On February 15, 2018, tax attorneys Steven Toscher and Michel R. Stein, principals at Hochman Salkin Rettig Toscher & Perez P.C., delivered a presentation entitled "New IRS Scrutiny on Cryptocurrency Reporting: Filing Requirements and Exchange Treatment." Earlier this month, President Trump nominated Charles Rettig, one of Toscher and Stein's colleagues, to serve as commissioner of the Internal Revenue Service (IRS). Perhaps their insights will shed some light on what informs Rettig's regulatory approach to virtual currency.
If you're not enthralled by the subject of cryptocurrency taxation, I'll simply provide Toscher and Stein's tips for virtual currency investors. They suggest:
- Create a record-keeping system
- Keep track of acquisition dates, sell dates and cost basis information.
- Report dispositions on Schedule D and Form 8949.
- Identify your exchange rate.
- Use regular capital gains strategies: offset gains with losses, time dispositions to qualify for long-term treatment.
- Watch tax rates: short-term v. long-term capital rates; gains subject to the 3.8% net investment income tax.
- Be aware of tax treatment for virtual currency received by "mining" them – may be business income subject to the income tax and self-employment tax.
- Deduct any investment-related expenses (Schedule A) (Pre-Tax Cuts and Jobs Act of 2017).
For a deeper exploration of cryptocurrency taxation, please read on.
Establishing the urgency of such discussions, Toscher and Stein's presentation explains, "Cryptocurrency is drawing increased attention from government regulators." They note that in November 2017, Coinbase was ordered to release information on approximately 14,000 customers.
As cryptocurrency has received attention from mainstream media, some investors and traders have made "huge profits" and "some are now experiencing large losses."
Means of Obtaining Virtual Currency
Toscher and Stein's presentation details six ways of obtaining cryptocurrency:
- Exchanging virtual currency ("VC") for Sovereign (fiat) currency
- Exchanging VC for property (i.e. Barter)
- Exchanging VC for VC
- Hard fork / Airdrops
- Initial Coin Offerings (ICOs)
These distinctions can be important for tax purposes.
Problems Posed By "Fair Market Value"
In 2014, the IRS Notice 2014-21 designated cryptocurrency as property, but since then, the agency has not issued further guidance, creating what Toscher and Stein call "challenging tax reporting issues."
Income derived from the exchange of virtual currency for goods or services is calculated at the fair market value (in USD) of the virtual currency on the date the property was received. As the price of cryptocurrency varies dramatically across exchanges and throughout the course of a day, it's not immediately clear how "fair market value" would be determined.
While timestamps are typically available on exchanges, how would the IRS or an individual cryptocurrency investor know the price of bitcoin (or another cryptocurrency) that was acquired or distributed without an exchange as a middleman? Matching up blocks on a blockchain and cryptocurrency prices seems like a real challenge. Another issue is this: would the price of the cryptocurrency be calculated at the time the transaction was submitted or at the time that the transaction was verified?
The 2014 IRS notice also provided that salaries paid in virtual currency are subject to normal reporting requirements (i.e. W-2, 1099 etc.) Still, there's an inherent problem due to the anonymity of cryptocurrency wallets.
This section is understandably longer, because there's a lot more that we don't have the answers to yet.
Toscher and Stein allege that the mining of virtual currency produces taxable income. Mining activity is subject to self-employment tax, they say, and the expenses associated with mining activity should be tax-deductible.
Their slides also touch on like-kind exchange. The favorable tax treatment for like-kind exchange of virtual currency was eliminated as of January 1, 2018 (it was essentially pared back to only apply to real estate, as it was originally designed).
With regard to hard forks, Toscher and Stein say "perhaps" this is a taxable event. It's not analogous to a stock split, but maybe it can be treated as a new asset with zero basis.
Other issues that remain include treatment of Initial Coin Offerings (ICOs). Toscher and Stein ask, "Is the raising of funds recognizable in income?" and they consider the differences between stock offerings and the sale of goods and services.
With many ICOs, the function of a token is not exactly clear. Are tokens meant to be used on a yet-to-be-made platform? How do tokens derive value – from investment opportunity or some utility?
Last week, in testimony before the Senate Banking Committee, Securities and Exchange Commission chairman Jay Clayton said that every ICO he's seen thus far qualifies as a securities offering.
Toscher and Stein's slides also make note of the American Institute of Certified Public Accountants (AICPA) proposal for a de minimis exception for small transactions. Worth noting is that in November 2017, the Cryptocurrency Tax Fairness Act (which proposed a $600 de minimis exemption for VC) was not adopted as part of the House tax reform bill.
Inconclusive thus far is whether there is some form of FIFO or LIFO accounting for gains and losses. Depending on whether individual units of a cryptocurrency are traceable, this might be an opportunity for investors to minimize their tax burdens.
One possibility in the cryptocurrency world is that a person might undertake an ICO with coins pegged to an artificially high price. Imagine if that's picked up by CoinMarketCap or another price tracking website. If a person pre-mines a substantial number of these coins and "accidentally" burns all of them, would that qualify as a loss? This isn't exactly wash trading, but nevertheless, false loss reporting remains a concern.
Near the end of the presentation, Toscher and Stein make reference to the tax planning strategy of moving to Puerto Rico, an option that has recently been utilized by a number of cryptocurrency holders. They also mention IRC 877, the expatriation tax, designed to address potential abuse.
The attorneys go into further detail about foreign disclosure requirements, but one of the pieces buried in the end of the presentation is a tiny note – one that really demands much more notice: as ETHNews previously covered in 2017, the Treasury Department signed a contract with blockchain investigation firm Chainalysis.