Updated: Nov 15, 2020
This article was originally published on Forbes by Shehan Chandrasekera on December 26, 2019
The popularity of cryptocurrency has been on the rise for years, and 2019 was a year of renewed crypto regulation — particularly in the tax space — as the IRS produced more detailed guidance after 5 years of the issuance of original Notice 2014-21. Prior to reflecting on my big predictions for the new year, it is important to look back on 2019 and recognize some of the most monumental moments in the space.
IRS Warning Letters
In July 2019, the IRS sent out warning letters to 10,000+ US taxpayers with cryptocurrency holdings. These letters came out in 3 variations: Letter 6173, 6174 & 6174-A. Letter 6173 warned of further examination if the recipient failed to respond, even though many had actually correctly filed their taxes. Letter 6174 & 6174-A alerted taxpayers how cryptocurrency related transactions should be reported.
In addition to these letters, throughout 2019, the IRS has been sending out CP2000 letters. These letters were automatically generated when there was a mismatch between what’s reported on Form 1099-K by the crypto exchange and what’s reported on the tax return by the taxpayer.
New IRS Guidance
On October 9th 2019, the IRS released comprehensive new guidance on cryptocurrency taxation including more clarity on hard forks, cost basis calculations, transfers, gifts & donations.This was the first guidance released by the IRS in over 5 years, so this was probably the most important moment in 2019.
Crypto Question On 2020 Schedule 1
The IRS also announced that it plans to ask every American taxpayer on Form 1040 Schedule 1 “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” This so called “crypto question” is designed to improve voluntary compliance and gather more data about US cryptocurrency holders. Notably, this is such a broad question that will help the IRS to collect information on taxpayers with both taxable and non-taxable cryptocurrency transactions.
As we end the 2019, it should be highlighted that the main focus of the IRS is not to achieve perfect compliance; the focus is to increase voluntary compliance and move taxpayers from reporting nothing to reporting something. When faced with complicated matters not directly addressed by the guidance, the service will look into the facts and circumstances of each case.
Increased Understanding Of The Space By Regulators
Beyond just increased interest and understanding from the IRS on crypto taxes, we saw three separate bills go before before the US Congress in 2019 that dealt with crypto - The Token Taxonomy Act (H.R. 2144), The Blockchain Regulatory Certainty Act (H.R. 528), and The Safe Harbor for Taxpayers with Forked Assets (H.R. 3650). It is clear that the US officials and governments across the globe are trying to understand the crypto compliance by actively talking to various industry groups, professional organizations, thought leaders, software companies and tax practitioners.
What To Expect In 2020?
Increased Crypto Tax Awareness
Inclusion of the crypto question on Schedule 1 will tremendously increase crypto awareness among US taxpayers. This will be a question every taxpayer has to answer on the tax organizer sent out by the accountant. Also, online tax preparation software will require you to answer the question during tax preparation.
Focus On Crypto Tax Planning
Crypto going mainstream will open taxpayers to new tax planning opportunities. Some of these include cryptocurrency tax loss harvesting, Self-directed IRA & trading without considering wash sales rules. Financial advisors and tax practitioners will take a deeper dive into these strategies to save money for their clients.
Importance Of Cryptocurrency Tax Software Tools
Various software tools that help taxpayers calculate gains/losses related to cryptocurrency transactions will be flourishing in the coming years. Crypto exchanges do not issue a report similar to the Form 1099-B listing proceeds, cost basis & gain/loss related to crypto activity. Therefore, accurately calculating gains/losses is the taxpayer’s responsibility. Proper valuation, basis tracking, record keeping & specific Identification of units/lots can only be achieved by using a reputed cryptocurrency tax calculator. Without a software tool, it will be virtually impossible to be tax compliant.
Exchanges May Issue 1099s
As regulators look more into this space, crypto exchanges may be mandated to provide better data so taxpayers can easily calculate cryptocurrency gains and losses. Some exchanges may take a proactive approach and start producing reports similar to 1099-Bs to make tax compliance easier. However, if you are trading in multiple exchanges and/or have transfers between your own wallets, exchanges may not have access to all information necessary to provide an accurate gain/loss report. In such cases, as mentioned above, cryptocurrency tax software tools will function as third party data aggregators providing vital support for US taxpayers.
It has been an amazing ride to watch the crypto space grow over the past decade, and it will be interesting to reflect on these predictions in one year from now.
Disclaimer: this post is informational only and is not meant as tax advice. For tax advice please speak with a tax professional.