Tyson Cross, a tax attorney from CrossLaw and BitcoinTaxSolutions, joined us to speak about some of the more complex issues in cryptocurrency taxation, as well as the effects that the 2018 tax law changes have had on crypto taxes. Tyson has several years worth of experience and knowledge regarding the intersection of cryptocurrency and taxation.

Tyson began helping the cryptocurrency community understand the tax implications of trading back in 2013, with a post on Reddit. [00:35]

Tyson: I got started with crypto back in 2013 – that was around the time that I bought my first Bitcoin. What happened was, I started seeing a lot of confusion and misinformation about the tax treatment of crypto. So I wrote a post on Reddit trying to help the community understand Bitcoin tax implications. From there, I started helping my clients with their crypto tax issues, and now have one of the biggest practices in the country. I help investors, day traders, and early adopters with tax filing and tax planning.

I asked Tyson to give us an overall summary of the tax situation in the United States, in regards to crypto. [02:45]

Tyson: Right now, we have very little guidance from the IRS. They issued a notice back in 2014 that provided some answers to questions about cryptocurrency taxation. It’s basically a FAQ that doesn’t touch on the finer points of cryptocurrency taxation. The basic outline for crypto taxation in the US is that crypto is a property. As property, basic property tax rules apply. The most significant tax impact is that every exchange of property for another type of property is a taxable event.

This means every single exchange of cryptocurrency is a taxable event – including using Bitcoin to buy a cup of coffee, or using one crypto to buy another. The notice also clarifies that mining crypto is taxable income – the same rule applies for staking, master nodes, or any other type of crypto being received from the network.

At the end of 2017, the Tax Cuts and Job Act was passed, changing tax implications for many cryptocurrency traders in 2018 and beyond. The use of “like-kind” treatment for cryptocurrency trades was no longer an option, as a result of this bill.[07:00]

Tyson: The change in the law at the end of 2017 redefined like-kind property and makes it only applicable to real estate.

How does this affect cryptocurrency traders who utilized like-kind prior to the 2018 change? [08:37]

Tyson: The change in the law only applies going forward – there’s nothing in the amendment that applies retroactively. Beginning January 1st 2018 is when you can no longer argue that cryptocurrency is like-kind property. Before that point it’s still an open question.

I would say that, at the very least, cryptocurrency traders should understand that they did take a risk by using like-kind calculation for cryptocurrency. There really is no clear legal authority that said cryptocurrency does qualify as like-kind property. That means the IRS is free to come back later and reject it.

Cryptocurrency trading has a few similarities to classic stock trading. However, cryptocurrency trading is not subject to the same rules as stock trading. The rule against wash sales, for example, does not apply to cryptocurrency trades in the United States. [11:06]

Tyson: Wash sales only apply by statute to shares of stocks and securities. So currently, with the IRS interpretation that cryptocurrency is property, by definition the wash sale rule does not apply to cryptocurrency.

Cryptocurrency traders should be aware of what’s called the Economic Substance Doctrine. [12:35]

Tyson: There’s a doctrine that the IRS keeps in its back pocket called the Economic Substance Doctrine. It’s a tool they use to attack almost anything that they view as existing or occurring purely for tax benefits and not carrying any economic effects. One thing you can do to avoid any sort of argument by the IRS on that point is to wait some amount of time after selling a crypto before you repurchase it (if the purpose of the sale was just a harvest a loss). By exposing yourself to market risk, then you do gain economic substance.

Two types of coin offerings are popping up more and more frequently: Stablecoins and ICOs. Stablecoins are unlikely to be treated differently by the IRS… [15:50]

Tyson: Right now, with every coin being property, I think ultimately the tax treatment should be the same whether it’s a stable coin or not.

…ICO tokens may be a different story. Tyson discusses some of the options that ICO investors have when attempting to assess their gains or losses from ICO investments. [16:25]

Tyson: From a tax standpoint, one of the issues is the timing of the ICO. Typically, when you invest in most ICOS, you contribute funds to a wallet address, and then you wait until the ICO period is closed; the coins are then released to you or, in some cases, they’re not released to you at that point either, and you wait even longer. So there is a question about which date to use for calculating your gain or loss on the coins that you contributed to the ICO. There’s not a right or wrong answer here.

Tyson: On one hand, you could treat it as being a sale of your coin on the day you contribute it and just calculate your gain and then wait until you get the ICO token back and you’ll know your cost basis at that point. Or, there is an argument that these are what’s called an open transaction. The transaction hasn’t been completed yet; you’ve put in your half but you’re still waiting for the ICO to put in theirs. In fact, that may be more accurate treatment because if the ICO decides to terminate or doesn’t reach its minimum threshold, your funds will be returned to you. So, you alternatively could say that the transaction is not complete until the ICO token is delivered and at that point you would calculate your gain or loss.

It’s more or less up to the individual investors and tax payers at this point to decide which one they want to do, until we get more clarification from the IRS. There’s really not a right or wrong answer there.

Airdrops are another type of cryptocurrency event that are gaining popularity. [22:35]

Tyson: There is nothing in the tax law that directly contemplates an airdrop – an airdrop is one of those concepts that didn’t exist before the advent of cryptocurrencies. So, there’s a lot of disagreement about this topic, and whether it’s a taxable event. The issue, I think, is that if we consider a taxable event, it becomes essentially impossible for the taxpayer to track and report all the different air drops that are occurring.I think it’s reasonable to say an airdrop isn’t taxable until you take a step to exercise dominion or control over the airdrop – you acknowledge ownership of that token.

I generally tell clients, if you don’t do anything with the tokens that are airdropped to you, in terms of claiming them, then I think you’re safe to ignore them for tax purposes. If you move them, sell them, or do anything to that effect, that evidences you’re taking ownership of the coin, the safest option is to assume that you have taxable income based on the value of those coins on that date.

In terms of BitcoinTaxes, if someone has an airdrop that they want to report, then I would tell them to just go into the Income Tab and plug it in. You can tag it however you want, it doesn’t matter. The important thing is that BitcoinTax will pull the value of that token on the date you indicate and include that into your income at the end of the year.

Token splits, like BTC & BCH, can cause a lot of headaches for cryptocurrency traders who are attempting to figure out their capital gains. [26:54]

Tyson: “A hard fork, or token split, is probably taxable income. Again, this is another area where we don’t have clarification from the IRS. I’m generally of the opinion that they taxable income. The issue is that you are economically richer after the hard fork than you were before – similar to airdrops.

The bar is very low for taxable income. If you’re made better off, it’s taxable.

You could take the position that there’s not been dominion or control until you move the coins that were received from the hard fork. If that’s your position, then that would be the date that you calculate your taxable income. The most conservative approach would be to have taxable income on the day of the hard fork. The issue is that, as values change, one might be better than the other.

I typically tell clients that they can choose: they can either recognize income on the date of the hard fork, or they can recognize income on the day that they moved the coins from the hard fork, which thereby evidences their control or ownership. The most aggressive option, and one I don’t really recommend, would be to do neither. Wait until you actually sell those coins from the hard fork, and then use a zero-cost basis.

Token swaps, like VEN to VET, can cause an even bigger headache – but the tax implications of these swaps aren’t as difficult to understand as they are for splits. [30:08]

Tyson: I think there’s a pretty good argument in the case of swaps like with VEN to VET that they’re not taxable. If you own holdings of VEN that are completely exchanged into VET, then you’re economically in the same position you were before and after. If you had 1 VEN worth $10 before the split, you would have 100 VEN worth $10 after the split. It wouldn’t make sense to say that there’s a taxable event there.

Many of the commonly used cryptocurrency exchanges are located outside of the United States. Income received on these exchanges is still taxable, and may be subject to foreign account reporting under FATCA, a federal law that says that US citizens and residents have to report their foreign bank accounts. [31:15]

Tyson: If you’re a US citizen or US Resident, you’re taxed on all of your worldwide income. Most people know that, but it’s always worth pointing out that just because your income is sort of occurring or realized overseas, it doesn’t mean that it’s not taxable. You still have to report it on your tax return.

I think that if your exchange account only has crypto on it, and no fiat currency, then you have a pretty good argument that it’s not subject to reporting. Where you may run into an issue is if you are allowed to buy or sell crypto with or for fiat on the exchange, your account is holding fiat, and you can wire that fiat out of your account . That may cross the line into being reportable. Either way, I tell clients if they are filing their taxes and reporting the income it probably doesn’t hurt just to go ahead and file the foreign account disclosures.

There will always be people in the cryptocurrency space who claim that cryptocurrency should not be taxable. [34:34]

Tyson: Like it or not, the IRS does have it’s ways to find out if you are under-reporting, and unfortunately, the IRS swings a big stick.

My position as an attorney, is that you have a legal obligation to accurately file your taxes – the United States tax system is voluntary. You are expected to do it yourself and prepare your own return and voluntarily disclose your income to the IRS. There’s certainly an opportunity there for investors or tax payers in general to be dishonest about their income from cryptocurrency – or any type of income frankly. That dishonesty carries significant risks. I understand the urge to do it, but I’ve seen the consequences of it and it’s not pretty.

Possible consequences for not paying your taxes on cryptocurrency capital gains include interest, penalties, and potential criminal charges for tax fraud. [36:44]

Tyson: Simple answer – it depends. Conceivably, if you don’t pay them, the IRS could come back 10 or 15 years down the line and say that you had this income back in 2017 – here’s your tax, plus interest and penalties.

There’s also something called civil fraud – that’s where they believe your conduct was purposeful, but not quite criminal, and that’s a 75% penalty. The dollars can really start to add up. I guess the ultimate worst case scenario would be that you’re criminally prosecuted.

The IRS is looking for badges of fraud, which are factors that demonstrate your subjective intent. For instance, you might accidentally forget to report your gains from crypto for one year. It could happen – maybe you sent them to your tax preparer, they didn’t put them on and you didn’t notice. Anything can happen once. If you have multiple years that you didn’t report your crypto, that’s tough to explain away as being an accident.

The risk is that if there are enough badges of fraud, the IRS believes that they’ll be able to pursue a criminal case against you. Frankly, I think that’s probably the first enforcement step we’re going see in this space.

2018 was not a great year for many crypto investors. Even capital losses need to be filed – but there is a silver lining. [42:58]

Tyson: If you have a loss it’s because you paid more for the asset than what you sold it for. The IRS doesn’t know what you paid for it, until you file your taxes. From their perspective, all they know is that you sold something, and received value for it – that’s a taxable event. The IRS would want you to file your tax returns, even if you had losses; and you should, because one issue here is that if you don’t file, and the IRS obtains records from your accounts somehow (e.g., a summons), they’re only seeing one side of the equation. That could lead them to look at you in a bad light, and could lead to an audit or a criminal investigation, depending on the volume involved.

Keep in mind, losses from crypto trading are beneficial to you. They offset gains from other types of capital assets. If you have gains from stocks or traditional investment portfolios, your crypto losses will reduce the taxes on those. You also get to off-set up to $3,000 of your ordinary income each year if you have a net capital loss. Whatever is leftover can be carried forward to future years. So, it’s generally in your best interest to go ahead and file and report those losses.

Unfortunately, official guidance on the treatment of crypto from the IRS is still lacking. [44:00]

Tyson: Taxpayers are in an unfortunate position, where they have to choose between doing what’s best for them, which might lead to some issues down the road with the IRS, or playing it safe and doing the most conservative option, so they don’t have a problem with the IRS in the future, but as a result pay more taxes each year. Going forward, I would just encourage everyone to remain vigilant, make sure you’re keeping good records, and do the best job you can to file your taxes accurately. If you do that, you shouldn’t have any problems in the future.

Cryptocurrency is certainly being discussed in the United States government. [45:15]

Tyson: We need lobbyists for crypto in Washington DC, pushing for legislation to solve a lot of these problems. If we can get legislation passed that, for instance, creates a de minimis exception for crypto transactions – that would be huge. A de minimis exception for crypto mean any transaction that produces less than $200 of gain is ignored. That’s one of the reasons that the tax treatment of foreign currencies is so much simpler. If we could get something like that for crypto, it would go a long way. Not only would it make everyone’s life easier when it comes to filing taxes, but it would also encourage adoption.

If you enjoyed our podcast, be sure to check back frequently for more great discussions about cryptocurrency taxation. If you have any questions for Tyson Cross, or want to schedule a consultation with him, he can be reached via his website BitcoinTaxSolutions.com, or via email at tyson@bitcointaxsolutions.com.