Tax-time scrutiny for bitcoin
Cryptocurrency traders and investors sweating recent actions by court, IRS
When Bao Dinh of San Lorenzo started buying cryptocurrency a year ago, he knew he’d eventually have to reckon with taxes, but set aside those concerns while he tried to master the mechanics of bitcoin trading.
“Everything was moving so fast,” said Dinh, 31. “I said let’s invest first and explore (the tax consequences) later.”
Now that tax time is here, he realizes just how complicated it will be, especially because he didn’t keep good trading records until late in the year. He’s also confused by all the “gray areas” relating to crypto taxes.
He’s not alone. Accountants have been getting inquiries from confused and worried cryptocurrency investors since the IRS started demanding customer data from Coinbase, a San Francisco company that lets users buy, sell and transfer bitcoin and several other digital currencies.
“I think it was a scare tactic,” said Erik Weinapple, tax director with accounting firm BPM in Walnut Creek. “I’ve had probably a dozen people over the last five or six months that have been coming
forward. They think they have a substantial amount they need to report.”
Coinbase says it has more than 10 million users. But an IRS investigation found that only 800 to 900 Americans reported transactions “likely related to bitcoin” in each year from 2013 through 2015.
The IRS filed suit two years ago in federal court in San Francisco, seeking records on any Coinbase user who conducted a virtual currency transaction in 2013, 2014 or 2015. Coinbase objected, and the IRS later narrowed its fishing expedition.
On Nov. 28, 2017, U.S. Magistrate Jacqueline Scott Corley ordered Coinbase to turn over the identities and certain trading records for any user who bought, sold, sent or received more than $20,000 worth of virtual currency in a single year from 2013 to 2015. That covers 14,355 users,
Coinbase said.
The last time the IRS provided any guidance on digital currencies was in 2014, when crypto trading was in its infancy. Its 2014 notice defined virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.”
The notice applied only to convertible virtual currency “that has an equivalent value in real currency, or that acts as a substitute for real currency.” It gave bitcoin as one example and said the “sale or exchange” of convertible virtual currency, or using it to pay for goods or services, “may result in a tax liability.”
It further explained that if held for investment, bitcoin should be treated like other capital assets such as stocks. Suppose you bought one bitcoin for $1,000. When it was trading at $10,000, you exchanged it for dollars, another cryptocurrency or a used car. At that point you would have a $9,000 capital gain.
If you owned the bitcoin for one year or less, it would be a short-term gain. Short-term gains are taxed at the same rate as “ordinary income” from a job or self-employment. If you held it for more than a year, it would be taxed at the lower long-term capital gains rate.
At year end, you combine bitcoin profit and losses with other capital gains and losses to determine whether you have a net short- or long-term capital gain or loss. If you have a net loss, you deduct up to $3,000 from your ordinary income and carry any remaining loss amount forward to offset income in future years.
The notice said that if you receive bitcoin from your employer, it’s taxable as ordinary income, just as if you received dollars. Likewise, if you mine bitcoin (by using computers to validate bitcoin transactions), any bitcoin you receive is taxable as self-employment income. If you hold onto the bitcoin you received for your work, any further appreciation or depreciation will be a capital gain or loss.
The IRS notice left a lot of unanswered questions that perplex CPAs, tax lawyers and investors.
“I think for most people, it’s a nightmare,” said cryptocurrency trader Chris Chuang of San Francisco. Paying taxes “is a hassle, but there were gains to be made.”
The price of bitcoin soared from around $986 at the beginning of 2017 to a high of $19,161 on Dec. 19 but then fell off a cliff. On Friday afternoon, it traded around $8,500.
A big problem for digital currency traders is record keeping. Unless a coin exchange provides transaction histories (many don’t), investors have to track it themselves, on paper, a spreadsheet or with a third-party digital tracking tool.
Dinh didn’t start tracking his transactions initially because he thought “one of the exchanges like Coinbase” would send him a 1099 form, like brokerage firms provide, at the end of the year.
When investors sell stock or other securities, they and the IRS get Form 1099-B, which shows their sales proceeds. In most cases, it also shows their cost basis, which is generally what they paid for the security, and whether their gain or loss is shortor long-term. This makes it fairly easy to file an accurate tax return.
Cryptocurrency exchanges don’t have to provide this form. Coinbase said it is sending Form 1099-K to certain customers “that have received at least $20,000 cash for sales of virtual currency related to at least 200 transactions in a calendar year.”
This is not anything like Form 1099-B. It shows only the “aggregate, gross value of certain transactions,” Coinbase said.
Form 1099-K is mainly used to report credit and debit card payments and online transactions that exceed the same threshold. Companies such as Paypal, Airbnb and Uber send it to users, and it often causes confusion when people get it the first time.
Coinbase says it is testing a product that tracks the cost basis for purchases and sales of virtual currency, but not for “transactions sending virtual currency into our out of your Coinbase wallet.”
Coinbase advises users to consult their accountant about taxes, but many CPAs are struggling with it themselves.
“It’s very nebulous,” said Peter Rehm, a nonpracticing CPA who contributes to the the Bitcoin Pub online community. “You have to apply a lot of principles of taxation that people don’t understand. You have to say this is similar to something else that is well understood. We are applying that principle to something that is brand new.”
Tax pros want more guidance, but don’t expect it soon, because the IRS also must provide guidance on the largest federal tax overhaul in three decades.
San Francisco bitcoin trader Ed Chang brought up bitcoin taxes when he talked with his CPA recently.
“He said let’s put a pin in it, and we’ll deal with it later,” Chang said. “For a CPA, especially one focused on Millennials or Gen Z, cryptocurrency is something they are going to have to learn about. Probably 30 to 40 percent of my friends are involved in cryptocurrency to some degree.”
“For most people, it’s a nightmare . ... But there were gains to be made.” Chris Chuang, bitcoin trader, on cryptocurrency taxes