The United States recently reached Tax Day. While always a daunting deadline,for crypto traders the recent changes in tax requirements for cryptocurrencies made it even harder.
However, US officials and exchanges worked together to help smooth over filing issues.
Crypto question added to Form 1040
Tax Day is the last day US citizens can file their tax returns for the previous year.
This year marks the first time questions about cryptocurrency, and digital assets appeared on the form. Taxpayers were asked if they have received, sold, sent, exchanged, or earned any financial interest in virtual currency.
A box with a simple “yes” or “no” option was where they provided their answer. However, a simple as this sounds, much like anything to do with federal tax forms, it’s not so cut and dry.
Tax crypto confusion
These new questions raised uncertainty among crypto investors. What transactions require me to report gains/losses? Are NFTs part of the equation? Do I need special forms?
This “crackdown” on crypto traders appears to stem from the growing tax gap in the US. IRS Commissioner Charles Rettig said that an estimated $442 billion in unpaid taxes is outdated because it does not account for virtual currency. Rettig said of the tax gap estimate:
“It does not include any focus with respect to virtual currency, which I indicated now is about a $2 trillion market cap. It does not include much information with respect to foreign source income. It does not include information with respect to illegal source income, which is taxable, and we do chase.”
He said it would not be “outlandish” for the actual tax gap to be approaching $1 trillion and that the top 1% of earners account for $175 billion of the tax gap.
Reporting gains not buys
The newest IRS guidelines state that cryptocurrency users must report their gains and losses. Specifically, if they received, sold, mined, or traded digital currencies in 2020.
IRS Notice 2014-21 states that cryptocurrencies, despite operating as a real currency, do not have any legal tender status in any jurisdiction. Cryptocurrency, like bitcoin, is, therefore, “convertible” virtual currency.
The notice, and the attached FAQ section, aim to help taxpayers understand why they are paying taxes on crypto and how to do it properly.
One crucial distinction the FAQ makes is for those who bought crypto with real currency in 2020 and did nothing else with it. These people could answer no to the cryptocurrency question.
It is small loopholes like this that likely caused, and will continue to cause, a lot of headaches. Especially for crypto owners who tend to do their taxes themselves.
Coinbase collaborates with IRS
The IRS is aware that these new mandates cause confusion, even among tax veterans. As a result, it teamed up with several entities to try to smooth out the process.
One example is the collaboration between Coinbase and the IRS. Along with other big crypto exchanges, Coinbase shares some customer records with the service.
When the IRS looked over the records from Coinbase, it found 750 users who sold more than $100 million in cryptocurrencies. This included one trader who failed to report over $5 million in transactions.
However, this doesn’t mean that the exchanges are just letting the government look in on users.
Coinbase does their part by updating the form they send users if they meet certain criteria. These users were sent the 1099-MISC form if they received $600 or more in crypto from Coinbase Earn, USDC Rewards, or Staking.
Coinbase sent both the user and the IRS a copy of this form so all parties can see what was earned from the platform and therefore what needs to be reported.
Traders not left in the dark
While the new regulations are an added stress for traders, the IRS did make an effort to warn those who would be implicated.
Over the last year, it has been sending out warning letters to customers who might need help with their forms or help to remember to pay their taxes. The letters come in three variants, 6173, 6174, and 6174-A, and all address crypto holdings.
These letters also alerted users that the IRS knows about their virtual currency holdings and previously unreported accounts. During the last year, over 10,000 letters were sent to Coinbase customers alone.
Coinbase is not the only exchange working with the IRS. As the new rules stay in effect, users should check if their exchange is sharing this information. If they do, it is likely the IRS already has this financial information and can choose to conduct an audit.
Tax software for crypto arrives
It’s not just the exchanges trying to ensure their users know how to navigate these new rules. Companies specializing in crypto tax have been working to make traders’ lives easier.
One such company is Taxbit. The startup provides automated taxation software to crypto users and companies using crypto. For example, BlockFi and Gemini are two of their larger clients. This is unsurprising as many big names see the need to help their users stay compliant with the updated regulations.
This year, the IRS selected TaxBit to aggregate transaction data to make sure taxes paid and taxes owed line up. Co-Founder and CEO of TaxBit Austin Woodward said:
“This is a milestone moment for the cryptocurrency industry. It indicates regulators are embracing the asset class but doing so in a way that ensures a straightforward approach to conform with existing regulations. We believe this is an important step for the enablement of widespread cryptocurrency adoption.”
The team-up came just weeks after TaxBit announced a $100 million Series A funding round led by PayPay.
Another partnership aimed at assuaging tax woes for crypto users is between ZenLedger and Abra. ZenLedger is a crypto tax software and blockchain analytics company. Abra is a financial service and tech firm that operates an all-in-one, custodial crypto wallet and exchange.
The collaboration allows Abra customers to access crypto tax help easily via the ZenLedger platform. As a result, users can view trading history, understand their liabilities and quickly generate tax forms using their stored info.
While the tax filing for 2020 has passed, these new regulations are going to stick around. So keeping on top of the requirements will continue to be important for crypto traders into the future.