard at capturing a lot of data about traders and what their activities are.

The Next Update Was In March 2018

So the next update was in March 2018, Coinbase had been sued and lost in court. They were being sued by the IRS to turn over information about their account holders of cryptocurrencies.

In 2014, 2015, and 2016 tax years, only 900 people had reported cryptocurrencies when Coinbase had a customer base of six million. Most of them were Americans.

At that time, they lost in court and had the turnover, some accounting, account information.

That was the first access to some information the IRS formally got regarding whom the crypto traders are in the US.

This is the big IRS challenge, to identify who the crypto traders are.

IRS Guidance Released In October 2019

In October 2019. The IRS came out with some guidance about how cryptocurrencies should be reported.

These are FAQs. If you go onto the IRS website, IRS FAQ, virtual currency, you will see the guidance.

It’s a very easy to read explanation about how to treat the tax reporting. However, on some very critical issues, the guidance is a little confusing.

So, they also came out with a revenue ruling, which was widely criticized, not only in the accounting space but also in the crypto media and Congress.

The IRS went on to do a presentation at the American Institute of CPA’s, their national convention, which had several faux pas.

It became grossly evident that the IRS was not listening or understanding the cryptocurrency marketplace.

The IRS was doing a poor job of getting this advice and guidance to meet the taxpayers’ needs.

March 2020 Crypto Conference With IRS

The IRS had a conference of crypto corporations in March of this year with all walks of the crypto chasm.

It was a listening session for the IRS to hear what the significant movers and shakers had to say about crypto taxation. And that’s where we are from a guidance point of view.

There’s not as much guidance as we would like, but there’s adequate guidance for us for the average taxpayer to provide a complete tax return.

What does the IRS history with crypto letters mean?

One of the forms of guidance that the IRS sent out were some letters.

Let’s look at it in terms of how the IRS did their enforcement.

We’re going to talk about enforcement and how the IRS is going after people either not reporting or reporting incorrectly.

The IRS has what they call a compliance campaign, which is the primary way of organizing their activities to go after a specific focus.

They have a cryptocurrency or virtual currency guidance campaign.

July 2019 The IRS Issued About 10,000 Letters

In July and August of last year, 2019, the IRS issued about 10,000 letters to suspected crypto traders. The slide above is showing us that there were three different types of letters.

There are two types: Letter 6174 and Letter 6174A, which is a little longer. These were benign letters to someone saying: you might want to think about how you reported your cryptos. The letters asked, did you report all of it correctly along with some thoughts about how reporting should be done.

The third Letter 6173 was sent to people whom the IRS thought had engaged in criminal activity. So if you got Letter 6173, it’s because you’re on a list of people the IRS believes to have an illegal issue.

Several clients contacted me with Letters 6174 and 6174A, which told me a lot about the IRS.

From a public viewpoint, we all knew that the IRS had some Coinbase data from 2013, 2014, 2015, and 2016. And it turns out that some clients that I worked with who received these letters never dealt with Coinbase.

So, the IRS found out about them apart from that court case.

I talked to about two dozen clients who received these IRS letters; almost all had at least $900,000 in Bitcoin at the peak in 2017. That tells me that the IRS had done some significant data mining activity, putting together the pieces. And they have a pretty good idea who the crypto traders are in the US.

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The fear of a political backlash, particularly from Congress, is what has restricted the IRS from going after all the taxpayers full force. Because when Congress gets angry, particularly the House of Representatives, they cut the IRS funding.

There’s a real balance here between the IRS and how aggressively they’re going after taxpayers.

It is my perception that the IRS has mainly focused their efforts on criminal activities: Silk Road types of things, organized crime using cryptocurrencies to launder money in the proceeds of their efforts, this has been mostly what we hear about.

What is the current situation regarding the IRS history with crypto?

Several Crypto Traders Received Audits Beginning March 2020

In March 2020, several crypto traders started receiving audits from the IRS. These are formal IRS audits of their tax returns for 2017. The IRS uses the same questions in both examinations.

I have two copies of the letters. One is my clients, and the other one is from another preparers’ clients. The wording is all the same on both letters.

Based on these letters, we got a good idea of how the IRS looks at that question during the “gathering portion” of an audit.

IRS Looked For Consultants In May 2020

Just last month, we found out that the IRS was issuing an RFP (Request For Proposal) to crypto gain calculation services to find services that would act as consultants and do analysis during audits and trial proceeds.

So the IRS is looking to line up the type of talent they need to go after non-criminal crypto traders, these would be people who have failed to report their cryptos.

Is it tax evasion? Perhaps.

It is, however, considered neglect.

Many people in 2017 made a lot of money and didn’t report it because they didn’t know how back then. But, they’ve had enough time to correct that oversight since 2017.

I just had a client who wanted to fix it. He had never reported in 2017 and wanted to fix that. The IRS has started to hone in on the average investor, and I expect to see a much stronger crackdown continuing.

The IRS issued guidance in the form of a question added to Schedule 1 of your tax return.

Schedule 1 is where taxpayers list income from different sources, and Schedule 1 asks, did you receive sell, send an exchange, or have any financial interest in virtual currencies? This is a yes or no question. Every taxpayer is requested to answer it. But, failure to answer this question exposes taxpayers to liability.

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Now, this is fundamentally a perjury trap, because when you sign your tax return, and you may never have read the fine print, you may have never actually looked at the form. But what it says, and I quote, “under penalty of perjury, I have read my return and attached statements and schedules, and it is complete, true and correct to the best of my knowledge.”

So you are swearing that it is complete and it is correct. Meaning that with this question, you’re saying with a yes, or no, I have had cryptocurrencies or have not, and the penalty if you’ve lied is perjury.

My advice is that everybody should answer yes to Schedule 1. Many fear the IRS will come after them because they are trying to develop a database. But what we've seen is the IRS will use this question later to come after somebody.

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There’s a similar question on schedule B part three: “Did you have a foreign bank or brokerage account or other financial accounts?” And it was also a yes or no. And the IRS used this in prosecutions after they’ve identified someone they wanted to go after.

So that general fear that people have that, answering yes will prompt the IRS to come after them, is not well-founded. The IRS does not have that much workforce to go after people like that. But I ask that people should all answer yes to this question.

The way that the IRS has defined virtual currency in their notice of 2014-21, says that "any store of value is a virtual currency." And under that definition, basic frequent flyer, miles are a store of value because you can use it to buy the essential things.

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Also, if you have a credit card that racks up points that you could buy stuff off the credit card, that too is a store of value. So rather than people being afraid of answering this question in hiding, by saying, no, I think you should check, yes.

You should get your mother to check yes on her form and your aunts. You should get everybody to check yes. In that manner, you dilute the value of this question in total. It’s all about honesty in the answering of that question. That’s my feedback.

The IRS is lining things up, as they need, in order to prosecute everyone. They have argued that they’ve given everybody enough time.

In the RFP (Request For Proposal) the IRS sent out to crypto companies requesting consulting work, they specifically use the example of failure to report in 2017.

The IRS is focused on the people who made a lot of money in 2017, regardless of what happens this current year with crypto gains.

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