There are two words together most every cryptocurrency investor hates to hear, cryptocurrency taxes. For most investors, the murky waters of cryptocurrency taxes providethe only headache when it comes to file.
To help break down the current status of cryptocurrency taxes, Coincentral got to interview Ernst & Young Global Blockchain Tax Leader Michael Meisler. Not only did Meisler give powerful advice that will help you file as tax season comes, but he also provided his thoughts on the future of the cryptocurrency and blockchain industry. Enjoy!
Interview with Ernst & Young’s Michael Meisler
How did the 2018 tax reform affect the cryptocurrency industry?
It’s fair to say that the Tax Cuts and Jobs Act (TCJA) impacted many industries, including the cryptocurrency industry. Tax reform has caused all taxpayers to consider how and where they conduct business, and the same is likely true for those businesses in the cryptocurrency industry.
With this said, while there was no specific guidance related to cryptocurrencies in the TCJA, one item worth noting is that the TCJA changed the rules related to like-kind exchanges under Sec. 1031 of the Internal Revenue Code (the Code). This change, effective for taxable years beginning during 2018 and beyond, makes it clear that like-kind exchanges now only apply to exchanges of real estate. Prior to the TCJA, like-kind exchanges could have applied to a broader range of assets.
It’s my understanding that, prior to this change, some taxpayers and tax advisors believed that a position existed to claim that exchanges of one cryptocurrency for another might qualify for like-kind exchange treatment. While this had not necessarily been my position prior to 2018, the TCJA now eliminates even the possibility of that position on a prospective basis.
Over the past year, how have regulators provided clarity for cryptocurrency taxes?
While I’d prefer to limit my responses to tax treatment, leaving other regulatory issues to attorneys that deal more directly with those matters, we have monitored the treatment of cryptocurrencies by regulatory bodies beyond [the] Treasury and the IRS to help inform our firm’s analysis of the tax treatment of cryptocurrencies under various provisions of the Code.
While a great deal of uncertainty regarding tax treatment still exists, one recent example of this can be seen in the fact that futures contracts for Bitcoin now trade on the Cboe and the CME. In addition, Bitcoin was deemed a commodity by the CFTC in 2015. These factors have provided support to consider Bitcoin a commodity for purposes of several provisions of the Code (i.e., for tax purposes).
Advisors continue to struggle with how far any analysis related to Bitcoin can be extended when considering tax issues related to other cryptocurrencies. However, it’s fair to say that the treatment of these assets for tax purposes may not be static and that continued changes in regulation could impact tax advice in this area.
What government agencies other than the IRS affect cryptocurrency taxes?
I’ve given some examples in my answer to the preceding question. However, while we monitor the activity of other agencies, it’s difficult for me to answer more specifically. I’ve stated that we monitor comments by the SEC and CFTC. But we’re also monitoring activity globally that could impact advice that we provide to those investing in cryptocurrencies.
Are there any tax differences between utility and security tokens?
Another difficult question in that there is such limited guidance from [the] Treasury on how to treat these tokens. The only guidance to date that [the] Treasury has provided related to cryptocurrencies is contained in Notice 2014-21. That notice provides that “convertible virtual currency” that is convertible into fiat currencies should be viewed as property for federal income tax purposes.
The topics covered in that notice cover activities related to mining cryptocurrencies and the tax consequences of using cryptocurrencies to pay for goods or services. The guidance doesn’t provide guidance on the appropriate treatment of taxpayers that either sell tokens or raise capital in connection with the issuance of tokens. Taxpayers and tax advisors have expressed different opinions regarding the appropriate treatment of taxpayers that raise capital through the issuance of tokens.
In the case in which a taxpayer issues a utility token, some taxpayers had previously taken the position that such tokens were not securities for SEC purposes and that their issuance generally either provided access to a platform to be built or access to a service or product to be developed in the future. This makes it difficult to look at the issuance of such tokens as relating to one of several exceptions to taxation that exist under the Code, suggesting that the sale of such tokens could be taxable.
Security token offerings differ significantly. In general, the sellers of these tokens have conceded that their tokens are expected to be viewed as securities by the SEC. Accordingly, these tokens may require registration. The tokens may have real assets that investors may have access to in the event of a liquidation of the underlying issuer.
Accordingly, these tokens may start to have more traditional equity features that move the analysis forward as to whether issuance of these tokens could qualify for tax-free treatment under the Code. It’s important to emphasize that any position related to either type of token issuance lacks any clear guidance from [the] Treasury at this point.
Accordingly, no one reading this should presume any certainty about the different treatment between these two types of tokens without discussing all of the relevant facts and circumstances of the tokens with a knowledgeable tax advisor.
Any words of wisdom for cryptocurrency investors to help them prepare to do their own taxes? At what point should an investor contact a tax specialist to do their cryptocurrency taxes?
First and foremost, sales or exchanges of cryptocurrencies should be considered as taxable transactions unless you’ve gotten appropriate advice to the contrary. That advice should carefully document which provision of the Code the taxpayer should rely on to support their position.
Second, keep in mind that a regulator, such as the SEC, stating that a particular cryptocurrency is or is not a security for its purposes may not mean that that cryptocurrency is or is not a security for tax purposes. The distinction of whether an asset is considered a security or not for tax purposes could have significant implications for US and foreign investors in these assets. For those that trade extensively, issues related to the method of accounting used to determine the adjusted basis of assets sold are important and should be considered.
As to which investors should contact a tax specialist, that’s another difficult question (without sounding self-serving). I would say that a trader with many trades on different exchanges or out of different wallets likely needs some help in considering the appropriate method to account for their gains and losses.
Investors or traders with significant built in gains or built in losses could benefit from help to consider their overall tax situation before recognizing those gains or losses. For investors that have gained access to new cryptocurrencies as a result of forks in a blockchain or as a result of an airdrop, additional issues arise as there is no clear guidance available as to the correct tax treatment upon the receipt of these assets.
We’ve even received questions related to FBAR filings for those investors holding accounts with cryptocurrency exchanges located outside the US.
Can you quickly explain when an investor needs tax Form 8949 or Form 1040 Schedule D?
To the extent that cryptocurrencies are considered capital assets with respect to a particular taxpayer, a taxpayer subject to US income tax reporting requirements with respect to any realized capital gains or losses in connection with a sale or exchange of cryptocurrency should report such capital gains or losses on Form 8949.
In addition, Schedule D should be attached to the taxpayer’s federal income tax return. The Schedule D provides space to report capital gains and losses reported on Form 8949, along with other capital gains and losses that may not have been captured on Form 8949.
What do investors need to know about cryptocurrency mining, airdrop, and staking taxes?
Well, investors should know what is known and what isn’t as a starting point. As previously stated, [the] Treasury provided in Notice 2014-21 that “convertible virtual currency” that is mined should be considered as income from self-employment. Still, I think further review of a taxpayer’s operating results could be warranted to consider whether such taxpayer is engaged in a trade or business related to that self-employment activity, or merely a hobby.
This could impact the taxpayer’s ability to claim losses/expenses related to this activity. In addition, as previously mentioned, there’s no clear guidance on how tokens received pursuant to an airdrop should be treated. Accordingly, a taxpayer that receives tokens pursuant to an airdrop should discuss the potential positions related to the timing and amount of income, if any, to be recognized in connection with an airdrop.
Similarly, there is no current guidance directly on point related to income associated with staking. Accordingly, taxpayers should consult with a tax advisor to consider the potential positions available to them in light of their facts and circumstances and their risk tolerance.
What areas of cryptocurrency taxes does the government need to provide more guidance on?
Many areas that have already been mentioned above. In particular, treatment of issuers in connection with raising capital through the issuance of tokens, treatment of income realized in connection with forks, airdrops and staking, information reporting requirements for taxpayers and exchanges, applicability of various provisions of the Code generally applicable to investments in securities or other financial instruments to traders and investors in cryptocurrencies (e.g., do the wash sale rules, mark to market and other “security” related rules under the Code apply to cryptocurrency transactions).
In addition, one important area of confusion is whether the “safe harbor” for traders in securities or commodities under Sec. 864(b) of the Code could somehow be extended to traders of cryptocurrencies.
Why was there a rise of Security Token Offerings over the past year?
I have some ideas. But, as I merely provide tax advice to participants in this space, I’d defer to those having more regular conversations with the regulators in this space.
What does 2019 have in store for the refinement and enforcement of cryptocurrency taxes?
It’s unclear at what pace any guidance will be forthcoming. With respect to enforcement, the trend towards increased enforcement to capture information regarding cryptocurrency gains should be expected.
The IRS has established a task force to focus on enforcement. In addition, the IRS has joined a global tax coalition to combat non-compliance, known as the Joint Chiefs of Global Tax Enforcement (J5). Members of this coalition include government agencies from Australia, Canada, the Netherlands, the United Kingdom and the United States.
Did we miss anything you wanted us to cover?
The potential need for FBAR filings for those that hold accounts with foreign exchanges may be a sleeper issue for many. No clear guidance is available as to whether these accounts are subject to FBAR. However, the potential penalties for failure to file, if required to do so, can be so high that taxpayers should discuss this with their advisor carefully, particularly for those taxpayers that wish to avoid reporting these accounts.
Also, I believe that the overall theme is that with there is tremendous uncertainty with respect to the tax treatment of a significant number of transactions/issues related to cryptocurrencies. I recommend that most taxpayers with more than a handful of cryptocurrency trades consider the need for additional tax advice.
Thank you for your time and insight!
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