According to the White House, about 16% of adult Americans have purchased cryptocurrencies. If we consider that there are about 258 million adults in the US, that’s about 41 million adults who have invested in cryptocurrency. While no one knows the exact number of taxpayers who have checked “yes” to the virtual currency question on Form 1040 and reported their crypto taxes, the extra $45 billion in IRS funding for crypto enforcement from Congress suggests that there’s a large gap between those who owe crypto taxes and those who actually report.
We’ve all known since 2014 that virtual currencies are treated as property and that US taxpayers have a tax obligation when transacting with them. The principles are simple, right? Report your gains and losses as well as any income. So why do taxpayers continue not to report their crypto taxes? I would argue that most want to be compliant and do the right thing. If that is the case, what can tax authorities and the industry do to help?
As a CPA with years of experience preparing tax returns and calculating crypto taxes, including my role with Accointing.com, I must admit that crypto taxes are complicated. Crypto tax software is supposed to make it easy, yet I’ve run my data through eight different tools, and results can vary widely. Transaction counts, proceeds, gains, losses, and income all are different depending on which tool you use, and the differences can change the entire outcome of a tax return. Every single tax tool that you use will struggle with different parts of the data which, unless corrected manually by the taxpayer, can cause substantial differences in the calculations.
The only way to fix this is by identifying any errors in a tax report, tracing the problem through the data, and figuring out what got broken in the chain that is leading to the wrong outcome. But this requires the user to be highly proficient in using the tax tool, be able to identify errors in a tax report, and be able to fix the error with sometimes little to no data provided by the exchanges or wallets. When you consider the volume of transactions and platforms that most crypto users interact with, you can see how this can be a difficult puzzle to put together.
Lack of a Standard
I would argue that the biggest issue today is the lack of a reporting standard and requirement. While the Infrastructure Investment and Jobs Act will help close this gap by requiring exchanges to issue tax forms, the earliest we will see these forms will be in 2024 for the 2023 tax year—if we’re lucky. Yet we know that the IRS is not going to wait to enforce taxation until tax year 2023. This means that taxpayers remain on their own to obtain their data, and they then calculate and report their crypto taxes for any year before that. What happens when you’re using an exchange that’s not supported by the crypto tax calculator of your choice? What if the exchange is supported, but the particular product (e.g., futures trading) is not? What if you traded on an exchange that no longer allows the user to access their data due to regulatory or financial issues?
The lack of a reporting requirement with a standard for the data is a huge obstacle that taxpayers and the IRS alike must overcome. The transfers and activity at other exchanges can be tracked, and data can be plugged, but the gains and losses will not be accurate.
Even once crypto exchanges issue tax forms (1099-DA), the issue may not be fully resolved, and we may see a lot of missing data on those forms. One of the biggest reasons we’re here today is because we’re trying to apply tax principles that rely on information collected by third parties to a decentralized system that was built to operate peer to peer. Sure, the exchanges are still centralized and can track and report information, much like any other broker. But crypto is interconnected, and the moment that funds flow from an exchange to DeFi, obtaining the correct data points relies on that particular blockchain’s data points.
According to CoinMarketCap, there are 565 protocols on ethereum, and the way each interacts with a smart contract and with the funds can be entirely different. And that’s just ethereum—there are many other chains used in crypto, each with potentially different code, data and decentralized apps (dapps). Many of these blockchains were innovated to work in a decentralized manner, with smart contracts automating the decisions and the data only being tracked by each node (wallet), without a central party tracking all this for anyone. Yet what happens in each of those chains could have a tax impact in a centralized exchange, assuming those funds eventually get converted back into fiat. That means that integrating the data from each different blockchain and dapp can be daunting, especially when the rate of innovation in crypto is generally increasing.
Considering the decentralization and interoperability of these platforms, it’s easy to see why we would struggle with applying tax principles that rely on collecting data for every transaction.
I would propose a different tax system as the best solution. Rather than taxing each transaction, adopting a property-tax system would be simplest and quickest. Other countries such as Switzerland and the Netherlands tax crypto based on the value at the end of the year—this makes sense when you consider that tracking and auditing a balance at a point in time and applying a valuation to it is much easier than creating the entire transaction history. This isn’t the only system, and perhaps we need to think more outside the box of conventional tax principles for property or securities—after all, crypto is a unique and different asset.
The ideal solution, however, will take time, and while we might get there eventually, taxpayers need help today. So what can be done?
Exchanges should be more proactive in helping taxpayers obtain data, figure out what to report, and do everything in their power to simplify their customers’ tax filing journey. After all, if your customers get into tax trouble, they won’t be customers for long. Protocols need to consider the information that is provided via their blockchain explorers and dapps to simplify taxpayers’ ability to obtain this data. Tax tools need to keep working day and night to keep up with every new chain and exchange. The regulators could provide clear guidance on many uncertain aspects of the crypto tax law and be more accessible to questions from the general public. And the taxpayers must be proactive in keeping track of their data, learn their tax tool of choice, and make sure to report their crypto income to the best of their ability.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
David Canedo, CPA, specializes in taxation of digital assets. He is the head of tax and compliance strategy at Accointing.com, a company that provides tracking, consolidation, tax and compliance solutions for crypto investors.
We’d love to hear your smart, original take: Write for Us.