tax compliance for bitcoin and virtual currencies

John WandriscoShaun Hunley

Tax compliance for Bitcoin and virtual currencies

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Tax compliance for Bitcoin and virtual currencies

Global uncertainty over the last year has made cryptocurrencies like Bitcoin and Dogecoin skyrocket in popularity and value. These new virtual mediums present alternative methods to buying and saving, but how does it impact taxes? The IRS estimates 18–21 million taxpayers will need to consider crypto when filing their return, and firms need to be armed with the knowledge and tools to navigate the new world of crypto-compliance. Join Thomson Reuters’ Shaun Hunley and Ledgible’s John Wandrisco for an expert discussion on navigating the compliance complexities of cryptocurrency.

Our cryptocurrency experts will provide you with insight into the world of virtual currencies, so you can better serve your clients. From the very first days of Bitcoin in 2008 to the present reality of the bull/bear market cycles, they will discuss the tax consequences of cryptocurrency, and give you answers on specific issues, like the dreaded virtual currency question on the 1040 form and how to avoid the crypto digital shoe box.

Tax compliance for Bitcoin and virtual currencies

Tax compliance for Bitcoin and virtual currencies3

Crypto 101• Virtual currency milestones• Other virtual currencies• Exchange vs. wallets

Why crypto?• Growth/adoption• IRS enforcement• Advisory/growth opportunity

Tax consequences and compliance for crypto

Agenda

Tax compliance for Bitcoin and virtual currencies4

Crypto 101

Tax compliance for Bitcoin and virtual currencies5

Virtual currency milestones

2009Bitcoin created

March 2014

IRS Notice 2014-21

November 2016

John Doe summons

July 2019IRS letters

October 2019

Rev. Rul. 2019-24

August 2020

New round of IRS letters

March 2021IRS

announces “Operation

Hidden Treasure”

April 2021Coinbase

goes public

Tax compliance for Bitcoin and virtual currencies6

• Ethereum (ETH)• Litecoin (LTC)• Zcash (ZEC)• Dash (DASH)• Ripple (XRP)• Monero (XMR)• Bitcoin Cash (BCH)• NEO (NEO)• Cardano (ADA)• EOS (EOS)• Dogecoin (DOGE)

Other virtual currencies

Over 4,600 virtual currencies tracked on CoinMarketCap.com as of mid April 2021

Tax compliance for Bitcoin and virtual currencies7

A service/platform that enables clients to trade cryptocurrencies for other resources, such as other cryptocurrencies, or US Dollars

Exchange

Exchanges use custodial accounts to hold their user’s funds and then track it on an internal ledger to allow for trading and exchanging funds

All these trades are made off-chain and no actual crypto is transferred as a result of these trades

Only movement in the ledger changes

Tax compliance for Bitcoin and virtual currencies8

A device, application or a service which stores and encrypts the public and/or private keys and can be used to track ownership, receive or spend cryptocurrencies

Wallet

Wallets don’t store the cryptocurrencyWallets store the Private Key used to sign transactionsAll transactions are written into the blockchain

Hot Wallet• Connected to the

internet

• More user-friendly

• Less secure

• Small day-to-day transactions

Cold Wallet• Not connected to the

internet

• Harder to use

• More secure

• Long term holding

Tax compliance for Bitcoin and virtual currencies9

Why crypto?

Tax compliance for Bitcoin and virtual currencies10

Growth/adoptionBitcoin vs Dow Jones Industrials

April 2016-April 2021

14,770.62%

88.55%

Tax compliance for Bitcoin and virtual currencies11

Growth/adoption

Tax compliance for Bitcoin and virtual currencies12

Why the IRS is worried about Bitcoin• Historically, transactions have been anonymous, which may lead to the underreporting of

income• Association with illegal activity• Many taxpayers don’t understand the tax implications

IRS enforcement

Tax compliance for Bitcoin and virtual currencies13

• Educational in nature (“may not know the requirements”)• Provides guidance on reporting virtual currency transactions and invites the taxpayer to

file amended returns– Taxpayer should write “Letter 6174” at the top of the first page– Mail to Pennsylvania address

• Taxpayer doesn’t need to reply to the letter

Letter 6174

Tax compliance for Bitcoin and virtual currencies14

• Educational in nature (“may not have properly reported your transactions”)• Provides guidance on reporting virtual currency transactions and invites the taxpayer to

file amended returns– Taxpayer should write “Letter 6174-A” at the top of the first page– Mail to Pennsylvania address

• Taxpayer doesn’t need to reply to the letter; however, the IRS may send other correspondence about potential enforcement activity in the future

Letter 6174-A

Tax compliance for Bitcoin and virtual currencies15

• For one or more of tax years 2013 through 2017, IRS hasn’t received either a federal income tax return or an applicable form or schedule reporting virtual currency transactions

• Taxpayer must take action– File delinquent returns and report virtual currency transactions (write “Letter 6173” at the top of

the first page)– If a mistake was made, file amended returns (write “Letter 6173” at the top of the first page)– If everything was reported correctly, mail (or eFax) response to the IRS

• Letter has a response date– Can request a 30-day extension– If no response, IRS may refer tax account for examination

Letter 6173

Tax compliance for Bitcoin and virtual currencies16

• Investors’ reporting doesn’t match other records in the IRS’s possession– Taxpayers will either agree or disagree with the notice– If taxpayer agrees, there’s generally no need to amend the return

CP2000 notices

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• The IRS has teamed up with Australia, Canada, the Netherlands, and the United Kingdom to investigate virtual currency crimes, including fraud and money laundering

• Countries will share information and conduct joint investigations

The J5

Tax compliance for Bitcoin and virtual currencies18

Announced in March 2021 and the Federal Bar Association Virtual Tax Conference• Cryptocurrency fraud is a top IRS Priority• A joint effort between the IRS’ civil office of fraud enforcement and its criminal

investigation unit, will train agents to look at blockchains to root out tax evasion among cryptocurrency users.

Operation Hidden Treasure

Tax compliance for Bitcoin and virtual currencies19

• Gain/Loss Harvesting

• Gift/Estate

• Tactical• Strategic

• Financial Statement

• Tax

• Bookkeeping• Tax

Compliance Audit Support

PlanningAdvisory

Advisory/growth opportunity

Tax compliance for Bitcoin and virtual currencies20

Tax consequences and compliance for crypto

Tax compliance for Bitcoin and virtual currencies21

Apply general tax principles• Gain or loss recognized every time• Must track tax basis• Can be classified as business property (mining), investment property, or personal

property

Virtual currency is property (Notice 2014-21)

Tax compliance for Bitcoin and virtual currencies22

• FMV (in USD) as of date of receipt included in gross income• Net earnings subject to self-employment tax

– Must constitute a trade or business– Mining not undertaken as an employee

Mining

Tax compliance for Bitcoin and virtual currencies23

• FMV (in USD) must be included in income– Consult the applicable exchange– Basis is FMV as of date of receipt

• If later exchanged for other property, gain or loss will be recognized

Receiving virtual currency as payment for goods or services

Tax compliance for Bitcoin and virtual currencies24

You digitally accept 10 Bitcoins as payment for services. On the date of receipt, Bitcoins are worth $1,000 each, as listed by Coinbase. Therefore, you recognize $10,000 ($1,000 × 10) of business income. A month later, when Bitcoins are trading for $1,500 on the Coinbase exchange, you use two Bitcoins to purchase supplies for your business. At that time, you will recognize $3,000 ($1,500 × 2) in business expense and $1,000 [($1,500 − $1,000) × 2] of gain due to the Bitcoin exchange. Since you are not in the trade or business of selling Bitcoins, the $1,000 gain is capital in nature.

Example

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Tax compliance for Bitcoin and virtual currencies28

• Gain or loss equals the difference between the amount received in the exchange and the adjusted basis in the virtual currency

• If held for investment purposes for more than one year, gain subject to preferential long-term capital gain rates when sold or exchanged (20% maximum rate)– Otherwise, short-term capital gain (37% maximum rate)

• Form 8949 used to figure capital gain or loss• Reported on Schedule D

Virtual currency as investment property

Tax compliance for Bitcoin and virtual currencies29

Hard fork• Cryptocurrency undergoes a protocol change resulting in a permanent diversion from the

legacy (or existing) distributed ledger• Typically results in the creation of a new cryptocurrency on a new distributed ledgerAirdrop• Mechanism used to disperse cryptocurrency units to multiple taxpayers’ distributed ledger

addressesTax consequences• Taxpayer doesn’t have gross income under IRC Sec. 61 as a result of a hard fork if he or

she doesn’t receive units of a new cryptocurrency• Taxpayer recognizes ordinary income as a result of an airdrop following a hard fork if he

or she receives units of new cryptocurrency

Hard forks and airdrops (Rev. Rul. 2019-24)

Tax compliance for Bitcoin and virtual currencies30

Reporting

Tax compliance for Bitcoin and virtual currencies31

Checking “Yes”• The receipt or transfer of virtual currency for free (including from an airdrop or hard fork)• An exchange of virtual currency for goods or services• A sale of virtual currency• An exchange of virtual currency for other property (including for another virtual currency)• A disposition of a financial interest in virtual currency

Checking “No”• Merely holding virtual currency in a wallet or account• Transferring virtual currency from one wallet or account you own or control to another that

you own or control

Reporting

Ledgible Crypto Tax

Making the“insanely complex”

as easy as 1-2-3…

1. Connect your Exchange Accounts and wallets

2. Review the Transactions

3. Import Results into tax software or provide to your tax preparer

Ledgible Crypto Tax

Transaction Matching

Our industry exclusive capability allows you to automatically trace when holdings move between crypto wallets and exchanges and track the cost basis the ensure client’s returns are accurate.

Complete Fee Accounting

Our leading capability to account for fees allows full wallet/exchange cost basis calculation to minimize taxes owed – clearly showing your firms value and expertise to your clients.

Robust Exchange and Wallet Integrations

Directly integrates with major exchanges and on-chain wallets ensuring data is accurate and up-to-date.

Ledgible Crypto Tax

Tax Planning

1. Unrealized Gain/Loss tracking

2. By currency short/long term breakout

3. Estimates, extensions and year-end

Ledgible Crypto Tax

The Crypto Tax Platform Trusted by Professionals

Used by Accounting Firms and Tax Preparers around the world

Passed extensive third-party security reviews

SOC Audited – Required for third-parties providing tools to accounting firms

Ledgible/Thomson Reuters automation flow

Taxp

ayer

Firm Send

Organizer

Complete Organizer

Generate Reports

Review Crypto Data

Enter Crypto Data

Import toUltraTax

Import toGoSystem

Crypto tax flow

Import toReturn

Generate Reports

Review Crypto Data

Enter Crypto Data

• Income?

• Gifts?

• Incorrect basis?

• Missing transactions?

• Form 8949

• Tax software import

• Income

• Gifts

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Questions

46 Tax compliance for Bitcoin and virtual currencies