Tax authorities’ stances on cryptocurrency places a heavy burden on investors. A civilized nation built on the certainty of its laws should never allow matters as important as taxes to be decided at the discretion and whim of officials.
Sadly, it’s a pattern seen time and time again. Tax agencies around the world provide lackluster guidelines to abide by where cryptocurrency is concerned.
It’s a bizarre and frustrating state of affairs for such a significant area of finance. The total value of all cryptocurrencies flirted with the $1 trillion 18 months ago. Presently it is holding steady well above USD $200 billion for months. Many US citizens have invested substantial savings in crypto, and millions of transactions a year are processed through it. Meanwhile, a huge crypto industry is being built that already employs tens of thousands of people.
This is perhaps why it’s surprising that the IRS has yet to provide updated guidelines on how taxpayers should report profits or losses on investments in Bitcoin and other crypto assets. On April 11, Rep. Tom Emmer sent a letter to IRS Commissioner Charles Rettig requesting the IRS “issue more robust guidance clarifying taxpayers” obligation for cryptocurrency. Rettig’s response came on May 16 with a generic statement of their intent to publish guidance on these and other issues “soon.”
Unfortunately, whilst the US may be the most prominent example to illustrate regulators dragging their feet to release guidance to effectively tax cryptocurrencies, it’s by no means the only jurisdiction that has failed to inform its citizens on how to proceed.
Though UK investors were no stranger to this ambiguity for some time, HMRC has recently published in-depth guidance on how to deal with crypto assets, tackling questions pertaining to blockchain-unique events like forks and airdrops. Still though, their guidance is limited to individuals and explicitly excludes businesses.
Reasonableness, Defensibility, and Consistency
Cryptocurrency tax software solution, have been forced to approach the many gray areas of tax laws with only reasonableness, defensibility, and consistency to guide us. Different experts will inevitably end up approaching these gray areas in different ways. The key is to take tax positions with a good faith belief that such a position has a reasonable chance of being sustained if challenged
Many thousands of taxpayers are filing earnings based on interpretation. Recent suggestions come from US Representatives Davidson and Warren. Their suggestions to alleviate the problem include exempting the first few hundred dollars from crypto trading. This only serves to sidetrack the conversation – and frankly, doesn’t make anything simpler. In fact, it is more complicated from a bookkeeping point of view.
Taxpayers would still have to account for trade activity and identify what is and isn’t taxable. For example, what happens when a blockchain is forked and suddenly a participant in one becomes a participant in several without ever having opted in?
2017’s Bitcoin Cash fork doubled every holder of Bitcoin’s amount of Bitcoin-like digital currency. This happened again in 2018 to the previously forked Bitcoin Cash. The IRS guidelines have yet to provide any guidance here. Fairness dictates that the cost basis should be zero, since the value of Bitcoin Cash on the day it was forked was set arbitrarily by the first few traders. A cost basis of zero allows for opting-in, whilst also exempting those with no interest in the forked coin. However, if the recipient chooses to dispose of the forked assets, then should tax be accessed as 100% gain of the asset’s value at the date of disposition.
In addition, forcing people to pay income on value they never had a choice in receiving – and were unable to reject – is illogical. Unfortunately the law can be interpreted as demanding exactly this. Even the UK guidance fails to tackle the problem logically, instead opting to consider individual occurrences “as they arise.”
Opening the Floodgates
This is just one critical point that needs to be addressed. The transparency of blockchains, in general, could open the floodgates to unreported income that no one actually considers income.
Specific identification of each piece of digital asset received should be tracked. This includes tracking as it is moved from wallet-to-wallet or from exchange-to-exchange. This falls directly within the spirit of the guidelines by treating cryptocurrency as property and not as actual currency.
Sophisticated software exists today to manage this flow. We believe it’s the only way to irrefutably account for income, gains, and losses in a space where regulation is either lacking, or incredibly nebulous. Only through specific identification can we calculate gains and losses capable of being independently verified by auditors.
But this way forward – albeit sensible – doesn’t solve the problem of the many legal gray areas that remain.
A Final Plea
Investors need to remain proactive in maintaining extensive audit trails of their cryptocurrency activity. Hopefully, this will be the last year where they’re left to feel their way through the obscure piecemeal guidance that comprises cryptocurrency tax regulation – the IRS finally seems to be rethinking its strategy. One thing is evident from the sparse guidance to date. The burden of securing and tracking assets falls with the owner. With this responsibility, it should be the utmost priority of tax agencies to educate investors on their liabilities. Furthermore, investors are advised to seek out software that does the heavy lifting for them.
In all commercial transactions the focus of laws should be certainty. At least then people can work out whether they are acting within the laws of their society or not.