Some 59 million Americans own some form of cryptocurrency. Despite its volatility, crypto remains a favorite among investors looking for a hedge against expansionary monetary policies and an unstable global economy, as well as those looking for potential huge returns.
As crypto continues to grow in popularity, tax authorities are slowly pinning down compliance and reporting regulations and starting to scrutinize crypto creation, platforms and transaction data. The result could be a nasty surprise for your clients who transact virtual currency.
“For a typical investor of cryptocurrency, the tax treatment will be similar to how other securities such as stocks or mutual funds are handled,” said Austin Bennett, Milwaukee-based principal with CliftonLarsonAllen. “The investor achieves preferential capital gain rates if the cryptocurrency investment is held for one year or more but is subject to ordinary income tax rates if it’s held less than a year.”
Jamie Hopkins, managing partner of Wealth Solutions at Carson Group in Philadelphia, adds, “When you transact with crypto, sell, exchange and so on, you need to think that [it] is likely a taxable event with a gain or loss attached. If you’re given a cryptocurrency as part of compensation, that is treated as ordinary income when earned.”
Seems straightforward, except that so far the regulation and enforcement still seem to fall short of other tax areas. “I’ve run into individuals who have hundreds of thousands and millions of dollars of taxable cryptocurrency transactions going on [who] are just paying no taxes at all,” Hopkins added.
The IRS made a crypto inquiry one of the first questions on the 2020 individual income tax return, though the question confused some taxpayers. Does the government want to know about mere purchases of cryptocurrency that don’t involve a sale?
Nevertheless, “it will be increasingly harder to hide crypto activity from the IRS,” said Julia Carlson, founder and CEO of Financial Freedom Wealth Management Group in Newport, Ore.
Crypto comes with a cost basis, she said: “What you originally invested, and then it becomes a taxable event when you sell your crypto. It will either be a taxable gain or loss based on your cost basis. You’d then be subject to the same tax treatment as you would if you sold a stock or other capital asset.”
“Misconceptions are still prevalent in the cryptocurrency space but have largely been reduced as more detailed IRS guidance has been published,” said Tom Cardinale, a partner at EisnerAmper in Iselin, N.J., specializing in corporate taxes, blockchain and cryptocurrencies. He added that the IRS has posted long-awaited FAQs that address tax reporting issues for many cryptocurrency transactions, including capital gains treatment, ordinary income events, exchanges and accounting methods.