05 Dec End of year cryptocurrency tax challenges: What to do?
About the only good news from the year-long crash in cryptocurrency values is the potential to offset losses against other tax liabilities for investors.
This creates several critical tax challenges and choices for digital currency holders and traders alike according to NODE40, creator of the Balance cryptocurrency reporting software.
“It is clear that, with the huge falls in cryptocurrency markets during 2018, many people will be weighing up whether this is a good opportunity to reveal the losses they have suffered. In doing so, they will be looking to take advantage of these losses in order to offset other tax liabilities. Having not reported their crypto activity up to now though, those choosing to reveal losses this year will need to report their crypto positions every year from now on, giving the tax authorities much better visibility of people’s crypto involvement,” said Perry Woodin, Co-founder of NODE40.
Reporting dilemmas, red flags
CNBC reported the IRS estimated 800 taxpayers claimed capital gains on their cryptocurrency trading between 2013 and 2015.
This sets up a potential tax problem for many cryptocurrency investors who hid or did not report prior cryptocurrency gains. Now faced with potentially huge losses, they will need to be very careful in how they report and file this year’s tax return to the IRS.
The IRS is investing significant resources to combat a suspected huge level of noncompliance in cryptocurrency investment reporting. It recently tried to secure 13,000 Coinbase cryptocurrency exchange customer records as part of the IRS efforts to assert tax liabilities.
Currently, the IRS considers cryptocurrency as “property” not currency. This sets up a requirement to track the cost of acquiring your cryptocurrency and the cost of disposing of it, whether by converting it to cash, trading, or using it for payments with merchants.
“There is a lot for individuals to consider when it comes to crypto accounting and their tax returns,” said Sean Ryan, Co-founder of NODE40. “For example, ‘hodlers’ will have a completely different set of circumstances to traders, while those receiving crypto from forks and then selling will also have a unique situation to deal with.”
Additional cryptocurrency tax compliance challenges
In a post at TheTaxAdvisor.com, Brad Polizzano highlights several additional tax compliance challenges with cryptocurrency.
“Cryptocurrency can be characterized as an investment property (like stock), business property (like inventory), or personal property (if used to purchase groceries, for example). Considering that a taxpayer cannot deduct personal losses, the IRS must further distinguish between holding cryptocurrency for investment and for personal purposes,” Polizzano writes.
Tracking the fair market value of the cryptocurrency received, traded and sold, and the record-keeping required to satisfy tax reporting requirements is a big challenge. Without clear IRS guidance, investors must make an educated guess on such issues as cost-basis when blocks of cryptocurrency are traded.
Although unclear at present, foreign asset reporting may also be required if cryptocurrency assets are held on a foreign exchange. This may require cryptocurrency investors to report according to the Financial Crimes Enforcement Network (FinCEN) guidelines in the near future.
What the fork?
How about the tax implications of cryptocurrency forks?
With several high-profile cryptocurrency forks taking place in the past several years, and the lack of clear guidance by the IRS, you’d better have a savvy tax accountant giving you guidance.
This cryptocurrency tax challenge is going to get harder without more substantial guidelines from the IRS.
Good luck with this challenge in the short-term.
Substantial potential penalties
Noncompliance in reporting cryptocurrency investments can put an investor and taxpayer at substantial risk of penalties.
“Paying taxes based on inaccurate calculations falls under Sec. 6662 and could result in penalties of 20% or up to 40%. In US Tax Courts, the burden of proof generally falls to the individual and not the IRS. This can be shifted with supporting documentation – using software that can retroactively generate an audit trail for individuals. For this reason, its important tax filers have a written record of all transactions they took part in along with proper cost basis assignments and accurate gains or losses recorded,” NODE40 reported in a news release.
According to Polizzano, penalties can be even higher:
- Civil fraud penalties under Sec. 6651(f) or 6663: 75% of the unpaid tax.
- Failure to file FBAR: Base penalty of $10,000 per failure to report an account per year; increasing, if the failure is willful, to the greater of $100,000 or 50% of the total balance of the foreign financial account per violation.
- Failure to file Form 8938: Base penalty of $10,000 per failure to report an applicable asset, with an additional $10,000 for each month the failure continues, beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000.
This list does not include possible criminal charges for tax evasion or other crimes.
Accurate records, timely reporting key
As always, accurate record-keeping is critical. The burden of proof is on the taxpayer, so evidence must be kept that can support your claims.
“I suspect a lot of people will be surprised at exactly where their true liability falls. I doubt very much anyone’s gut feeling is remotely close to accurate,” said Sean Ryan, Co-founder of NODE40.
Node40 Balance software is one of the tools that can help cryptocurrency traders and investors in accurate record-keeping for tax purposes. Key among its features:
- recover historical trade activity
- provide cost basis reasonable enough to stand up to the Penalty for Misstatement of Asset Value or Pension Liability paragraph of section 6662,
- track activity across multiple exchanges and wallets
- provide a detailed audit trail of each and every calculation.
Finally, in addition to seeking out tools that can help you in your record-keeping and reporting, we recommend you seek the advice of a qualified financial advisor and tax accountant to ensure you are protected from tax liabilities.
For many cryptocurrency investors, 2018 may be a year of tax reckoning.
You can learn more about NODE40 Balance software here.