Taxing Cryptocurrency: What CPAs Need to Know
In a loosely regulated and rapidly changing cryptocurrency world, CPAs must build valuable expertise in helping clients decrypt the use and taxation of digital currencies.
In the 12 years since Bitcoin’s release, it and other cryptocurrencies, like Ethereum, Litecoin, and Dogecoin, have evolved from theoretical flashes in the pan to monetary vehicles with staying power and growing influence. And as cryptocurrencies, which are also referred to as digital or virtual currencies, become mainstream, understanding the evolving tax requirements and helping clients navigate their uses may soon be imperative for every CPA.
“Though the digital assets space is still very much in the early stages, it has enough momentum and real-world usage that the industry is here to stay,” says Illinois CPA Society member Curt Mastio, CPA, managing member of Founder’s CPA in Chicago. “It will evolve over time—similar to the internet.”
“Cryptocurrency is here to stay for multiple reasons,” adds Shehan Chandrasekera, CPA, head of tax strategy at CoinTracker. “Blockchain technology has a lot of applications in a lot of industries—cryptocurrency is just one of them. Institutions and publicly traded companies are also getting into cryptocurrency by offering crypto-related services and holding Bitcoin on their balance sheets.”
“Cryptocurrency is now front and center,” says Andrew Gordon, CPA, attorney with the Gordon Law Group Ltd. in Northfield, Ill. and a director of the Blockchain Institute. “You now have to ask all clients if they have received, sold, sent, exchanged, or otherwise acquired any financial interest in any cryptocurrency.”
Millions of Owners—and Counting
So, what exactly is cryptocurrency? Put simply, it’s digital currency that’s created, tracked, and traded via decentralized virtual ledgers powered by blockchain technology. Owners manage their cryptocurrencies inside digital wallets that store the keys to decrypt currency and allow it to be used, transferred, or converted into cash. A recent Finder survey indicates about 59 million Americans own some form of cryptocurrency, a number that has risen steadily over the past decade.
“As more individuals and businesses become involved with cryptocurrencies and as avenues for using cryptocurrencies expand, CPAs are beginning to field more questions on this topic,” says Jim Brandenburg, CPA, tax partner at Sikich in Milwaukee. “It’s a rapidly developing area that CPAs should become familiar with.”
“Many in the accounting industry hold a misconception that while cryptocurrency might be growing in popularity, their clients are not involved with it,” says Stephen Eckert, a Chicago-based senior manager in Plante Moran’s national tax office. “Many CPAs are surprised by the number of their clients that are maintaining cryptocurrencies.”
In other words, you’d better make sure if any of those 59 million cryptocurrency holders are your clients—especially as the IRS is targeting cryptocurrency tax evasion more intensely. Although, critics are quick to say the agency is moving too slowly to enforce compliance.
The Tax Outlook
“Digital asset technologies are evolving at lightning speed, while tax and accounting guidance is moving at a methodical pace,” Eckert says. “The current amount of tax guidance related to cryptocurrencies is fairly limited. The IRS is convinced that cryptocurrency transactions are a source of significant underreported income and are aggressively looking for taxpayers who fail to report such transactions.”
The IRS addressed “how existing general tax principles apply to transactions using virtual currency” in Notice 2014-21 and has since created a virtual currency FAQ page. “The IRS is trying to get its arms around the expansion of cryptocurrencies and is focusing on the potential for fraud and abuse,” Brandenburg says. “It’s important to understand what transactions need to be reported. Not all cryptocurrency transactions are illegal, as some assume, but even legitimate transactions could trigger IRS scrutiny if not properly reported.”
“Some people think that cryptocurrencies are mainly used for illegal activities and tax evasion, but cash is used for more illicit activity than cryptocurrency,” Chandrasekera says. “Plus, cryptocurrency is the worst asset to evade taxes on because there’s a permanent record of your transactions on the blockchain.”
Another misconception to debunk: Taxation actually kicks in on a variety of transactions, not just when cryptocurrency owners cash out.
“A lot of folks believe that taxes are only triggered when digital assets are exchanged for fiat currencies, such as selling Bitcoin for the U.S. dollar,” Mastio adds. “Not true. Trading one digital asset for another—Bitcoin for Ether, for example—is a taxable event. In addition, receiving digital assets either as payment for services or through an airdrop or fork is also taxable.” (An airdrop is a promotional distribution of a new cryptocurrency. A fork is when there are software updates or other changes to the protocol of a cryptocurrency.)
The IRS isn’t the only institution looking to clarify and regulate the cryptocurrency markets. A recent proposal by the Biden administration to expand brokerage tax information reporting related to cryptocurrencies is “a clear sign of things to come,” Eckert says. All the more reason for CPAs to prioritize understanding when and how cryptocurrency is taxed.
“In some respects, cryptocurrency reporting is similar to the reporting of foreign bank and financial accounts,” Brandenburg says. “Both foreign accounts and cryptocurrencies are top priorities for the IRS. It’s not illegal to have these accounts, but one must be diligent when reporting.”
For instance, cryptocurrency is treated as “property” for tax purposes under current guidance, similar in many respects to a share of stock. “Imagine what would happen if you exchanged a share of Apple for a share of Amazon, or if you used that share of stock to buy a pizza. You’ll often get the same answer if you used cryptocurrency to do the same thing,” Eckert says. “Complexities begin when you realize the variety of transactions that cryptocurrencies are now a part of.”
Cryptocurrency activities can incur capital gains, and holders of cryptocurrency—who may keep crypto on multiple platforms—might also receive reward payments for holding their crypto on a certain platform (aka “staking”). Such payments, according to Gordon, are “akin to receiving interest on a bank account” and are taxable.
Tactics to minimize cryptocurrency taxes resemble general tax strategies: holding long enough to incur a better capital gains rate; offsetting gains with losses; and gifting, donating, or bequeathing. Despite these comparison points, the tax challenges of cryptocurrencies are unique.
“The hardest part about preparing returns for cryptocurrency clients is calculating the gains and losses from the cryptocurrency activity,” Mastio says. “This is a problem unique to cryptocurrencies because, unlike with stocks, the taxpayer won’t receive a 1099.”
Capitalizing on Cryptocurrencies
Cryptocurrency tax troubles seem to be on the rise, but the challenges also present an excellent opportunity for CPAs who are willing to dive into the cryptocurrency world and become subject matter experts.
“We’re seeing it becoming more of an issue for taxpayers, especially with CP2000 mismatch notices,” Gordon says. “CPAs need to ask about cryptocurrency, especially considering that most professional tax preparation software will default to ‘no’ concerning whether an individual client acquired cryptocurrency. There’s now an argument for ‘willfulness’ if the box is checked no.”
He recommends asking clients these questions:
- Do they hold cryptocurrency now?
- Did they own any in the past and, if so, when did they first acquire the cryptocurrency?
- Have they ever exchanged one cryptocurrency for another or used it for a purchase or payment?
- Did they ever sell cryptocurrency for cash?
- Did they ever give or receive cryptocurrency as a gift?
Gordon’s firm starts billing for cryptocurrency-related services at $250 hourly. “If you have a business come to you with a box full of statements, it’s tough to tell how long it’s going to take,” he says. “The level of expertise needed is also much higher than typical accounting: We train our staff for two months. We do a lot of work for CPA firms that can’t do it themselves.”
For CPAs eager to learn more about this area, there are plenty of resources. “Read up on cryptocurrencies and look for continuing professional education opportunities,” Brandenburg advises. “Learn how cryptocurrencies operate and try to compare them with other products you may be more familiar with.”
But perhaps the best way to learn is hands-on: Buy some cryptocurrency yourself and learn the tax mechanics of it firsthand. Seek out consultants and specialized software—and recognize how the entire tax industry faces a global and fast-moving issue that can easily ensnare clients.
“Existing guidance for cryptocurrency taxation has struggled to keep pace with the evolution of the industry,” Mastio says. “There are a lot of uncertainties with the current regulations, but the worst thing a taxpayer can do is not report cryptocurrency activity at all.”
That’s where CPAs come in: We can—and should—strategically guide clients through the process of cryptocurrency use and reporting to get ahead of the challenges and changes of taxing a new currency.
Jeff Stimpson is a writer based in New York. He has covered tax concerns for more than 20 years for various industry publications, including Accounting Today and Financial Advisor.