Regulating and taxing cryptocurrency is a gray area: it’s not treated as currency for tax purposes, yet it can purchase assets; it’s not regulated by the SEC, yet it can be traded and exchanged at set values. Several major companies accept it as a means of payment including AT&T, Starbucks, PayPal, and more. Soon, the laws and regulations surrounding cryptocurrency will change thanks to President Biden’s $1.2 trillion Infrastructure Investment and Jobs Act. Many of the changes are designed to bring transparency to cryptocurrency trading, reporting, and taxation. In fact, under the new regulations, cryptocurrency will now be subjected to the same reporting requirements as brokerages. This includes reporting cryptocurrency gains on IRS Form 1099-B and the requirement to report when more than $10,000 is received in the digital currency. It is expected that the changes will help bring legitimacy to the digital asset class and make it more difficult for digital investors to avoid federal oversight. To help clients, prospects, and others, Calvetti Ferguson has provided a summary of the key details below.
Cryptocurrency Tax Basics
Cryptocurrency, a form of virtual currency stored and secured on a blockchain, is treated as property for tax purposes. This means it is not subject to ordinary income taxes, but rather capital gains and losses when exchanged for real currency. Like other property assets, crypto held for less than a year is subject to short-term capital gains, while crypto held for a year or longer falls under long-term capital gains. The amount of gain or loss is figured based on the change in value from when the crypto was purchased to when it is exchanged or sold for real currency; again, like property.
Cryptocurrency can be used to pay for goods or services, including wages. It can also be used to make charitable contributions and purchase other digital assets, like non-fungible tokens (NFTs). These are unique assets that cannot be duplicated, though owners can change hands. NFTs can be audio, video, graphics, or other digital files.
NFT transactions will trigger capital gains tax when purchased using cryptocurrency, selling one NFT to buy another, or selling NFT for cryptocurrency. Historically, NFTs escaped formal taxation up until this point, though they could be taxed as either property or collectibles.
New Cryptocurrency Reporting Requirements
Soon, all digital assets – cryptocurrencies and NFTs – will be treated as securities. The IRS defines a digital asset as “any digital representation of value, which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the IRS.” This provision helps to provide clarity on what exactly cryptocurrency is in the eyes of regulators; it’s like stocks, bonds, and certain other commodities traded on a stock exchange. While the definition is slightly different, the tax treatment is the same and still involves capital gains.
Also changing is the definition of a broker. It will be broadened to include all cryptocurrency exchanges, like Coinbase and Robinhood, which will soon be treated the same for tax and reporting purposes as established brokers like Fidelity and Schwab. A broker, under the new definition, is “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.”
Moving forward, brokers, or digital currency exchanges, must adhere to reporting requirements for customers and regulatory agencies. This is interpreted to mean Form 1099-B, which brokers send to investors and includes information on capital gains or losses. Failure to comply will result in a $250 per customer penalty up to a maximum of $3 million.
Also changing is the reporting requirement for larger cryptocurrency transfers. Digital assets valued at $10,000 and above will be treated as cash for reporting and tax purposes. This applies to anyone who receives virtual currency valued at $10,000 or more while engaged in a trade or business. Taxpayers should use Form 8300 and include the name, address, and identification number from whom the transaction was received, the amount, and the date and nature of the transaction.
Because the reporting requirement applies to those engaged in a trade or business, it can be interpreted that bona fide gifts of cryptocurrency would be exempt; though, more information is needed to make a final determination.
It’s estimated these new regulations would raise around $28 billion to support the provisions within the infrastructure bill.
How Crypto Investors Will Be Affected
As written, the reporting requirements could give rise to inaccurate 1099s. Many exchanges currently don’t have enough information on customers to adequately report cost basis. This means the exchange wouldn’t know the initial value of an NFT or virtual currency; only when it’s sold or exchanged. Thus, investors will need to keep track of this information individually.
Another impact could be privacy. The IRS will require reporting for any transaction above $10,000. Personal information, such as name, address, and Social Security number, could be attached to the digital currency. If businesses are required to report these transactions, that would also involve storing and transmitting sensitive information.
That’s not to say that cryptocurrency is completely safe; because there aren’t any regulations, it’s easy for investors to be scammed or defrauded. This has been a top SEC concern for several months now. Proponents of the crypto regulations say that as written, the bill lays out the intent; it will be up to the IRS, Treasury, and other regulatory bodies to determine specific rules in the months to come.
The new reporting requirements take effect beginning January 1, 2023. Tax filings would be affected beginning in 2024. Cryptocurrency investors thus should not expect to receive a 1099-B from their exchanges or brokers, until early 2024 unless they adopt the new requirements sooner.
Note that U.S. taxpayers have been required to report cryptocurrency gains or losses on their annual tax returns since 2014. The new 1040 even included a mandatory question asking if the taxpayer had received, sold, exchanged, or acquired a financial interest in any virtual currency.
Exchanges are lobbying hard for changes to the language in the new reporting requirements. Many feel the definition of a broker is too broad and will result in unnecessary and overly difficult compliance requirements. Others are simply seeking more clarity around how the SEC will be involved – to date, the regulations do not disclose much detail on that front.
At any rate, taxpayers have two years before final regulations take effect. Cryptocurrency is on a clear path for legitimacy either way, and that comes with more scrutiny and oversight. Hopefully, the final requirements will balance the transparency and security inherent in most virtual currency transactions with the regulatory requirements that other assets and currencies already face.
Clients with an interest or financial stake in cryptocurrency or NFTs will need to carefully examine the new reporting requirements. Even if an exchange doesn’t keep track of basis, gains, or losses, individuals should still maintain thorough documentation. If you have questions about the information outlined above or need assistance, Calvetti Ferguson can help. For additional information, click here to contact us. We look forward to speaking with you soon.