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Crypto Hedge Funds Face Tough Choices on Tax Day

Jon P. Brose is a partner and Brett R. Cotler is an associate in the blockchain and cryptocurrency practice at the law firm of Seward & Kissel.

The following article is an exclusive contribution to CoinDesk’s Crypto and Taxes 2018 series.

Like so much else in cryptocurrency taxation, the rules for crypto funds – pooled investment vehicles that seek above-market returns from digital asset investments – are far from straightforward.

In some instances, a tax law concept may include (or not include) crypto assets as securities or commodities for tax purposes. In other instances, existing interpretation of U.S. tax law predates the advent of cryptocurrency (thus not considering unique characteristics of crypto as an asset class).

Such discrepancies may lead to non-intuitive outcomes for crypto funds. Here’s a quick overview.

US investors

U.S. investors in crypto funds (other than tax-exempt investors) will typically invest in domestic partnerships or LLCs. Onshore funds could stand alone but could also be part of larger structures, incorporating one or more entities accommodating tax-exempt and non-U.S. investors (e.g., mini-master, master-feeder and side-by-side structures). 

As partnerships, onshore crypto funds are generally not subject to tax, but rather their investors are taxed on the funds’ profits. Each year, investors receive “K-1s” reporting their respective shares of the crypto fund’s items of income, gain, loss, deduction and credit for the prior year, regardless of whether profits were distributed.  

Investors may be limited when claiming certain deductions or losses, including passive activity losses, business losses, business and investment interest expenses, and miscellaneous itemized deductions, which are currently non-deductible (including for alternative minimum tax purposes).

In addition, crypto funds should restrict withdrawal rights or limit the number of investors to avoid classification as publicly-traded partnerships, which are taxable as corporations. Unlike partnerships, corporations are taxed on their income, and shareholders, on distributions.

Funds that do not limit withdrawal rights or number of investors rely on the “qualifying income” test to avoid publicly-traded partnership classification. It is unclear whether 90 percent of a crypto fund’s income would be “qualifying income” to avoid publicly-traded partnership classification.

If crypto funds allow investors to contribute cryptocurrency (rather than fiat) when subscribing for fund interests, investors may be required to recognize gain (but not loss) on the contribution. If contributions in-kind can be made tax free, crypto funds must track the contributors’ bases in the contributed cryptocurrency and allocate any pre-contribution gains or losses to such investors.

Investor or trader?

Different U.S. federal income tax rules apply to investors, traders and dealers. Generally, dealers make a market in an asset class by being willing to buy and sell assets at certain prices, profiting from bid-ask spreads. Most crypto funds will not be dealers.

Crypto funds will be traders if their trading activities are substantial, seeking to profit from short-term market swings (rather than “hodling” for long-term appreciation). In determining a fund’s status as a trader, relevant factors include the total number of trades in a year, frequency of trading activity, and portfolio turnover.

Unlike traders, investors are not engaged in a trade or business. Crypto funds that are not traders in crypto will be investors.  

Classifying crypto funds as traders or investors affects whether expenses (other than investment interest expenses) of the funds are deductible for U.S. federal income tax purposes.

Traders in commodities, which may include crypto for this purpose, can elect to mark-to-market their open commodities positions (other than those identified as held for investment) at the end of each year, recognizing gains or losses as ordinary income or losses. Funds with significant mismatches between long-term capital gains and short-term capital losses may want to make this election, since recognition of short-term capital losses may be limited.

In addition, crypto futures that are “1256 contracts” and remain open at year end must be marked-to-market. Any gains or losses will be treated as 60 percent long-term capital gains and 40 percent short-term capital gains.

This tax treatment carries through to the general partner as part of their carried interests. However, straddle rules might delay recognition of losses if crypto funds hold, for example, crypto long and crypto futures short.

Other investors

Non-U.S. persons and tax-exempt investors in crypto funds will typically invest in an offshore corporation formed in a no- or low-tax jurisdiction.

Offshore funds will either invest into a master fund (master-feeder), into an onshore fund (mini-master) or alongside an onshore fund (side-by-side). Unless an offshore fund’s activities is limited to certain investments, the offshore fund (but not its investors) may be subject to U.S. federal income tax to the extent the offshore fund is engaged in a U.S. trade or business.

Generally, offshore funds will not be treated as engaged in a U.S. trade or business if the funds only buy and sell stocks, securities and certain commodities for their own account (and certain other requirements are met). These are known as the “securities trading safe harbor” and the “commodities trading safe harbor.” For purposes of the securities trading safe harbor, securities generally means debt instruments.

For purposes of the commodities trading safe harbor, the commodities must be “of a kind” that is customarily dealt in on an organized (i.e. CFTC-regulated) exchange and the transaction is “of a kind” customarily consummated at such place. For this purpose, “commodities” generally means commodities in the ordinary financial sense. The CFTC, which generally regulates commodities markets, has stated that cryptocurrencies are commodities.

The commodities trading safe harbor may apply to crypto trading if the crypto is “of a kind” that is customarily dealt in on an organized commodities exchange. Currently, only bitcoin futures are traded on an organized exchange. While non-U.S. persons’ bitcoin trading activity in the U.S. should fall within the commodities trading safe harbor, it is not entirely clear if trading other cryptocurrencies (e.g., ethereum, litecoin and altcoins) come within the commodities trading safe harbor.

For a more comprehensive look at U.S. federal tax issues affecting digital assets, see our white paper entitled “Hand Over Your Digital Wallet: Yes, Cryptocurrency Transactions are Taxable.”

Tax form image via Shutterstock

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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Why the IRS Should Treat Crypto as a New Asset Class

Zac McClure is the Co-founder of TokenTax, a cryptocurrency tax startup.

The following article is an exclusive contribution to CoinDesk’s Crypto and Taxes 2018 series.


2017 was a banner year for cryptocurrency–an expansive bull market, exciting new coins, and an explosion of crypto-related services.

As cryptocurrencies finally reached the mainstream, regulators and governments have stepped up their oversight. While some nations banned (and rapidly un-banned) cryptocurrency marketplaces and services, the United States moved towards more stringent IRS enforcement by establishing a dedicated cryptocurrency team and forcing major exchanges like Coinbase to turn over user information on trades.

Some may view any governmental activity as anathema to the ethos of cryptocurrency. However, increased IRS scrutiny does have a positive benefit: it adds a layer of legitimacy to the cryptocurrency world as, instead of banning cryptocurrencies, the US government is tentatively acknowledging it as a financial asset.

This is a powerful step forward in the growth of this new industry. I want the U.S. regulatory bodies to embrace and celebrate the transformative potential of cryptocurrency, rather than be mired in an antagonistic battle against the movement.

The current crypto-tax landscape is so chock full of “gray areas” that it would make winter-time Chicago blush. Are you allowed to defer taxes by claiming a 1031 Exchange on your coin-to-coin transactions? Which accounting methods can be used? Do wash sale rules apply? Are forks and airdrops taxable?  

As a result, tax professionals in the cryptocurrency space are applying a hodgepodge of rules that historically have been applied to stocks, bonds and other tradable securities, real property, intangible property, and so on. Having spent the last several months helping people calculate their cryptocurrency tax liabilities has often felt like driving while staring straight into the rear view mirror.

Without clear guidance from the IRS, the resulting non-consensus amongst cryptocurrency tax professionals has led to an environment where it seems even most accountants are hesitant to handle crypto taxes.

In fact, the majority of my firm’s clients are actually calculating their own capital gains not to file on their own, but in order to make life easier for their accountant. This is especially surprising given the asset class ended the year worth more than $600 billion, and many investors had capital gains much larger than their annual salary, and minimal to no experience calculating capitals gains in the past.

Notably, no tax rules are being drawn from crypto’s namesake – currencies.

That is because the most recent meaningful statement from the IRS about cryptocurrency taxation came in 2014 when the agency specified that crypto was not actually a currency, and therefore even tiny gains were taxable and needed to be reported, unlike with actual foreign currency that has a de minimis exclusion for gains under $200.

What is the IRS going to do when another government adopts a cryptocurrency as its national currency? The Marshall Islands intends to issue the Sovereign, or SOV, to supplement the USD as local tender. Venezuela is also heading in that direction and many more nations will surely follow.

Crypto tax reform

Here are a few foundational ideas I would propose for cryptocurrency tax reform:

  • De minimis exclusions (e.g. spending less than $200 for a good or service should be exempt from reporting and capital gains tax)
  • Designate cryptocurrencies as a new asset class, complete with common sense rules that are customized for cryptocurrencies’ unique use cases, as opposed to strained comparisons to semi-related asset classes
  • Last in, first out (LIFO) or specific-shares should be the default accounting methods, as they more closely track the economic realities of investors buying fresh bitcoin or ethereum in order to transfer it to other exchanges and invest it in other cryptocurrencies
  • Exempt bitcoin and ethereum from wash sale rules. As currencies often traded for others they should be exempt from rules about not buying back a currency you’ve recently sold. Those same rules should apply to other currencies to prevent selling and buying back just to harvest tax losses
  • Safe harbor for reporting back taxes: Once guidance is given, offer investors a chance to pay back taxes or amend prior returns given the uncertainty of the current environment
  • Safe harbor for regulations around reporting foreign assets via the FBAR and/or FACTA forms – most people do not even know where in the world an exchange is located, unless it’s Bitmex or Coinbase
  • Explicit tax deferral on cryptocurrency capital held within one exchange: When an investor trades cryptocurrency only for other cryptocurrencies without transferring it out of an exchange and being able to convert it to USD, for example, it seems a bit unfair that he or she would be expected to pay paper gains in USD that have not been realized
  • Aggregate reporting of gains and losses at exchanges that do not offer exchange to USD or other fiat – as opposed to the burdensome task of requiring billions of trades made in “Satoshi’s” (e.g. units of bitcoin) to be converted to USD when no consensus market price exists for most currencies at any time. Instead, a user would report the USD values of cryptocurrency transferred in (effectively a “buy” from a capital gains perspective), and the USD value of cryptocurrencies transferred out of an exchange (a “sell”)

I am sure the IRS would love nothing more than to give clear guidance on all of this- but the truth is if there were easy answers we would already have them.

While the dust settles on this tax season, my hope is that the new IRS cryptocurrency group will gather together a working group of industry practitioners tasked with building consensus around these topics and writing sensible regulations.

I think it is unfair to expect the IRS to do all of the hard work of making these decisions on its own. Progress is neither automatic nor inevitable.

It is much easier for us in the industry to hide behind the caveat of “well, the IRS hasn’t said anything about it yet…” than to try and drive the space forward with meaningful thought leadership. I sincerely hope I get the chance to participate in a group like this someday.

Happy tax filing day everyone!

Lightbulb image via Shutterstock.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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What ICO Issuers and Investors Need to Know About Taxes

Lisa Zarlenga is Co-Chair of the Tax Group and John Cobb is an associate at the law firm of Steptoe & Johnson.

The following article is an exclusive contribution to CoinDesk’s Crypto and Taxes 2018 series.


In the last couple years, blockchain token issuances–sometimes referred to as initial coin offerings or ICOs–have skyrocketed, both in terms of number and size.

According to CoinDesk’s ICO tracker, there were 43 ICOs in 2016 raising an aggregate $256 million; that number jumped to 343 ICOs in 2017 raising in excess of $5.4 billion; thus far in 2018, 92 ICOs have raised in excess of $3 billion.  

Much attention has been paid to regulatory issues in connection with token issuances, including the potential treatment of tokens as securities subject to regulation by the Securities and Exchange Commission, treatment of tokens as commodities subject to regulation by the Commodity Futures Trading Commission, and treatment of issuers as money services businesses subject to regulation by the Treasury Department’s Financial Crimes Enforcement Network (FinCEN).  

Less attention has been paid to the potential tax issues that may arise for both issuers and investors. But these issues are just as real.

The Internal Revenue Service (IRS) has not issued any guidance concerning the tax treatment of token issuances. Practitioners and taxpayers, therefore, generally are left to apply existing tax rules by relying on precedents and rules that provide imperfect analogies to token issuances.  

Many areas of uncertainty exist, including the proper characterization of tokens for tax purposes; reporting and withholding issues for token issuers; and the treatment of token pre-sales through the use of such instruments as Simple Agreement for Future Tokens (SAFT) or Simple Agreement for Future Equity or Tokens (SAFE-T).

Token tax treatment

In general, the facts and circumstances of a particular token issuance, including the rights associated with a token, must be analyzed to determine the appropriate characterization of the tokens for tax purposes.  

A token might properly be treated as debt or equity interests in the issuing entity, as equity in a de facto partnership among holders of the tokens if there is no entity, as a prepayment for goods and services, as “convertible virtual currency” under Notice 2014-21 (which is treated as property), or as some other type of property. The tax consequences to issuers and holders will depend upon which of these buckets the token falls into.

Equity. Tokens characterized for tax purposes as equity of a corporation (because, for example, they have rights to distributions, rights to a share of profits, or voting rights) generally do not result in current tax to issuers, and, if structured properly, investors may defer tax on any appreciated cryptocurrency used to acquire the tokens until they use or dispose of the tokens.  

If the equity interest is in a partnership, however, the rules can get very complicated, and the taxable income of the partnership will flow through to the investors, so they may have ongoing tax liability.

Debt. Tokens characterized as debt (because, for example, there is a definite obligation to repay the investor with interest) generally do not give rise to current tax to either the issuer or investor, but can result in deemed interest payments over the life of the “loan” and can result in tax to the issuer if the loan is ever forgiven.

Prepaid good/services: Tokens may represent the ability to acquire goods or services provided on the platform and, as such, may be characterized as a prepayment for such goods or services. If the issuer meets certain requirements, including not recognizing the income for financial accounting purposes, it may defer recognition of the income from prepaid goods or services until the following tax year.

Property. Tokens characterized as property (whether convertible virtual currency under Notice 2014-21 or otherwise) generally result in current tax to the issuer equal to the amount of the proceeds received less any basis in the tokens.  

In addition, if the investor used appreciated cryptocurrency to acquire the tokens, it will generally result in current tax to the investor on the appreciated cryptocurrency, though depending on the facts, the investor may be able to argue that the exchange of cryptocurrency for tokens was a tax-deferred like-kind exchange, at least before 2018.

Many of the tokens we’ve seen have multiple uses, including as a medium of exchange on the platform, and probably fall into this category.

Thus, ICOs permit token issuers to raise money early in the life cycle of the company, and that money may be taxed up front if the tokens are treated as property. However, the expenses to fully develop the platform may be incurred into the future, thus reversing the typical pattern of a start-up company.

Token airdrops

Some token issuers issue some of their tokens free of charge through an “airdrop.”

Recipients often sign up for airdropped tokens through the issuer’s website, and they sometimes have to do something to receive them, such as using social media to spread the word about the tokens.  

The value of tokens received in an airdrop is likely taxable income to the recipient, but they could give rise to a deduction to the issuer if they are considered payments for marketing activities.

Reporting and withholding

Token issuers should be aware of a variety of reporting and withholding requirements that could apply to token issuances.  

For example, token issuers could be subject to barter exchange reporting rules on Form 1099-B if the tokens are properly characterized as “scrip” through which customers of the issuer exchange property or services.  

If a token properly is characterized as equity or debt, then a token issuer may need to report on payments made to U.S. holders on the appropriate Form 1099 or withhold and report on payments made to foreign holders of tokens on Form 1042.  

If the token is properly treated as a partnership interest, the issuer must file Form 1065 and Schedule K-1’s to partners. Finally, token issuers should consider the potential application of reporting and withholding requirements on Form 1099 or 1042 if they airdrop tokens.

SAFTs and SAFE-Ts

Token issuers often pre-sell some tokens through a SAFT or SAFE-T.  

Under a SAFT, the holder typically pays a fixed amount (in either fiat or cryptocurrency) for the right to receive a determinable amount of tokens upon the occurrence of a token sale to the public.

SAFTs typically provide that the intended tax treatment of the SAFT is as a forward contract. If this treatment is respected, then taxation of the purchase amount should be deferred until delivery of the tokens to the SAFT holder. 

However, the characterization of a SAFT as a forward contract will not necessarily be respected by the IRS; the agency may seek to re-characterize a SAFT as a debt instrument or to distinguish it from a traditional prepaid forward contract and tax the proceeds upon receipt.

A SAFE-T is based on a Simple Agreement for Future Equity (SAFE), which is intended to be treated as equity rather than convertible debt. The tax treatment of a SAFE-T is uncertain, but it contains elements of both a SAFT and a SAFE.  

Depending on the terms of the SAFE-T, it could be treated as a contingent stock right, a SAFT with an equity kicker, or an investment unit consisting of an equity element and a SAFT element. 

Conclusion

It should be obvious from this discussion that there is little guidance from the IRS on how to treat a token offering, SAFT, or SAFE-T for tax purposes.  

Determining how to characterize these instruments for tax purposes is a fact-intensive process. Issuers should consult a tax adviser for assistance in structuring their token offerings so as to minimize the risk that the IRS will re-characterize them.

Tax form image via Shutterstock.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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What If You Can't Pay Taxes on Your Crypto Gains?

Kirk Phillips is an entrepreneur, certified public accountant (CPA) and author of “The Ultimate Bitcoin Business Guide: For Entrepreneurs & Business Advisors.”

The following article is an exclusive contribution to CoinDesk’s Crypto and Taxes 2018 series.

Your attempt to get clarity around crypto tax brain teasers can result in some surprising and unexpected tax liabilities at this time of year.

As we’ve seen through the CoinDesk crypto tax series, there’s a whole new realm of tax considerations that didn’t exist four years ago.

Maybe you’re caught in a crypto squeeze play, wondering how to pay tax liabilities by liquidating the crypto you don’t want to liquidate.

Perhaps you’re finding out that some crypto you received at its highest historical price is taxed as ordinary income and now it’s worth 30 percent of its former self.

For example, you got paid in Xcoin on the date of its $32 historical high, then the floor dropped out of the market, the price slid to $9 and you continued to HODL. Then you sell all your Xcoin at $9 to cover the tax and end up back at zero.

These situations are not for the faint of heart.

Extensions and payments

If you need more time to gather information for your crypto tax calculations, you can always file an individual extension on April 17 for tax year 2017.

Importantly, extensions only extend the time to file, not to pay taxes. Filing tax returns and making the related tax payments are independent of, and parallel to, one another.

Payments have to be timely to avoid penalties and interest, regardless of whether you file on time or extend your return.

Penalties as friends

Generally speaking, if you made estimated tax payments for 2017 equal to or greater than your 2016 tax, then you’re in the safe harbor for that big tax payment on your once-in-a-lifetime gains until the April deadline.

For example, if your 2016 tax was $30,000 and you estimate 2017 taxes at $150,000, you should have paid 2017 estimated taxes of at least $30,000, which leaves you needing to pay $120,000 on the April due date.

But what if you can’t pay or don’t want to pay the tax at the moment penalties and interest start accruing?

This could be a strange-but-true tax strategy where you end up with more resources rather than less. Penalties and interest are seen as a taboo paradigm, but sometimes they can be your friend.

Installment agreements

Individuals can generally get an installment agreement for a tax liability of $50,000 or less, including penalties and interest, for up to 72 months, no questions asked.

Businesses can get a similar arrangement for $25,000 or less. Anything over those amounts requires you to go under the IRS microscope by filing additional paperwork.

For example, you’re an individual with a $150,000 tax liability, so you painfully pay $100,000 and then finance the remaining $50,000 by using and managing future cash flows and crypto appreciation.

You make several monthly payments of $800 each until the crypto market explodes later in 2018, allowing you to sell for big gains while paying your tax in full with a smile.

In this scenario, you’ll have paid $3,500 in penalties and interest, but you benefited from $65,000 of appreciation by leveraging the IRS gift of installment payments.

In addition, liquidating any position in a hurry, crypto or otherwise, is not a good investment strategy, and an installment agreement buys you time to systematically liquidate – like dollar-cost averaging in reverse.

You will also likely end up with more resources using this method rather than an all-at-once liquidation near the tax deadline.

There’s still risk

All else equal, you should always pay your taxes in full and on time. However, if you’re willing to take the risk, now you know how to do it and take advantage of tax financing.

Keep in mind that instead of a sustained crypto market rebound, the opposite could happen and your portfolio could tank further, putting you in a worse position.

It’s a game of hedging and managing resources. Die-hard crypto enthusiasts already know this well.

Tightrope image via Shutterstock

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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Crypto Tax Dodgers Are Tempting Fate

Mark Gladden is the sole proprietor of a digital asset mining and trading business in New Mexico.

The following article is an exclusive contribution to CoinDesk’s Crypto and Taxes 2018 series.


Benjamin Franklin’s 1789 axiom that “in this world nothing can be said to be certain, except death and taxes” is a pragmatic truth. It deals with what “is.” We all pass on, and we all pay our dues.

These days most citizens are accustomed to the idea that – however much we dread it – paying taxes is as much a guarantee in life as the conclusion of life itself. It represents the outcome of the legislative process, in which elected leaders draft bills which ultimately become law.

Institutions like the Internal Revenue Service are then tasked with enforcing these laws, but they do not create tax law themselves, nor do they make decisions regarding tax expenditures.

Above all, they do not care if a taxpayer disagrees with the law because it’s not their responsibility to create or amend legislation. They collect and enforce – period.

Yet many cryptocurrency enthusiasts seem utterly dumbfounded by this, and are brazenly willing to risk the threat of a lifetime of recurring audits, massive fines which wipe out their capital gains, and even downright imprisonment – all for the sake of the wholly separate topic of how much tax “ought” to be collected and how those dollars “ought” to be spent.

Did Al Capone think he “ought” to pay less tax? Sure. Did it matter when the cell door slammed shut behind him? No.

What ‘ought’ to be

This second form of truth – what “ought” to be – is normative in nature, concerned with ideals, and inherently a messy subject with a myriad of factions all claiming to be right.

Some citizens want to pay no tax at all, presumably content to drag down their neighbors while imagining a world in which fires put themselves out, highways and bridges build themselves, and no armed forces are required to prevent foreign invasion because everyone will sing each other to sleep at night.

Others want the rich taxed so heavily that anyone with an ounce of gumption decides it’s a waste of time growing a business, and a presumably endless spigot of tax dollars will magically pay for everyone to go hiking seven days a week before watching the latest episode of “Game of Thrones” on free satellite internet beamed into their free tiny home situated on a free lot on the peak of forever-free Mt. Utopia.

Clearly the truth is closer to the middle, and if there is indeed a middle ground where some amount of tax is necessary, then everyone who enjoys the benefits of tax expenditures – safety from invasion, use of transportation services and infrastructure, access to a robust legal system – must also pay their share.

That doesn’t mean we should accept a broken system if taxes are being used inappropriately. Far from it. We should fight with every available legal means to change it to better serve our collective interests.

Being active in political campaigns, calling representatives, sending articles to news outlets, and joining active campaigns designed to force politicians to live up to their promises – all of these are among the freedoms which every citizen of a democracy enjoys.

Yet how many of people actually do the legwork before complaining about the status quo, then rationalizing their decision to hide income?

Facing reality

Most citizens are inflamed by ultra-rich politicians and businessmen who are found to have hidden millions in offshore accounts, and similarly the crypto community should raise a skeptical eye at those who claim they are hiding income because the world is not what it “ought” to be. Deal with the reality of what “is,” then set about changing things to how they “ought” to be.

Even if you vehemently advocate for hiding income, at very least do yourself a favor and research just how many clever tax cheats have been caught, fined, or jailed years later when old technology was proven vulnerable and exploited by weaknesses that new tech uncovered.

Every action you perform online, from bank deposits, purchases, and email exchanges – all of it, including all activity on most of the major crypto exchanges – is now or may soon be available to your government’s tax enforcement institution. Some government agencies have even been reported to wholesale track all internet data, going so far as to store all encrypted traffic until future technology renders it vulnerable.

Do you really want to risk everything when the alternative is to simply do your best and provide a good faith reporting of your capital gains and mining income for this year or any previous year you’ve missed?

Sure, you’ll pay somewhere between 0% and 39.6%, but that still leaves you with 100% to 60.4% of secure, guaranteed income, possibly more if you make use of all available deductions and depreciation expenses.

Deal with what “is” by reporting your income and paying your taxes, then deal with what “ought” to be by getting involved and advocating for changes to tax law and expenditures.

You’ll sleep easier at night by remembering Franklin’s maxim about death and taxes.

Tempting fate image via Shutterstock.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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A Bitcoin Rally After Tax Day? Don't Bet the Farm

Tanzeel Akhtar is an independent British journalist whose work has been published in the Wall Street Journal, CNBC, FT Alphaville, Investing.com, Forbes, Euromoney and Citywire.

The following article is an exclusive contribution to CoinDesk’s Crypto and Taxes 2018 series.


When tax season ends, will the crypto bear market end with it?

With the April 17 U.S. deadline to file approaching, there’s much speculation that the crypto winter of 2018 was largely due to investors frantically selling to raise funds, so they could pay taxes on 2017 gains.  

“We may look back on this time as the ‘Crypto Tax Crisis of 2018,’ as thanks to tax liabilities we’re witnessing the most concentrated period of net fiat outflows that the cryptoasset ecosystem has experienced in its short life,” Chris Burniske,  a partner at Placeholder VC, and Jonathan Cheesman wrote in a recent, highly detailed Medium post.

And there has almost certainly been some tax-related selling, judging from posts on Reddit and various cryptocurrency forums from investors who had cashed out cryptocurrency during the December run-up and became concerned about their tax liability.

“I didn’t know this back then but it looks like I owe income taxes on those trades, which adds up to about $50,000 if I add up state (California) and federal,” a Redditor who goes by the handle of thoway wrote a month ago.

Further, Japan’s tax deadline was March 15th. Like, the U.S., Japan is a huge participant in the crypto market, so this would further support the thesis.

But there are several reasons to discount the contribution of such selling to the recent market rout – and thus the probability that prices will suddenly surge again after Tax Day.

Coming up short

First of all, investors who sold during the slump would not likely have raised enough to cover their tax liability. Perry Woodin, Chief Strategy Officer at HashChain Technology, Inc, did the math.

“Imagine an individual who purchased 1.5 bitcoins in January of 2017 for $1,200 a bitcoin,” Woodin told CoinDesk. “If that individual sold one bitcoin in December of 2017 they could have realized a gain of ~$18,000. This short term gain is taxed as ordinary income in the U.S. Assuming a tax rate of ~30%, the tax liability would be about $5,400.”

As we spoke in early April, bitcoin was trading around $6,700. Hence, Woodin said, in his hypothetical example, “the remaining 0.5 bitcoin (or $3,350) is not enough to pay the $5,400 tax liability.”

So, tax-driven selling would have been irrational. Of course, people don’t always behave rationally.

Trevor Gerszt, CEO of CoinIRA, a company that specializes in digital currency individual retirement accounts (IRAs), gave another reason to doubt a strong connection between the crypto slump and tax selling. He pointed to the recent activity on the bitcoin blockchain, or lack thereof.   

“If tax selling were really a driver of bitcoin prices, we would expect to see a spike in selling, yet confirmed transactions have been relatively low and have remained that way for the past two months,” Gerszt said on Tuesday.

To be sure, major exchanges started batching transactions in the first quarter, so the number of liquidations reflected on the public ledger might be understated.

Eric Ervin, CEO of Reality Shares, which has launched an exchange traded fund (ETF) investing in blockchain technology, said taxes were certainly a factor in the performance of crypto, but not the primary one, as evidenced by the timing of the dips.

“The market selloff began in December, first bottoming in February, and now we are retesting the lows we saw in February,” Ervin said Tuesday.

Source: CoinDesk’s Bitcoin Price Index

There’s no point in trying to sell your crypto holdings in a panic just because Uncle Sam is knocking on your door. If worse comes to worse, you will have to work with the IRS, set up a payment plan and then hope for a recovery in crypto markets.

And if you’re going to buy in anticipation of a recovery, don’t hold your breath for it to happen right after Tax Day.

Spring flower image via Shutterstock.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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Hobbyist in Hell: Tracking My Crypto Assets for the Taxman

Chandan Lodha is co-founder at CoinTracker, a portfolio and tax manager for cryptocurrency. He can be reached on Twitter here.

The following article is an exclusive contribution to CoinDesk’s Crypto and Taxes 2018 series.

As a hobbyist investor, my first foray into cryptocurrency was with Coinbase.

I was buying a few coins here and there, and everything was simple enough to manage in a spreadsheet. I would record the date, time, and amount bought and sold for every transaction. This worked well enough for the first 10 transactions.

Soon, however, like many others in the space, I found myself deep down the cryptocurrency rabbit hole.

I had exchange accounts on GDAX, Poloniex, Binance and a bunch of others. I was buying privacy coins on decentralized exchanges. I had read about the large-scale exchange hacks which burned many folks in the past, so I set up cold storage hardware wallets and ended up with over 15 different wallets for different types of altcoins.

Still, I was a hobbyist; I was new to the space and just tinkering with small amounts of these coins, learning, curious to see how this digital, decentralized economy operated and how the underlying technologies all worked.

It was fascinating, but also confusing as hell.

The moment I moved a single coin out of Coinbase, the exchange no longer had an accurate reporting of my holdings and transactions so its tax report was incorrect.

My own spreadsheet was getting unwieldy, as I started to integrate Google Apps scripts to look up exchange prices from the different exchange accounts I had, plus match-up cost bases for wallet-to-wallet transfers.

The spreadsheet got more and more complicated, until one day it took two minutes to load.

Money on the line

That was the breaking point – there had to be a better way than running this hacky spreadsheet.

Normally, for a side project I wouldn’t have cared, but this was actual money on the line and I didn’t have a clue how much fiat money (U.S. dollars) I had invested. How was I going to calculate my capital gains taxes on crypto if I didn’t even know how much money I have invested in the first place? It was becoming financially irresponsible for me to not have a better grasp of this.

I turned to my friend sitting next to me and asked him how he was solving the same problem for himself. He turned his laptop to me: a nearly identical complicated spreadsheet (in fairness, his was better than mine).

There was no way that mainstream users were jumping through these hoops. We immediately started researching what other crypto-enthusiasts were using to solve the tracking problem.

To our disappointment, there were no good tools. The most popular tool was a mobile app that operated like a stock ticker app: it would show you the prices of coins daily and, if you wanted, allowed you to manually add these coins into a portfolio, one at a time.

This was even worse than the spreadsheet we already had and wasn’t at all personalized to our particular portfolios, let alone calculating our cost basis, capital gains, or providing any useful information for taxes.

Then and there, my friend and I decided to stop doing what we were doing and productionize our spreadsheets (OK, his spreadsheet) into a simple website. It was the first incarnation of what has now become CoinTracker.

Takeaways

The moral of the story: make sure you keep good records of your transactions, or use exchanges which provide these records for you.

If you are using multiple exchanges and wallets, trading multiple coins, or using secure cold or local storage for your coins (which everyone should do) then there are several tools out there which can help you track your whole portfolio, your return on investment, the amount of fiat invested, and perhaps most importantly your cost basis and capital gains.

In the future, ideally the IRS will help clarify the tax rules which apply to cryptocurrency, especially around grey-area issues such as like-kind exchange, which accounting methods are acceptable for capital gains (e.g. FIFO, HIFO, etc.), and airdropped coins.

Until then I hope to see exchanges and brokers making easy reporting a priority so that their users are not left scrambling to figure out their tax situation.

Meantime, I recommend educating yourself about how to secure your coins, and learning about how cryptocurrencies are regulated in your jurisdiction. If you haven’t already nailed down your 2017 cryptocurrency taxes, file a free tax extension (but make sure to pay your estimated taxes due to avoid late fees).

Even though cryptocurrency is still a nascent space with lots of uncertainty and some headaches – like the ones I’ve described above – I’m very hopeful about the future of the industry. Rarely does such a revolutionary tech come along and there are lots of great materials out there to learn more.

Headache image via Shutterstock.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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Crypto Tax Support Is Coming Slowly to India

While the focus may be on the U.S. of late, cryptocurrency tax issues are becoming a global problem.

India, for example, has responded by sending tax notices to crypto traders and investors after a survey found $3.5 billion in transactions may have been performed by citizens over the past 17 months. The country’s income tax department has even gone so far as to raid exchanges over suspicions that their customers were evading taxes.

In the midst of all this, local startups are proving proactive, offering services that can help crypto users determine what they owe.

One example comes from tax software startup Cleartax, which recently introduced a crypto tax advisory service in partnership with bitcoin wallet Zebpay, a move that echoes those by other global startups like Coinbase (which recently issued its own cryptocurrency tax calculating tool.)

Demand for the product so far has been strong, according to representatives at Cleartax.

“The surge in crypto pricing saw a lot of interest from India,” the representative told CoinDesk. “We started to receive hundreds of queries about tax implications of these transactions.”

And it’s easy to see why. With cryptocurrencies neither legalized nor regulated in the country, taxpayers are struggling to report their crypto profits.

Cleartax continued:

“There is lack of clarity and anxiety, and several views are floating about how gains from [cryptocurrencies] must be reported in tax returns.”

But Nischint Sanghavi, head of exchange at Zebpay, believes the new tool will help resolve concerns.

ClearTax will make taxation related to cryptocurrencies simpler for people so that they can plan their taxes in a better manner,” Sanghavi said.

Indeed, the advisory service is designed to solve any query related to the taxation on trading and sale of cryptocurrencies, as well as those that might be asked by salaried financial traders and freelancers. Plus, Cleartax has launched certified accountant-assisted tax filing services for investors, helping them report their short- and long-term capital gains from the sale of cryptocurrency.

Answers ahead?

That said, both companies will be limited by India’s ongoing regulatory uncertainty over the technology.

The nation’s central bank, the Reserve Bank of India (RBI), has been repeatedly issuing warnings to users, holders and traders of cryptocurrencies, stating that it has not given any license to any entity or company to operate or deal with bitcoin or any cryptocurrency, potentially putting a damper on tax disclosures.

“[With this], the possibility of any formal details on how to tax and report these remains low,” Archit Gupta, CEO of Cleartax, told CoinDesk.

Yet, bitcoin exchanges in India including Unocoin, Zebpay and CoinSecure are seeking clarifications over tax liabilities for their operations.

Still, Gupta said, even with “no clear directive” from the country’s income tax department on how cryptocurrency holdings must be reported, users, at least, should pursue paying some form of tax on them.

In the absence of such rules, he said, “it would be wiser to report these as ‘income from other sources’ and pay a 30 percent tax on gains from them as opposed to reporting them as capital gains, which would mean these are capital assets.”

And summarizing Gupta’s view, a Cleartax representative concluded:

“While the law is unclear – it is certain that this [cryptocurrency] income must be offered to tax.”

India money image via Shutterstock

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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What You Don't Know About Crypto Taxes Can Hurt You

Steve Latham is the chairman of Claritas, a new venture that provides consolidated views of crypto holdings, gains and losses.

The following article is an exclusive contribution to CoinDesk’s Crypto and Taxes 2018 series.


The cryptocurrency bull run of 2017 was awe-inspiring. The resulting taxable implications are not.

Tax season is in full swing but there seem to be more questions than answers.  As shown below, searches for “bitcoin tax” grew almost as much as crypto market caps.

With the IRS focusing on the new tax laws, there has been no new cryptocurrency tax guidance since 2014. Consequently, few investors fully understand the issues and implications of how to treat 2017 crypto gains.

“There’s a lot of confusion around taxes and cryptocurrency, and for good reason,” said Mark Steber, Chief Tax Officer and CPA at Jackson Hewitt. “Changes in tax law significantly lag the rapid growth in crypto popularity. It’s not always clear when a realized gain is taxable income, as defined by the IRS.”

With the goal of shedding light on the most important (and lesser known issues), here are some essential insights to help you navigate this tax season:

What most know

Hopefully, everyone knows taxable gains (or losses) are “realized” when you sell cryptocurrency.  

If you bought 2 bitcoins at $4,000 in August and sold 1 for $14,000 in December your taxable gain is $10,000 (less commissions or fees). You realize a gain on the coin you sold. If you held it less than 12 months (short-term) the gain is taxed as ordinary income.

You don’t have to withdraw funds for the gains to be taxable.  If proceeds from the sale are sitting in your Coinbase US dollar wallet, you still owe tax on the gain.

Exchanging one coin for another coin is a taxable event. If you sold 1 bitcoin (with a $4,000 cost basis) for 20 litecoins valued at $400 each ($8,000 total), you realized a $4,000 gain – just as if you had sold bitcoin for $8,000 in $US dollars.

“While traditional investment gains and losses typically easy to track and report, cryptocurrency can be confusing,” Steber said. “For example, even when trading one coin for another, gains and losses must still be reported.”

What some know

Spending crypto is the same as selling it.  

If you purchased a $14,000 car with 1 bitcoin, it’s the same as if you had sold bitcoin for $14,000 and used the proceeds to purchase the car.  If your cost basis was $4,000, your gain is $10,000. The tax you’ll owe on that gain just made that car significantly more expensive.

Cryptocurrency donations are deductible! Assume you donate 10 litecoins to charity valued at $200 each ($2,000) and that your cost basis is $50 each ($500). You can deduct the greater of the market value or the cost basis without paying tax on the gain.

In this case you can book a $2,000 donation and avoid tax on the $1,500 gain.  Now you can see why crypto donations exploded in 2017.

Pro tip: make sure you document the transaction so you can account for it on tax day.  

What few know

To date, the IRS has not been specific about which methods are acceptable for calculating cost basis for gains and losses. That said, experts believe that when the IRS does issue guidance, it’s going to treat cryptocurrency the same as securities.

For stocks and index funds FIFO (First In, First Out) is required unless you specifically match a lot you sold to a lot you purchased (not a trivial task with crypto). Last In, First Out and Average Cost are also popular methods for accounting. But if you choose the wrong approach, it could be costly.

Why does it matter if you choose FIFO, LIFO or Average Cost?  While FIFO is safer, it will result in a higher tax bill for most who bought and sold crypto in 2017.  

To illustrate:

  • Assume you bought 1 bitcoin in September for $5,000 and 1 bitcoin in November for $10,000 ($15,000 invested with an average cost of $7,500)  
  • If you sold 1 BTC in December for $15,000 your FIFO cost basis was $5,000, implying a gain of $10,000.  Under LIFO (last in, first out) your cost basis would be $10,000, implying a gain of only $5,000. Using Average Cost, your cost and gain are $7,500.

US residents who choose LIFO or Average Cost will likely be under-reporting their 2017 tax liability.  While a few loopholes may tempt some to take an aggressive approach (e.g. LIFO or Like Kind Exchange), it’s likely the IRS will require FIFO in the future – possibly with retroactive enforcement.  If you choose LIFO for 2017, this could result in future payment of back-taxes, penalties, and interest.  

What everyone must know

When thinking about your tax strategy, remember 3 things:

  1. The IRS will (at some point) issue new guidance on cryptocurrency taxation
  2. IRS rules can be retroactively enforced
  3. IRS audits may cover the three previous years

Decisions you make today may help you (or hurt you) in the future.  If you fail to report (or materially under-report) for 2017, it may come back to haunt you.  

We believe it’s only a matter of time before crypto brokerages and exchanges have to report as traditional brokerages do today.  On February 23, 2018, Coinbase announced it had been required to provide the IRS with information on 13,000 customers (about 0.1% of its customers).  This is likely a sign of things to come for US residents who use US brokerages.

If you under-report for 2017, you may face monetary damages in the future – or worse.  At a minimum you could owe back taxes, penalties, and interest. Those who severely under-report may face the risk of criminal charges for tax evasion.  As ignorance will not hold up as an excuse, please talk to a tax professional.

“The best advice I can give is to work with a tax professional who understands cryptocurrency,” Mark Steber said. “It’s also a good idea to check in with your advisor throughout the year to make sure you’re not caught off-guard come tax time.”

Reporting tools

There are numerous new tools on the market (including my company’s) to help you calculate taxable gains for 2017. But regardless of the tool you use, the quality of the reporting is governed by the quality of the information you enter.

For this reason, it’s critical that you take the following actions:

  1. Include all crypto exchange accounts and digital wallets
  2. Review all transactions – especially transfers, payments, gifts and donations – to confirm they are correctly classified.  
  3. Spot-check some of the calculations to make sure they are right.  Our initial review of some of the popular tools found that accuracy varies by provider.  
  4. When in doubt, talk to a professional.

Buy time

The IRS allows residents to request an extension (for any reason) for up to six months, provided you pay your estimated taxes by April 17.

In talking with CPAs and active traders, we anticipate a spike in extensions this year as taxpayers buy time to figure out their crypto tax picture.

For more on filing extensions, please talk to your tax advisor.

X-ray image via Shutterstock

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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Making the Most of Crypto Mining Tax Breaks

Mario “The Problem Solver” Costanz is a lifelong entrepreneur and the author of “Crypto Taxes Made Happy: The Definitive How-To Guide For Preparing Cryptocurrency Tax Returns In The United States,” available for free on Amazon. He was named to the “One to Watch” section of Accounting Today’s 2017 Top 100 Most Influential in Accounting List. 

The following article is an exclusive contribution to CoinDesk’s Crypto and Taxes 2018 series.


Ever since the bitcoin genesis block, coin mining has been the lynchpin of the cryptocurrency ecosystem.

Miners power the transaction and verification processes that make most virtual currencies function. As a result, mining has a dominant position in the ever-expanding world of virtual currency.

For many, cryptocurrency mining has grown into a thriving business characterized by substantial investments in complex systems and costly resources. As cryptocurrency mining becomes more costly and competitive, miners are looking to take greater advantage of tax breaks to help them maximize their profits.

Taxable income

The Internal Revenue Service treats cryptocurrency mining income as business income, even for miners who only operate on a small scale. Anyone who receives mining rewards worth over $400 in a calendar year must report their activity to the IRS.

Miners must report income from every coin they receive in a given tax year, at the market value of the coin at the time it is received. Those who own their mining equipment individually must report their mining income as self-employment income on Schedule C of their tax return. The net income on a Schedule C is subject to ordinary income tax plus a 15.3 percent self employment tax.

From a tax perspective, however, some coin miners prefer to own their mining equipment through a company and be treated as business entities rather than as self-employed individuals. Corporate tax policies can be more generous than individual tax rules if there is significant net income for the mining business.

If the net income exceeds $60,000, for example, an S Corporation (or a LLC taxed as an S Corp) may make sense. Utilizing an S Corporation, you may be able to eliminate paying the 15.3 percent self employment tax charged to individuals on a portion of the mining income.

In a high-cost industry like cryptocurrency mining, these tax benefits can carry substantial value. However, depending on the state in which a company is registered and does business, business entities other than an S Corporation may make more sense.

Be sure to consult a credentialed tax professional to discuss the best options for your particular scenario. Business entities also generally have a lower instance of audits than self-employed Schedule C filers.

Expenses and losses

Good mining operations can be incredibly profitable. However, cryptocurrency mining is full of technical and financial pitfalls that can send a mining business into the red.

The most significant cost facing just about any cryptocurrency mining operation is the hardware and electricity used to keep it going. Miners living in areas with deregulated electricity marketplaces are advised to rate shop to pursue cheap rates. A few cents per kilowatt-hour can mean the difference between profit and loss.

Miners with access to cheap electricity do brandish this substantial competitive edge in regards to profitability. Even mining businesses in higher cost areas that aren’t so lucky can still deduct their mining-related electrical costs from their business income, reducing their net profit. For miners that spend thousands of dollars each year purchasing electricity, this tax deduction can quickly add up to a substantial value.

Cryptocurrency mining uses a staggering amount of electricity, and all that power goes towards running complex mining hardware systems called “rigs.” A mining rig includes various pieces of specialized equipment, including graphics cards and a GPU, a microprocessor specialized for graphics calculations.

Better hardware specs can be very expensive, but they lay the groundwork for the efficiency of your mining operation. As a result, efficient rigs often require coin miners to lay out some serious cash.

Fortunately, however, the IRS allows miners to deduct the depreciation of their mining equipment. Using the Accelerated Cost Recovery depreciation methods recognized by the IRS, coin miners typically deduct the value of their rigs over a span of three to five years. However, in most cases a deduction of the entire purchase price of equipment in the year it was purchased can be made using special Section 179 depreciation rules.

Some rigs are simply not powerful enough to generate a profit, particularly for coins that a particularly difficult to mine. After adding up the cost of electricity, office space, hardware and other mining expenses at the end of the year, some miners discover that they actually lost money in their operations.

If there is a net loss on a mining operation, those losses can be used to offset other income. Mining companies should accurately document all business expenditures that are related to the endeavor so they are prepared to maximize the tax savings.

A business and an investment

The goal of mining activity is to provide the necessary resources for blockchains that also create profits for the miners. This profit oftentimes hinges on the market value of the cryptocurrency being mined. A bad day in the cryptocurrency market can mean the difference between profit and loss, so talented coin miners must be both competent technicians and skilled investors.

Typically, cryptocurrency miners focus their resources on coins that return good value. Because some crypto coins offer higher rewards for miners than others, mining operations sometimes swap their mined cryptocurrency to another crypto that they prefer to hold on to. When miners make this exchange one coin for another, they are actually selling the first coin in return for buying the second coin which in turn creates a capital transaction.

These coin-for-coin swaps are required to be reported separately and additionally to the actual mining income as business income. They create short- or long-term capital gains or capital losses to be included on Form 8949 which then flows to Schedule D.

Long-term capital gains are taxed at favorable rates and are applicable to those coins held on to for over one year. Short-term capital gains are taxed at ordinary income tax rates which are higher. There are numerous accounting methods potentially available to apply to these capital gain transactions to create tax efficiency when reporting the subsequent sales of any mined coins.

Audit safety

Safety is critical to success.

Coin mining income received individually is usually taxed as sole proprietorships on a Schedule C which are audited much more frequently than individuals without self-employment income.

As a result, coin miners should always make sure to keep their financial records in order in case of an audit.

From the classification of mining income to deductions, depreciation schedules for rig equipment to having a second reporting and tax requirement after the mined coins are sold, tax rules for cryptocurrency miners can get complicated.

Anyone who generates more than a few hundred dollars per year in cryptocurrency mining income would be wise to speak with a credentialed tax professional – either a certified public accountant, a tax attorney or an enrolled agent.

Mining farm image via Shutterstock.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.