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WithumSmith+Brown, PC | Certified Public Accountants and Consultants | BE IN A POSITION OF STRENGTH

BE IN A POSITION OF STRENGTH SM

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Speaking Today

Ryan BabiakTax PartnerStartup & Emerging Growth Technology Group

Daniel MayoTax PrincipalNational Tax Services Group

Anthony AnielloTax PartnerFinancial Services Group



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Agenda

▪ Background & Introduction to Cryptocurrency

▪ IRS Guidance

• Notice 2014-21 (March 2014)

• Rev. Rul. 2019-24 (October 2019)

• IRS Q&As (43 in total) (October 2019)

▪ IRS Enforcement

▪ Tax Reporting



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Virtual Currency

▪ Term used by the IRS intended to define cryptocurrency and other digital assets

▪ Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency (i.e., the coin and paper money of a country that designates it as legal tender and requires it to be accepted as a medium of exchange), but it does not have legal tender status in the U.S. Cryptocurrency is a type of virtual currency that utilizes cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain, DAG, or Tempo.

▪ Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin, Ether, Roblox, and V-bucks are a few examples of a convertible virtual currency. Virtual currencies can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.



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Currently Over 1,600 Cryptocurrencies



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How Does Cryptocurrency Work?

Understanding the “Blockchain”

Who are “Miners”?



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What Is The Blockchain?

▪ Blockchains are ledgers (like Excel spreadsheets), but they accept inputs from many different parties.

▪ When someone wants to add to it, participants in the network — all of whom have copies of the existing blockchain — run algorithms to evaluate and verify the proposed transaction.

▪ If a majority of nodes agree that the transactions identifying information matches the blockchain’s history then the new transaction will be approved and a new block added to the chain.

▪ There's no need for a central authority to approve transactions.



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Mining and Miners

Bitcoin Mining is a process of adding transactions to Bitcoin’s public ledger.

Whenever somebody makes a bitcoin transaction, these miners verify the transaction against the existing records to confirm its validity.

By confirming its validity, miners ensure that no bitcoin is double spent (bitcoin once spent can’t be spent again).

Miners, in turn, receive rewards in the form of freshly created bitcoin for every new block they discover. These fresh coins are given to them as an incentive for contributing to the network.



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Utility Tokens, Security Tokens, and SAFTs

▪ Tokens• Used to access services on decentralized applications

• Typically sold by app developer

• Almost always sold for a cryptocurrency with a ready cash value (e.g. Ethereum or Bitcoin)

▪ Utility Token• Token having some utility within the decentralized application that is being developed.

• Generally have a finite supply within the application for which it has utility

▪ Security Token• Crypto tokens issued to investors in a token sale or ICO

• May pay dividends, result in profit share, pay interest or invest in other tokens or assets to generate profits for the token holders

▪ Simple Agreement for Future Token (SAFT)• Concept follows the Simple Agreement for Future Equity (SAFE)

• The SAFT is the commercial instrument used to convey rights in tokens prior to the development of the tokens’ functionality.



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How is virtual currency received or acquired?

▪ Most Common• Purchase through cryptocurrency exchanges

• Accept as payment for good or services

• Exchange or sale of one virtual currency for another

• “Mining” for virtual currency

▪ Less Common• Hard Forks

• Air Drops

• Initial Coin Offerings (ICOs)



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IRS Notice 2014-21 – Key Takeaways

Virtual Currency (“VC”) treated as Property, NOT Currency, for

US tax purposes

• Gain or Loss recognized when VC used as payment for goods or services, exchange of VC for other property or sale of VC

• Receipt of VC as payment for goods or services

Character of gain or loss depends on nature of holdings in the hand of the owner – e.g., investment

property, inventory

Basis of VC is the FMV (in USD) on date of receipt, as payment

for goods or services, or amount paid in cash

Categorizes cryptocurrency (e.g., Bitcoin) as Convertible Virtual Currency



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The Taxation of Cryptocurrency: Basic Principles

▪ Federal Income Tax Characterization• Treated as property• Gain or loss recognized when exchanged for fiat currency, other property, or used in the

purchase of goods or services

▪ Character of gain or loss• Held by taxpayer as a capital asset

• Gain or loss is capital gain or loss• Preferred tax rates apply on capital gain for individuals and trusts

• Held by taxpayer as other than a capital asset (e.g., inventory)• Gain or loss is ordinary



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The Taxation of Cryptocurrency: Disposal / Sale

▪ “Crypto-for-crypto exchange”▪ TCJA limited tax-free like-kind exchanges (section 1031) to real property, beginning in

2018

▪ 2017 and earlier is not clear

▪ Recognize taxable gain or loss equal to the difference between your basis in the previously held property and the FMV of the acquired property

▪ Exchange for equity▪ Potential tax free exchange under sections 351 or 721

▪ Taxpayer’s basis in equity interests will equal his or her tax basis in the cryptocurrency. Partnership or corporation’s tax basis in the cryptocurrency will be the adjusted basis of the cryptocurrency at the date of contribution



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The Taxation of Cryptocurrency: Charitable Donations

▪ Valuation• Exact valuation can be difficult due to multiple exchanges and lack of reports • “Qualified appraisal” for property exceeding $5,000 – likely needed only for lesser-known coins

that do not have exchange pricing

▪ Tax Considerations• If held for more than 1 year, then you can deduct the FMV of the cryptocurrency• If position held at a loss, then best to liquidate, claim your loss, and then donate the proceeds • Increased standard deduction to $12,000/24,000 (S/MFJ) will limit charitable deductions

▪ Options for Donation• Direct to Charity: avoids capital gain tax, but few charities are capable of receiving• Donner-Advised Funds: third party that accepts crypto and will donate on behalf of you – same

treatment as direct gift



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The Taxation of Cryptocurrency: Tokens & SAFTs

▪ Utility Tokens• Most often considered an advance payment for services. Function of token is to be

redeemed in exchange for services.

• Taxable to the issuer of the token independent of how the holder of the token uses it

• Deferral of income to the succeeding tax year, depending upon circumstances

▪ Security Token• If it represents true equity, likely not taxable to extent cost equals FMV of token

▪ SAFTs (Simple Agreement for Future Tokens)• Most often considered a forward contract. Taxed when contract is settled

▪ Stablecoins• Consider the function of the coin, how it was acquired, and what it is used for (is it

an advance payment, deposit, notional principal contract, option or warrant, note or investment, etc.)



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Receipt of Crypto in Exchange for Services

▪ Taxable income = FMV on date received• Risk/opportunity to business and service provider due to market volatility

after receipt of crypto

• Challenges with payroll tax reporting

• Tax consequences are independent of a later sale/exchange of crypto

▪ Recipient of token-based awards should consider filing an election under section 83(b)

▪ If service provider is an employee• Federal & state income tax, FICA, and FUTA

• W-2 wage reporting

▪ If independent contractor• Self-employment tax, estimated tax obligations

• 1099-MISC if $600 or more



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Revenue Ruling 2019-24

▪ Issued October 9, 2019

▪ Addresses “hard forks” and “airdrops,” and whether they give rise to gross income to holders of cryptocurrency under §61

▪ Hard forks – when a cryptocurrency undergoes a protocol change resulting in it being recorded on a new distributed ledger (such as blockchain)• a new path is created to access a cryptocurrency and like a fork

in the road, one path follows the new, upgraded blockchain, and the other path follows the old path

• After a period of time, the old chain becomes irrelevant as users upgrade to the new chain



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Revenue Ruling 2019-24 (cont’d)

▪ Airdrops – a means of distributing units of a cryptocurrency to the addresses of multiple taxpayers

• Usually occurs after a hard fork, but not always

• Units are received when a taxpayer exercises dominion and control over the cryptocurrency, which is usually on the date and at the time it is recorded on the distributed ledger



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▪ Situation 1

• T owns Crypto M. M undergoes a hard fork, resulting in Crypto N, but no units of N are airdropped to T or otherwise transferred to an account owned by T

• Holding: T does not recognize gross income as a result of the hard fork because it has no accession to wealth



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▪ Situation 2

• Crypto R experiences a hard fork, resulting in the creation of Crypto S

• 25 units of S have a FMV of $50, and are airdropped to T solely because T owned units of R before the hard fork

• T can dispose of R and S immediately after the airdrop

• Holding: T recognizes ordinary income when it has dominion and control over Crypto S, which is immediately after the airdrop occurs

• T recognizes gross income of $50

• T’s basis in Crypto S is $50 (so no allocation of basis between old and new cryptocurrencies)



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IRS Q&As

▪ Expand upon the examples in Notice 2014-21, explaining how longstanding tax principles apply to cryptocurrency

▪ Apply only to Ts who hold cryptocurrency as a capital asset

▪ Reaffirm IRS view that cryptocurrency is property and not currency (Q&A #2)

▪ Discuss general rules for selling a capital asset – timing, gain/loss calculation, basis, holding period, etc. (Q&A #4 – #7)



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IRS Q&As (cont’d)

▪ Ordinary income results from the receipt of cryptocurrency in exchange for the performance of services (Q&A #8 – #10)

• Subject to self-employment tax if received by an independent contractor

• Constitutes wages for employment tax purposes if received by an employee (FICA & FUTA)

▪ Exchanges of crypto give rise to gain/loss (so no reorg-type provisions apply) (Q&A #15)



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IRS Q&As (cont’d)

▪ Valuation (Q&A #25 – #27)• If a cryptocurrency is traded on an exchange, then FMV is

the amount recorded by the exchange in US dollars• Same valuation approach for cryptocurrencies that are off-chain

(i.e., not on an distributed ledger) but the receipt of the cryptocurrency was facilitated by an exchange

• If not traded on an exchange, and there is a peer-to-peer transaction, then FMV is determined as of the date and time the cryptocurrency is recorded on the distributed ledger (or would have been if an off-chain transaction)• IRS will accept evidence of value from a cryptocurrency or

blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculates the value at an exact date and time

• If an explorer value is not used, then taxpayer’s must prove that the value they used is an accurate representation of FMV



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IRS Q&As (cont’d)

▪ Valuation (cont’d)

• If T receives cryptocurrency in exchange for property or services, and the cryptocurrency is not traded on an exchange and does not have a published value, then its FMV is equal to the FMV of the property or services exchanged when the transaction occurs

▪ Soft forks do not result in gross income (Q&A #29)

• Soft forks involve a protocol change that does not result in a diversion of the ledger (i.e., no fork in the road) or a new cryptocurrency



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IRS Q&As (cont’d)

▪ No income upon receipt of cryptocurrency as a gift; only when a sale, exchange or other disposition occurs (Q&A #30)

▪ No gain/loss on transfer of cryptocurrency between wallets owned by the same person, even if an information return is received from an exchange or platform as a result of the transfer (Q&A #35)

▪ Specific identification of lots of a cryptocurrency can be made before a sale (Q&A #36 – #37)• Made by documenting the unit’s unique digital identifier such as a private

key, public key, and address, or by records showing the transaction information for all units of a specific cryptocurrency held in a single account, wallet, or address

• Records must show (i) date and time each lot was acquired, (ii) T’s basis and FMV of each unit at time of acquisition, (iii) date and time each unit was sold, exchanged, or disposed of, and (iv) the FMV of each unit when sold, exchanged, or disposed of, and the amount of money or property received for each unit

▪ FIFO is the default lot relief method (Q&A #38)



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IRS Q&As (cont’d)

▪ Income, gain or loss must be reported even if no payee statement is received (e.g., W-2 or 1099) (Q&A #39)

▪ Sales are reported on Form 8949 (Sales and Other Dispositions of Capital Assets), and then summarized on Form 1040, Schedule D (Q&A #40 – #41)

• Ordinary income is reported on Form 1040, 1040-SS, 1040-NR, or 1040, Sch. 1 (Additional Income and Adjustments to Income), as applicable

▪ General documentation requirements (Q&A #43)

• Records documenting sales, exchanges, or other dispositions of cryptocurrency, and the FMV of same



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Increasing IRS Focus

▪ Since 2015, the IRS has been employing software to identify tax fraud

▪ The goal of the software is “to identify and obtain evidence on individuals using Bitcoin to either launder money or conceal income as part of tax fraud or other Federal crimes”

▪ July 2, 2018 - LB&I Compliance Campaign on Virtual Currency

• To address noncompliance related to use of virtual currency through multiple treatment streams including outreach and examinations

• IRS not contemplating a voluntary disclosure program specifically to address non-compliance involving virtual currency



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Increasing IRS Focus (cont’d)

▪ July 2019: the IRS began sending letters to taxpayers they believe had virtual currency transactions. Extension of the IRS’ Virtual Currency Compliance Program

▪ Most notices are not assessments. The goal is to find taxpayers that the Service believes may have failed to properly report income

▪ 10,000+ letters sent as of August 2019

▪ Letters being sent:

• 6174 Inquisitive and information. No response required

• 6174-A Inquisitive and information. No response required but“you’re on the IRS’ radar.” Future correspondence may be coming

• 6173 IRS response requested. Potential examination for failure to respond



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IRS Virtual Currency Transaction Letters (cont)

Letter 6174Reporting Virtual Currency Transactions



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IRS Virtual Currency Transaction Letters

Letter 6174-AReporting Virtual Currency Transactions



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IRS Virtual Currency Transaction Letters

Letter 6173Reporting Virtual Currency Transactions

Also required is a signed ‘under penalty of perjury statement’



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Notice CP2000 – Information Mismatches

▪ IRS now issuing CP2000 mismatch notices

• These are the most severe of the IRS notices to date, because unlike the 3 educational letters, these contain IRS calculations of underpaid tax, plus interest

• Taxpayers must respond within 30 days, either by paying the tax due as calculated by the IRS, or by disputing the IRS’ calculation and providing an explanatory statement and supporting documentation

• To inform taxpayers that discrepancies have been detected and to ask them to justify the positions they took on their returns

• This notice is not new or unique to VCs

• Most people who got 1099-K from their virtual currency exchange are probably going to get CP2000 notice• 1099-K doesn’t provide basis information like a 1099-B for equities• As a result, mismatches are reasonable and expected because gross amount

realized does not equal net gain/loss (need basis to determine gain/loss)



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Tax Reporting

▪ Crypto Traders and Investors• Form 8949 and Schedule D

• Form 8938

▪ Crypto Exchanges• Cost Basis Reporting – 1099-B. Reporting is generally not required

• Many exchanged and crypto accounting software providers to provide tax reporting tools

• Some exchanges take the position that they are a Third Party Settlement Organization and issue 1099-Ks

▪ New Developments• June 2019: FBAR not required to report virtual currency*

* June 2019: FinCEN responded that regulations (31 C.F.R. §1010.350(c)) do not define virtual currency held in an offshore account as a type of reportable account. Therefore, virtual currency is not reportable on the FBAR, for now.



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IF Are you preparing tax returns…

Ask your clients this ONE question:

Did you buy/sell cryptocurrencies?

If Yes…It’s time to dig a bit deeper

How did you acquire the cryptocurrency?

Purchased it with US dollars?

Exchanged cryptocurrency

for another cryptocurrency?

Received cryptocurrency from an Airdrop or Hard

Fork?

Participated in an ICO? Did you hold cryptocurrency on

multiple exchanges? Which ones?

Did you track the cost basis of the gains/losses?

Or use a software that can track across

multiple exchanges?

Is there a consistent cost recovery method being used? (e.g. Specific

Identification, FIFO, LIFO)

Is your cryptocurrency held in a wallet or on

the exchange?



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Thank you!

withumsmith+brown, pc | certified public accountants and ...€¦ · 2017 and earlier is not clear...

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