US Crypto Taxes Are Still A Kafkaesque Nightmare

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Taxes are never popular, but in the U.S., paying for crypto gains is like solving a Rubik’s Cube without touching it. While blindfolded. You might have correctly filed your obligations, but there’s no knowing until the tax authority explains exactly what those obligations are.

Leaving aside the fact that the government is seeking revenue on a technology that it still hasn’t figured out how to regulate, the current taxation regime is riddled with inconsistencies and informational black holes.

Let’s recap what’s happened so far. Back in 2014, the IRS issued an official guidance note on the treatment of virtual currency transactions. In summary, crypto is treated not as currency, but as property, so U.S. crypto taxes are based on gains and losses in a similar way to stocks.

At six pages, the guidance was probably shorter than your tax return.

After those six pages, the tax authority went silent until 2018, when it obtained a court order to obtain data on Coinbase users and their cryptocurrency transactions. It also announced a compliance campaign aimed at digital currencies.

A Case of Poor Timing?

It seems safe to infer that the Coinbase data was used for letters issued in July to around 10,000 cryptocurrency users. There were three types of letters, ranging in tone from “we have our eye on you” to “we’re pretty sure you’ve been lying to us about your holdings.”

Those letters came only a few months after IRS Commissioner Charles Rettig confirmed it would be releasing new crypto tax guidance “very soon, perhaps even within the next 30 days.” He made that statement on May 30. Four months on, everyone is still waiting, and some face threats of criminal action.

Sean Ryan of crypto tax and accounting firm Node40 believes that the legislative arm of the IRS is most likely disconnected from the enforcement arm, and this back-to-front approach will cause problems for the tax office:

“It’s just not a good approach to try and get people to comply with U.S. crypto taxes. By and large, people understand taxes are a part of life, but not fully explaining the process just creates more work for them [the IRS] on the enforcement side. It just doesn’t make any sense.”

He elaborated:

“I think they’re making more headaches for themselves than they are for the taxpayers, because they’re severely understaffed.”

Gidi Bar-Zakay, of blockchain-based crypto tax platform Bittax, agrees:

“The prevailing assumption was that the IRS would publish the clarification for crypto tax, so I guess many users were left surprised by the letters, but also by the fact that they were sent before the clarification has been published.”

Why Assume the Exchanges Will Reveal All?

Forcing exchanges to disclose the transaction data of their users seems like an extremely blunt instrument. It’s highly unlikely that the exchange data is going to correlate exactly to all of the transactions associated with someone’s crypto portfolio. So, using this data to send menacing letters leaves a lot of room for error.

The IRS doesn’t calculate your real estate taxes by forcing realtors to cough up their customer transaction data. The same goes for stockbrokers. So, why is this a legitimate approach for crypto users?

It certainly helps that realtors and stockbrokers are heavily regulated. But the U.S. government is still scratching its head over crypto and blockchain regulation.

The entire approach seems to be to treat the crypto community as if we’re all tax-dodging criminals. Although many crypto users understand how property taxes work, there’s also a good chance that many won’t. But rather than educate, the IRS seems to be treating crypto owners like Al Capone.

According to Ryan, a lighter touch would be far more productive:

“I think there should be an amnesty period where there are no fees, no fines, no threats of criminal prosecution, and no interest charged. Give people a year to fix all of their back returns once the new guidance is released.”

He laments:

“Instead, their approach has been to send letters containing wording around criminal actions, which is just so scary and unnecessary when people are trying to do the right thing.”

2009-2012 – Crypto Taxes Free for All?

Another conundrum is on the periods the IRS appear to be scrutinizing. The letters issued in July refer to tax years 2013 through 2017. There’s no mention of transactions that took place from the time that Bitcoin launched in 2009, to 2012.

Does this mean that anyone who acquired and held BTC during that time is off the hook for their crypto taxes? Given that the initial guidance note only emerged in 2014, that could be a fair assumption. Or will the IRS turn up later, demanding retroactive crypto taxes for transactions between 2009 and 2012?

Furthermore, if the long-promised guidance ever emerges, will it be applied retroactively for 2018 and 2019? If that’s the case, and if there are significant changes from the current guidance, it could mean that you’ve been paying the wrong taxes all this time.

There are many more holes in the 2014 note, arising from the fact that crypto isn’t the same as other kinds of property. Nobody seems to know how to handle forks and airdrops. If you bought obscure altcoins during the ICO mania that are now worthless, there’s no clear way of writing off the losses.

So, until the powers at the IRS decide to issue the new guidance on crypto taxes, we’re all stuck waiting for answers to these questions.

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