If it hasn’t happened yet, it will soon. A client will approach you with questions about how cryptocurrencies should be treated on their tax return and what the Internal Revenue Service has to say about tax reporting related to crypto assets. They will want to know vital information to file their state and federal taxes: what their capital gains or losses are if they sell or buy cryptocurrency if profits are considered taxable income, and many more interesting, and at times challenging, questions about their cryptocurrency transactions.
Understanding blockchain and distributed ledger technology and IRS Notice 2014-21 are quickly becoming everyday terms for many tax professionals. For the client, understanding that crypto is, in fact, a capital asset (for most taxpayers) and that there are crypto tax ramifications when buying goods or services with digital assets may be uncharted territory for them.
As the excitement grows about the potential upside of owning crypto, investors in the United States and abroad are clamoring for attention about handling a gain or loss of their crypto and what the tax liability will be. Some people understand that crypto is considered a capital asset and not just currency to be spent as they please, and some don’t.
How Well-Versed Are You in Cryptocurrency?
If you have a long-term relationship with a client and they have started interacting with the crypto market, it would be a good investment to get up to date on tax issues involving crypto assets now that the IRS has an increased stringency for tax reporting. Your clients now expect you, as a trusted advisor, to become their educator on all things crypto.
How can you best fill this additional role you’re being asked to play? Setting clear expectations with your client is critical to meeting client needs and not losing them to a CPA specializing in crypto. An ever-increasing number of tax professionals see this as an opportunity to win clients from tax advisors that have only surface knowledge of crypto assets.
We’re going to share some of the key points covered in an event sponsored by the American Institute of Certified Public Accountants (AICPA) called “Preparing for the 2020 Crypto Tax Reporting & Compliance Season.”
- Tax Form 1040 is now asking if a taxpayer invests in virtual currency. The question reads, “At any time during 2020, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?” In our opinion, there is no reason to suspect that this same question won’t be asked for tax year 2021.
Clients should be encouraged now to alert you if they have invested in cryptocurrency in 2021. You can then help them gather the personal information they’ll need to have for you the next time you file your taxes for them.
- Most virtual currency exchanges are not issuing a Form 1099-B. This form provides the investor with information concerning capital gains and losses. Since 1099-B’s are required for traditional asset brokerages (think Robinhood and E-Trade), crypto investors may not be equipped to or aware that they must keep and provide accurate records to inform their tax professional of trading activity.
Many crypto exchanges do not issue a Form 1099-B, as those exchanges believe the regulations do not explicitly apply to them. Some have chosen to issue Form 1099-B’s proactively, but such exchanges are few and far between, further emphasizing the need for accurate record keeping.
The burden now is on the taxpayer to record all information concerning transactions and then communicate that information to ensure you can accurately file state and federal taxes.
Keeping detailed and accurate records is vital for clients. Some major exchanges only allow individuals to access 90 days of transaction market data. The client with transactions dating back longer than three months ago will likely not have the information you’ll need; they must know that they need to keep their own records of their transactions.
Adding to this necessity for accurate and complete recording is that some exchanges have been hacked in the past, causing them to deny access to any transaction data by individuals while they correct the situation.
- Advisors need to know the language of crypto, what constitutes a taxable/deductible event, and what doesn’t. For example, the sale of currency is taxed differently than mining. Your clients need to make you aware of various transactions they engaged in so you can help them assemble the necessary information for every transaction.
Taxable/Deductible events include:
- Air drops
- Charitable donations of cryptocurrency
- Compensation
- Hard forks
- Interest income
- Mining income
- Receipt of crypto as compensation for services
- Rewards (equivalent to credit card loyalty or referral rewards)
- Staking Income
- Use of crypto to purchase goods and services
Non-taxable events include:
- Gifting cryptocurrency (this may trigger a gift tax filing requirement, which may cause the transaction to be taxable)
- Receipt of cryptocurrency after coin swap/migration
- Receipt of cryptocurrency as a gift
When a dependent of the taxpayer invests in virtual currency and doesn’t file an individual tax return, all information regarding their investment must be reported on their parent’s tax return. This pertains to the general question about virtual currency investments on the first page of Form 1040.
And, along with understanding the language of crypto and the tax code concerning it, you’re also faced with the IRS’ practice of targeting non-compliance by taxpayers for crypto asset transactions. They especially seem to be looking for individuals who haven’t reported their virtual currency transactions and investments. As their advisor, you should make your client aware of these potential risks and reinforce the importance of providing you with all necessary documentation to guarantee compliance.
Conclusion
The popularity and enthusiasm over digital currency continues to grow, and many individual investors are starting to invest in crypto assets to reap the rewards from this emerging sector. The regulatory environment surrounding these assets continues to evolve, and your clients who invest in crypto need to be made aware of any updates to tax guidance, which you can communicate to them.
It’s incumbent upon professional tax advisors to become fluent in terms of crypto. If you aren’t already, your clients will be using words like blockchain and mining, and they’ll expect you to understand precisely what they’re referring to. Doing your homework on crypto and keeping current is mandatory to maintain clients and gain new ones.
Luckily, Lukka has a variety of resources to help you in your crypto education. Lukka Library is a content database filled with articles, educational resources, and position papers from some of the industry’s foremost thought leaders on crypto tax and many other subjects. If you’re looking for a software solution to manage your clients’ and their transaction data, LukkaTax for Professionals provides you with an easy-to-use, affordable solution. Manage any number of clients and only pay $40 when you generate their tax reports needed for filing.
