The US government has turned a keen eye to cryptocurrencies in recent years. This focus was evident last October when the Internal Revenue Service (IRS) posted its first piece of cryptocurrency tax guidance since 2014. For many, this lifted the haze, which has shrouded crypto tax for several years. For others, however, crypto tax in the US is just as foggy as ever. But what do you need to know, and how will the US cryptocurrency tax landscape shape up in the years to come?
Per the latest IRS guidance, the agency has deemed digital assets as "property for US federal tax purposes." This not only applies to bitcoin, but also includes altcoins such as Ethereum, Litecoin, and XRP - regardless of classifications made by the security and exchange commission (SEC). In other words - much like commodities such as gold and silver, as well as stocks and real estate - capital gains and losses now apply to bitcoin and its various derivatives.
Taxable and non-taxable events
As for what triggers a taxable event, the 2019 guidance sticks to the advice offered in 2014. Taxable events include crypto-to-crypto and crypto-to-fiat trades, spending cryptocurrencies on goods and services, and earning crypto as income (including mining rewards). Each of these scenarios entails calculating the fair market USD value of the cryptocurrency at the time of the trade.
Non-taxable events fall under scenarios such as gifting cryptocurrency or merely transferring it between exchanges or digital wallets. However, it's essential to note that buying cryptocurrency with fiat is not, in itself, a taxable event. Tax liabilities only arise once a cryptocurrency is traded, sold, or used to purchase goods and services.
This last clause, in particular, has raised a few eyebrows. The obligation to keep track of every single trade, along with the fair market price of the cryptocurrency at the time of the deal, makes for an accounting nightmare - especially for frequent traders. The crypto market's inherent volatility exacerbates this. With each crypto-to-crypto trade incurring capital gains tax, a poorly executed trade could cost dearly when tax season comes around.
Interestingly, there has been some contention as to what should classify as a taxable event. Some argue that day-to-day cryptocurrency purchases fall under a de minimis tax exemption. As such, a bill known as the Virtual Currency Tax Fairness Act was introduced to congress back in January, aiming to impose a $200 capital gain exemption threshold on personal transactions.
What does the future hold for crypto tax in the US?
One principle facet of the IRS' 2019 crypto update was the introduction of the 2020 Schedule 1 tax forms. These forms compel taxpayers to disclose their cryptocurrency investment and trading ventures. The subjects posed on this questionnaire aim to better inform the IRS on cryptocurrency holder's activities. This not only aids the IRS in reaching a better understanding of the crypto space but also helps investors comprehend their tax obligations. Moreover, it makes it increasingly difficult for those attempting to feign ignorance toward crypto tax law. This provides a clear use case for crypto tax platforms and software, which can help expedite accounting.
As the IRS harvests further information on crypto activities, it's likely to funnel into a more coherent regulatory framework throughout 2020. We can assume that more thoughtfulness will be put into future guidance, hopefully with the result of streamlining some of the more opaque direction currently provided.
Bolstering IRS understanding will undoubtedly prove advantageous, not only for crypto traders and holders but also for crypto-centric businesses - as well as companies accepting cryptocurrencies.
With the introduction of crypto directives from the Financial Action Task Force, more crypto-based businesses are seeking licenses to operate. However, many still choose to ignore their duty to provide tax reporting to customers. This is another area we can expect the IRS to clamp down on in 2020.
As touched upon, the Virtual Currency Tax Fairness Act of 2020 will also look to establish some tax developments in early 2020. If passed, the bill could proliferate cryptocurrency's utility as a medium of exchange.
The need for clarification
Still, while the future of crypto tax looks promising, in the short term, cries for clarity are louder than ever. This week, several governmental panels touched upon the topic of crypto tax. The first, hosted by the IRS itself, heard from global tax associates from crypto exchanges Coinbase and Kraken. The predominant message from both was that there remains an overwhelming need for clarity. Similarly, During a US congressional meeting on March 4 detailing the benefits of blockchain, Protocol Labs General Council member Marvin Ammori explained that doing taxes for crypto is a "nightmare," thanks to the over-complicated regime.
Indeed, while tax liabilities on trading, income, and crypto bartering are relatively self-explanatory, the idiosyncrasies of the cryptocurrency industry clearly test the IRS' comprehension. Let's take lending for an example. Under the current guidance, interest earned on lending crypto is taxable via income tax rates. This is simple enough. However, the rise of DeFi lending devices such as staking complicates matters somewhat.
Within staking, a temporary token is created to validate the staked value. Under the IRS tax regime, this temporary token would create a taxable event.
If we look at staking ETH 2.0 for illustration, based on current estimates, one could expect a return of about 3-5% per annum. Under current guidelines, unless you are getting a return in excess of 7-10% above the gains you make via staking, any profits you make will be paid in taxes, due to the fact that the rate applied will be the short term capital gains rate at 22-30%.
In addition to any tax related to interest income, you may also have to pay a 3.8% NIIT, which applies to the lesser of one’s capital gain from the sale of exchange of crypto.
The same applies to IRS guidance on forked assets.
According to the IRS, tax liabilities arise as soon as a fork occurs. Per the guidelines, if a taxpayer has "dominion and control," i.e., is able to transfer, sell, or exchange the cryptocurrency, then capital gains tax applies.
The problem is, not everyone wants forked assets. Communities who choose to fork a cryptocurrency can effectively impose a tax liability onto any crypto holder, regardless of whether they consent or not. To that end, some may be utterly oblivious to the newly forked coins in their possession and, therefore, unwittingly partake in tax fraud.
To avoid completely stifling innovations in DeFi and the wider crypto sector, tax rules need to be modernized and clarified. They also need to consider intent - rather than being based on an unyielding trade-by-trade analysis.
About the Author
Vamshi Vangapally is the founder of BearTax. BearTax Integrates with all major exchanges, fetching trades from everywhere, identifies transfers across exchanges, auto generates tax documents and calculates tax liability in minutes.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.