The IRS has issued a strong reminder about the reporting requirements for cryptocurrency transactions; taxpayers who fail to properly report cryptocurrency transactions can be audited and held liable for penalties and interest. The more complex tax regulation issues were previous discussed in “How does ownership impact taxation on cryptocurrency?“
Dishonest taxpayers could be subject to criminal charges including tax evasion and filing a false tax return if cryptocurrency holdings are not reported.
A conviction of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000 while the penalties for filing a false return are a prison term of up to three years and a fine of up to $250,000.
The IRS focuses on cryptocurrency used for “real world” transactions. Coinmarketcap.com tracks 1,582 different types of cryptocurrency. There are over one hundred currencies with market capitalization over $100 million. The five top currencies in market capitalization are Bitcoin, Ethereum, Ripple, Bitcoin Cash and Litecoin.
Although cryptocurrency is praised for its anonymity and democratization of finance, using Bitcoin like untraceable cash is ineffective. Bitcoin’s official website describes “…. the Bitcoin network is sharing a public ledger called the ‘block chain.’ This ledger contains every transaction ever processed, allowing a user’s computer to verify the validity of each transaction.” This mean every Bitcoin transaction ever is publicly available forever and is only pseudonymous; your wallet is ultimately traceable.
If you fail to report a large amount of gross income, the statute of limitations on your tax return is extended from three years to six; however, if you don’t file at all, the statute is forever. All your transactions on the block chain are also easily accessible forever, so, it is just a matter of connecting them to you to get bused for breaking tax law.
The IRS ruling referred to in the warning Notice 2014-21 boils down to two items: cryptocurrency counts towards income and is classified as property.
If somebody pays you in Bitcoins, you have exactly the same type of income as you would have had they paid in fiat currency. Since cryptocurrency is property, when they are exchanged for something else, including money, you have to recognize gain and possibly loss.
To pay taxes on your cryptocurrency, connect the public identity of your accounts to Node40, bitcoin.tax or libratax.com and they will produce a capital gains schedule for you. Node40 comes highly recommended. If your transaction volume is not very high, this should be fairly easy; however, there are complicating factors.
Bitcoin Cash resulted from a difference in opinion about how to run blockchain; anyone who held Bitcoin at the time Bitcoin Cash was created became owners of Bitcoin Cash.
This means Bitcoin holders, as of block 478558 (August 1st, 2017 about 13:16 UTC), own as much Bitcoin Cash as they had Bitcoin at that time.
While the IRS has asked for comments so that it can issue some guidance on hard forks, there is no regulation that obviously applies. For instance, in regards to the new coins received as interest on existing assets, hard forks should produce income at the moment of the fork creation. In contrast, if categorized more like a stock split, it is more like a change in the form of ownership and not the receipt of something new. The IRS can control the outcome by declaring that it will adopt one analogy or the other.
Hard forks present a number of issues that make the interest analogy more difficult than meets the eye, however. It is sometimes not clear what the value of the new coins are when the split occurs. In some cases the taxpayer must take steps to claim the coins. What if the taxpayer effectively disavows the coins by never claiming them? The stock split analogy is also difficult to follow through because the new coins are actually different from the original; the taxpayer has the original coin as well as something new.
Karen Hawkins, Chair of the ABA Tax Section, wrote to the IRS Acting Commissioner on March 19, 2018 suggesting the creation of a safe harbor which would be an income pickup of zero, with zero basis and a holding period starting on the date of the Hard Fork. That seems like a reasonable answer, but, again it is just a suggestion right now, not guided by clear and established regulation.
How long will it take the IRS to issue specific regulation regarding these nuanced cryptocurrency issues?
Even if regulation was implemented this week, it would still not allow enough time to react to the ruling by April 17. However, it’s possible there might be some regulation enacted by October 15 when extended returns are due so if you want to be compliant and Bitcoin/Bitcoin Cash transactions are material to your return, filing an extension known as Form 4868 could be the best choice.