The major tax myths about cryptocurrency debunked


Crypto and taxes will not be a match made in heaven, however taxes appear inevitable, and the United States Internal Revenue Service (IRS) has made it clear it’s going after individuals who don’t report. With IRS summonses to Coinbase, Kraken, Circle and Poloniex, plus different enforcement efforts, the IRS is on the hunt. The IRS sent 10,000 letters in numerous variations asking for compliance, however all had been nudges to encourage taxpayers to be compliant.

The IRS hunt for crypto has usually been in comparison with the IRS hunt for international accounts greater than a decade in the past. Unfortunately, it isn’t clear if there’ll ever be a crypto amnesty program emulating the offshore voluntary disclosure applications the IRS formulated for offshore accounts.

Related: More IRS crypto reporting, more danger

The IRS made its first huge announcement about crypto in Notice 2014-21, classifying it as property. That has huge tax penalties, accentuated by wild worth swings. Selling crypto can set off achieve or loss and be taxable. But even shopping for one thing with crypto can set off taxes. Paying workers or contractors does too. Even paying taxes in crypto can set off extra taxes.

We are already seeing crypto audits by the IRS, and by some states (notably California’s Franchise Tax Board), and extra are positive to observe. At least now, there are monitoring and tax return preparation options that may make the method simpler than it was within the early days. Everyone is making an attempt to attenuate taxable crypto positive aspects and to defer taxes the place legally attainable.

Still, it’s straightforward to get confused about the tax remedy and take tax positions that could be onerous to defend in case you are caught.
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With that in thoughts, listed below are some issues I’ve heard, that I’ll name crypto tax myths.

Myth 1

You can’t owe any tax on cryptocurrency transactions except you obtain an IRS Form 1099. If you didn’t obtain a Form 1099, you may examine the field in your tax return that claims that you just didn’t have any transactions with cryptocurrency.

Actually: Tax should be owed, even when the payor or dealer doesn’t file a Form 1099. A Form 1099 doesn’t create tax the place no tax was beforehand due, and loads of taxable earnings shouldn’t be reported on Forms 1099. A Form 1099 is likely to be improper wherein case, clarify it in your tax return. But in case you are audited and your greatest protection is that you just selected to not report your transactions since you didn’t obtain a Form 1099, that’s weak.

Myth 2

If you maintain your crypto by means of a non-public pockets as an alternative of an change, you don’t must report the crypto in your tax returns.

Actually: Private pockets or change, the tax guidelines are the identical. The impulse to cover possession by transferring wealth to nameless holding buildings shouldn’t be new. When Swiss banks started disclosing their U.S. accountholders to the IRS and U.S. Department of Justice, many U.S. taxpayers tried simply about all the things, however almost everybody paid in the long run, often with huge penalties. The cryptocurrency query on the IRS Form 1040 shouldn’t be restricted to cryptocurrency held by means of exchanges. If you say “no,” although you maintain crypto by means of a non-public pockets, you’re doubtlessly making false statements on a tax return signed underneath penalties of perjury. You is likely to be betting that you’ll by no means get caught, however 1000’s of U.S. taxpayers who’ve Swiss financial institution accounts who can attest how poorly that guess can performed out.

Myth 3

If you maintain your crypto by means of a belief, LLC or different entity, then you don’t owe tax on the crypto transactions and would not have to report. Besides (the parable continues), earnings generated by means of LLCs is tax-free.

Actually: Owning crypto by means of an entity could hold the earnings off your tax return. But except the entity qualifies (and is registered) as a tax-exempt entity, the entity itself will possible have tax reporting obligations and will owe taxes. For tax functions, LLCs are taxed as firms or partnerships, relying on their info and tax elections. Single-member LLCs are disregarded, so the LLC earnings finally ends up on the only real proprietor’s return. If your entity is a international entity, there are complicated U.S. tax guidelines that may make you straight responsible for sure earnings produced inside the international entity.

Myth 4

If I construction the sale of my crypto as a mortgage (or another non-sale transaction), I don’t must report the proceeds.

Actually: Consider in case you are loaning or promoting the crypto. The IRS and courts have strong doctrines to ignore sham transactions. Are you getting the identical crypto again that you’re loaning? Are you charging curiosity on the mortgage, and paying tax on the curiosity as you obtain it? Some loans could not maintain water. And should you promote crypto and obtain a promissory be aware, which will complicate your taxes additional with installment sale calculations.

Myth 5

A crypto change is a sort of belief since you may’t unilaterally change the insurance policies of the change. So you don’t personal the crypto in your account for tax functions and would not have to report transactions by means of an change.

Actually: The IRS has not mentioned any of this. IRS steering means that the IRS views taxpayers as proudly owning the cryptocurrency held by means of their change accounts. It appears extremely unlikely that the IRS would view crypto held by means of an change account as owned by the change itself (as trustee), somewhat than owned by the account holder. Taxpayers usually personal their belongings by means of accounts held by establishments, resembling financial institution accounts, funding accounts, 401(ok)s, IRAs, and so on.

In most circumstances, the tax regulation treats taxpayers as proudly owning the cash and belongings held by means of these accounts. Some particular accounts like 401(ok)s and IRAs have particular tax guidelines. And having an account handled as a belief shouldn’t be essentially tax consequence. Beneficiaries of trusts, and notably international trusts, have onerous reporting obligations. Thus, earlier than you contemplate crypto exchanges as trusts, watch out what you want for. Calling one thing a belief doesn’t imply earnings generated inside the belief is exempt from earnings tax.

Myth 6

Congress’s modification to Section 1031 of the tax code that limits like-kind exchanges to actual property doesn’t make crypto-to-crypto exchanges taxable.

Actually: Section 1001 of the tax code supplies {that a} taxable achieve outcomes from the “sale or other disposition of property.” The sale of any sort of property for money or different property can create a taxable achieve. The IRS says crypto is property, so buying and selling crypto for different crypto is a sale of crypto for the worth of the brand new crypto.

Before the Section 1031 modification took impact in 2018, a crypto-for-crypto swap may need been okay as a like-kind change underneath Section 1031. But the IRS is pushing again on this place in tax audits and has issued steering that denies tax-free treatment for certain cryptocurrency swaps. That shouldn’t be precedential and doesn’t cowl the waterfront, but it surely tells you what the IRS is considering. In any case, now that Section 1031 has restricted like-kind change remedy to actual property, crypto-to-crypto swaps are taxable except they qualify for one more exception.

Takeaways

Every taxpayer is entitled to plan their affairs and transactions to attempt to reduce taxes. But they need to be cautious of fast fixes and theories that sound too good to be true. The IRS seems to consider that many crypto taxpayers will not be complying with the tax regulation, and being cautious sooner or later and performing some clean-up for the previous is value contemplating. Be cautious on the market.

This article is for basic info functions and isn’t supposed to be and shouldn’t be taken as authorized recommendation.

The views, ideas and opinions expressed listed below are the creator’s alone and don’t essentially mirror or signify the views and opinions of Cointelegraph.

Robert W. Wood is a tax lawyer representing shoppers worldwide from the workplace of Wood LLP in San Francisco, the place he’s a managing companion. He is the creator of quite a few tax books and regularly writes about taxes for Forbes, Tax Notes and different publications.