In part 2 of our multi-transcription series with Charlie Shrem, Clinton and Charlie discuss the accuracy of a crypto tax return and how the IRS will use anti-money laundering forms to come after crypto traders.
Read my e-book, the Basics of Crypto Taxes, to learn how cryptos need to be reported on anti-money laundering forms.
Can your crypto tax return ever be 100% perfect and accurate?
[Charlie Shrem]: Is that physically possible? Can your crypto tax return ever be 100% perfect and accurate?
[Clinton Donnelly]: A tax return is not like your high school math test where you’re trying to get a 100.
[Charlie Shrem]: Oh man, this is a great sound bite. That’s the first time I’ve ever heard anyone say that.
[Clinton Donnelly]: You just want to be close.
[Charlie Shrem]: Fuck, brilliant.
[Clinton Donnelly]: You want to be close.
[Charlie Shrem]: Honest, right?
[Clinton Donnelly]: Yeah.
"You want just to be honest, have integrity. That's what I've always tried to do with my tax returns."
[Clinton Donnelly]: Hey look, the IRS auditors are under quotas.
I had a former IRS auditor work for me, and he said they have monthly quotas that they have to go after.
They have penalties that help them hit it, but if you’re pretty close, and they know they’re going to lose, they don’t want to waste time on you. They want to move on to the next bigger guy.
“Most people think the IRS is going to audit a tax return by going through that long list of transactions to see if you calculated it right, you know FIFO, LIFO, and all that. That's not at all how they're going to do it."
[Charlie Shrem]: What are they looking for?
Are they looking for someone who intentionally lied about a holding and then had an exchange account overseas and didn’t report it?
Or are they looking for someone who reported $60,000 in income instead of reporting $100,000 by mistake, and just not going back and fixing it?
Can an auditor read the tax return and say, okay, maybe this guy or girl made a mistake?
Or do they read a tax return and say no, this guy was intentionally dishonest?
[Clinton Donnelly]: The IRS is in the business of compliance. In what we’ve seen in their public statements, they want to go after the criminals okay. They have those blockchain analysis tools because then they can go after who was doing the dealings.
But if you’re just an honest guy, a regular crypto trader who’s a large fish and didn’t know how to do your tax return correctly or your preparer didn’t know, the approach on that is different.
It comes down to how the IRS can prosecute a law case.
If they look at your crypto reporting and how you made these trades, there are a whole bunch of “taxpayer’s rights” procedures in the law, and they have to do appeals and send letters and stuff.
READ MORE: How Are Cryptos Reported On Anti-Money Laundering Forms?
"If they use the anti-money laundering laws, they use a different section of the code. It's not a part of the tax code even though the IRS manages it; it is Title 18 of the Bank Secrecy Act. And from that, they can immediately go to prosecution and penalties. So, it's much easier. That's the way they're going to come after you."
[Charlie Shrem]: What people don’t realize is when I got arrested in 2014, I got arrested by an IRS special agent.
And, we went on to being on pretty good terms over the years.
I try to have respect for people that are just doing their job.
So, with the IRS anti-money laundering, there’s a huge overlap there, and so what you’re saying is important.
What type of things are they looking for?
For my crime, there was a money transmission, and there was a company that I owned that wasn’t tax-related.
READ MORE: Why Crypto Traders Are Low-Hanging Fruit For The IRS
What are some crypto tax-related things that the IRS is looking for when it comes to anti-money laundering?
[Charlie Shrem]: Because it seems like that’s something people should look out for at the top.
[Clinton Donnelly]: The first one is the major anti-money laundering law, called the Bank Secrecy Act 1990.
It created an organization called the Financial Crimes Enforcement Network, lovingly known as FinCEN, and they’re the ones that develop the regulations that all banks, brokerage houses, money lending, money service businesses have to follow.
“And it's the FinCEN violations that got you, Charlie. They applied FinCEN regulations against cryptocurrencies, and it's surprising. I'm shocked how much denial traders have, and even tax preparers have that crypto people have to report anti-money laundering. Some of them don't even think it's cash or that it's a financial asset.”
But for an individual, you have to report FinCEN form 114, which is most commonly endearingly called the FBAR, the Financial Bank Account Report, and you have to report.
"Every crypto trader has to file an FBAR report and file a form 8938, which is an overlapping tax money laundering form. It came from the FATCA law of 2010. These are required unless you're a small fish; if you're a small fish, there's a filing threshold and you don't have to file."
[Charlie Shrem]: What if you never held accounts overseas or even exchange accounts?
Is this something you have to deal with?
And what if the exchange has a U.S entity like Binance? And, they are based in Hong Kong, but they have Binance America. Isn’t Binance America required to do the reporting, not you?
[Clinton Donnelly]: None of the U.S exchanges are under full regulation of the SEC, all right. So if they were, then that reporting would be done by them, but since they’re not, you still have to report.
[Charlie Shrem]: I feel like that would be better. Wouldn’t that be better? If you have a brokerage account, it’s your brokerage that’s required to do all the tax reporting for you. Isn’t that so much easier, or would you rather it be, as an accountant, that traders themselves are reporting it on their own?
[Clinton Donnelly]: Absolutely what you’re saying is right. And that’s where I think we’re headed for a couple of different reasons.
There’s been international regulation, and the U.S said they’re doing it.
They’re going to force all US crypto exchanges to comply with the all banking and brokerage regulations.
In the future, you’ll get a 1099B just like you do from a brokerage statement listing all your trades and what you bought it for fully certified; it would be straightforward for your crypto tax returns.
We’re not there yet.
[Charlie Shrem]: I feel like that would be such a pivotal point for Bitcoin and crypto. If I could tell a friend of mine who wants my Bitcoin, yeah, you go on this exchange, and then don’t worry about it.
You see all the IRS headlines; you see the government taking people down.
If you can go to an exchange and know that exchange is going to be sending you that form at the end of the year, I feel like a lot of people would trade more comfortably that way.
Not everyone wants to be their own bank; not everyone is an anti-statist or whatever. I don’t know what you call the term, but some people want that comfort. And I understand that, and I do get it, especially non-tech people.
[Clinton Donnelly]: We’re definitely headed there. There’s an exchange called Robinhood, where it’s totally insulated. You cannot do transfers in and out of Robinhood, you have to bring cash-in, and only cash-out, any coin stays in Robinhood. As a result, they know what you bought it for, they know what you sold it for, and they could generate a 1099-B.
They’re very close to doing that. I think the Uphold exchange is getting close to doing that.
But as long as we have that you can move coins from this exchange to that exchange, to the other exchange, then the exchanges don’t know the buy and sell prices, and they cannot give you that type of report. It’s a term called covered securities.
[Charlie Shrem]: It’s a good point. If they don’t have that content, then how are they supposed to issue a report?
[Clinton Donnelly]: But I think, trend-wise, what we’re going to see as we have more and more people getting into crypto, is that trading becomes more mainstream. They’re going to demand this. They’re not going to accept anything with the chaos that we have now.
And as a result, Fidelity is going to have a crypto exchange, Merrill Lynch is going to have a crypto exchange, and it’s going to be all-inclusive.
How can I say this? It’s all-inclusive like Robinhood is; you cannot trade between exchanges.
That’s where we’re headed. And in that case, because then those will be SEC-regulated exchanges, it could be very attractive.
It has to be very mainstream. There’s probably some downsides on that too, but I think from a tax point of view, it’d be very attractive.
[Charlie Shrem]: You know when you don’t understand something, you become hostile to it automatically when you’re constantly trying to understand something over time, and you can’t. That’s why there’s a lot of hostilities still towards crypto because simply people don’t understand it.
And why I’m telling you this is, if you do a Google search and you type Bitcoin taxes or crypto taxes or IRS Bitcoin, it’s all negative. It’s negative; it’s fear, it’s uncertainty, it’s doubt, it’s scary, there’s no clarity.
And I think that’s one of the reasons that a lot of people just simply say, “Okay, if I don’t get it and it’s too complicated, how is the IRS supposed to get it and not be too complicated?”
That’s the wrong mentality to have, right?
Just because something is scary, if you’re in our space, if you’re in our industry, you have to pay attention to your taxes.
READ MORE: Why Your Crypto Taxes Need An Enrolled Agent Specializing in Crypto
What CPAs will handle anti-money laundering forms for crypto traders?
“The problem is that a lot of CPAs that I've gone to, and other people went to, they either say I don't want to touch this, or they make you more scared.”
Do you know what a lot of CPAs are doing now? They’re saying hire our tax firm to do your tax return if it is not a normal return. There’s a word for it, where they have to go deep dive into it.
What’s the term I’m looking for? Is it forensics?
We have to do forensics on this now, so it’s more expensive. So now charging more money because someone’s in crypto.
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