How crypto traders can avoid the wrath of the IRS

While independence from government intervention was one of the key tenets that Bitcoin was built on, the majority of cryptocurrencies now operate under far more scrutiny from the authorities than many early pioneers would have hoped for.

Unsurprisingly, one of the most interested government authorities is the IRS. The tax agency has noticed the extraordinary profits that some individuals have made from cryptocurrency trading and made it its mission to identify what these successful individuals might owe.

Certainly, its efforts have not been pitch perfect and the lack of complete guidance in various areas has done little to assist those who are trying to operate within the law. One thing is clear though; a practice of hiding your crypto trading activity is not the right course.

Instead, crypto traders should familiarize themselves with the realities of crypto taxation and take these matters seriously. With a clear focus on transparency, activity tracking and seeking expert advice, crypto traders will probably find that their obligations are less scary than they had assumed.

Understanding the basics

One of the most important things to understand about crypto taxation in the US is that the IRS considers virtual currency as property, just like physical assets. This means general tax principles, like capital gains, are applicable to virtual currency transactions. For example, if you purchased 10 BTC for $10,000 at the start of 2017, then sold them mid 2018 for $50,000, you would have a taxable capital gain of $40,000.

However, while cryptocurrency is property, it isn’t real property. As such the like-kind exchange rule under IRC section 1031 doesn’t apply. Therefore, if you buy one coin and sell it to buy another, any gain is subject to tax.

Another important area to understand is your use of foreign exchanges. Taxpayers may be required to report foreign crypto accounts that exceed certain figures. Therefore, you need to be ready to fill in an FBAR (the Report of Foreign Bank and Financial Accounts) if the aggregate maximum value of your account(s) exceeded $10,000 at any time throughout the year.

If the balance of all crypto held on foreign exchanges exceeds $50,000 on the last day of the year, you may be required to complete Form 8938 (Statement of Specified Foreign Financial Assets).

Don’t hide your activity

If you’re tempted to simply close accounts held abroad without reporting them, don’t. The IRS has several methods of discovering foreign investments, including the use of subpoenas, and has specialised software that can examine files.

In fact, the whole idea that crypto traders will somehow be able to hide their activity from the authorities is becoming less and less likely. This was made clear by the IRS’s pursuit of Coinbase with a John Doe summons, which demonstrates the lengths the agency will go to to identify crypto traders with tax liabilities.

Between 2013 and 2015, fewer than 900 taxpayers claimed Bitcoin gains. In seeking the details of Coinbase customers, the IRS is clearly on a mission to uncover US citizens it believes owe crypto-related tax. What’s very worrying from a tax perspective though is the way they seem to have gone about the process.

Firstly, the deal they struck with Coinbase resulted in the exchange releasing information on a limited number of users, for whom 1099-K forms were produced. The problem is that these forms are meant for payment processing receipts. The 1099-B form that covers barter exchange transactions would have been far more appropriate.

Not only that, the 1099-B form shows far more detailed information about individual transactions than the 1099-K does, which is needed to properly calculate crypto-taxation.

Keep track of everything

The IRS’s dealings with Coinbase demonstrate a worrying lack of understanding of how crypto taxation should work. In targeting a single exchange and requesting limited information through 1099-K forms, the agency is not getting the full picture, and it’s creating confusion for taxpayers.

Crypto traders know that using a single exchange for all their trading activity is very rare. Not only that, this sort of limited snapshot doesn’t take into account the activity that occurs outside the exchanges, such as interactions with and storage within wallets. All of these play a part in a proper crypto taxation calculation.

Therefore, while it might seem difficult, crypto traders should be keeping accurate records of their exchange activity and trading history so they can get the full picture of what is owed and why. Software solutions that connect to multiple exchanges and wallets to give a clear view of what the blockchain shows are available and these should be used in conjunction with the advice of crypto taxation experts to make sense of this seemingly complex subject.

While this might seem time consuming at first, it is the surest way to calculate what you really owe and, in turn, to avoid the wrath of the IRS.

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How crypto traders can avoid the wrath of the IRS was originally published in Hacker Noon on Medium, where people are continuing the conversation by highlighting and responding to this story.