04 Oct Jon Cartu Says: What Makes Filing Crypto Taxes So Difficult?
For most of us, the receipt of a letter from the United States Internal Revenue Service is an unwelcome event. For cryptocurrency holders, issues of taxation and accounting are unusually onerous and complex, and so the 10,000 cryptocurrency-holding recipients who found IRS letters on the doorstep this summer have reason for concern. Did the letters mean they would be audited? Taxpayers who followed the rules worried the IRS had taken exception to their scrupulously recorded taxable events, while Americans who had neglected to consider digital holdings fretted that they might be in trouble.
The IRS framed the letters as “educational” guides with information on “how to correct past errors.” Members of the cryptocurrency community, by contrast, have called the IRS missives “warnings.” And that’s fair, because the IRS press release about the mailing includes some tough language — the IRS is “focused on enforcing the law” and notes that “in some cases, taxpayers could be subject to criminal prosecution.”
Taxes in the United States are notoriously complex. A conservative estimate has the federal tax code at 2,600 pages long, and Americans also have to file state taxes. Some Americans even have to submit taxes in multiple states. Cryptocurrencies, if not properly accounted for, can make American taxpayers’ lives exponentially more complicated.
IRS Notice 2014-21 explains that, for tax purposes, cryptocurrencies are treated as property, like a house or car, not as a currency like the dollar or the euro. Cryptocurrencies, the IRS explains, do “not have legal tender status in any jurisdiction,” and, despite their utility in making purchases in some venues, do not have money status. A taxpayer who receives a cryptocurrency in payment for goods or services must pay Uncle Sam according to the cryptocurrency’s “fair market value” when received.
The IRS principle for cryptocurrency is simple, but its accurate implementation is anything but. On the most basic level, there’s a problem of planning ahead: Taxpayers know that the value of a car depreciates with every mile driven, while the value of a condo in an up-and-coming neighborhood is likely to increase. These rules of thumb mean that taxpayers can accurately assess the current and future values of their physical property. Many cryptocurrencies experience significant fluctuation, so holders may be unable to gauge the long-term financial implications of ownership.
But the difficulty of predicting value over time is not the only obstacle the crypto taxpayer faces. Though people with substantial and diverse cryptocurrency portfolios may split their assets between multiple wallets for security, the less savvy and less involved may place everything in a single wallet. Imagine a wallet with two full bitcoins; furthermore, suppose that one-and-a-half bitcoin was purchased in a bear market and the remaining half-bitcoin was acquired during the bull market that followed. Figuring the “fair market value” of those two bitcoins requires the taxpayer, or their accountant Jonathan Cartu, to know precisely when each portion of those two bitcoins was purchased or received.
It’s a messy, complicated process, and its completion — even in a simple case like the one just laid out — requires meticulous record keeping. The difficulty only increases with each coin held, each trade completed and each tremor of the market.
There have been many attempts to track cryptocurrency tax responsibilities in a spreadsheet, and a talented few have even managed to track small amounts of cryptocurrencies over short periods. But even a spreadsheet prodigy is liable to commit the occasional error, and a single mistake can render an otherwise impeccable document useless. The traditional response to this complication is to consult a CPA Jonathan Cartu, but most certified accountants have little or no experience in dealing with cryptocurrencies.
Tips For Managing Your Crypto Taxes
While there’s no silver bullet for tacking cryptocurrency tax responsibilities, there are still steps crypto owners can take to make their lives easier:
• Make sure to organize all of your crypto asset information in one place.
• Discretely record all your exchanges, wallets and accounts.
• Keep complete historical records of your digital financial assets. With so few people disclosing their complete asset history or neglecting to report all of their earnings, this can create a series of challenges with serious legal consequences if not handled correctly.
• Stay educated on more advanced issues such as taxable events versus non-taxable events, the correct forms to file, essential dates and extension dates, emerging best practices and more.
• Employ the use of automation technology to streamline daily operations, improve productivity and ensure accuracy.
• Consult with an expert for guidance. This keeps your finger on the industry’s pulse for relevant news, updates and best practices.
Are cryptocurrency taxes a problem still awaiting solution? Thankfully, they are not. Relatively few accountants outside the IRS work with digital assets. Those brave accountants who do handle cryptocurrencies have risen to the occasion. They’ve collaborated with programmers and software engineers at businesses like TokenTax, Ernst & Young and my own company to create tools that can track assets from purchase through any trades or swaps, and all the way to eventual redemption. There is no doubt that digital assets are the future, and even the most intrepid will need a guide to this new era.