A friend of mine who is an active crypto trader recently told me about doing his personal crypto taxes. He’s a die-hard, anti-system kind of a guy, but he did everything to a tee. Because you never know what broke governments are willing to do.
After recording every single transaction, his supporting documents came out to more than 10,000 sheets. More sheets than the IRS will even allow you to submit. I have to say, that made me very glad to be in the HODL camp.
If you are a US citizen or resident, the hard truth is that you’re dealing with one of the most complex tax systems in the world. On top of that, if you’ve actively traded crypto over the last year, your life just got far more complicated. In fact, even if you’ve used crypto to buy and sell goods you’re in for a challenge.
Hopefully, by now, you’ve already enlisted professional help to prepare your taxes. But just in case, read on in today’s article to learn how crypto investments fare in the hands of an archaic tax system.
US crypto taxes
In 2014, the IRS officially classified cryptocurrencies as ‘property’. This effectively means that all cryptocurrency investments are subject to capital gains tax.
This may not seem like much of a big deal. But the reality is that this classification significantly complicates life for crypto investors. Because now, each and every transaction must be treated as a taxable event.
Crypto tax recording requirements for transactions
Investors and users must record everything from tiny transactions to large investments. This includes the date of each transaction and its value in US dollars. And yes, this includes the cup of coffee you bought with Bitcoin last September.
It’s a thankless and time-consuming task, not to mention intrusive.
Imagine if you had to report every single purchase you made with your credit card to the government each year. And then convert all of those purchase prices into a different currency. Not only at today’s price, but at the fair market value at the time of the purchase.
You would need to know the exact time of each transaction and price of the crypto at that precise moment! That’s the practical result of having crypto classified as ‘property.’
And it doesn’t stop there. Having recorded this data on a spreadsheet, you must then determine your capital gains or losses. You must make calculations within the parameters of short and long-term investments. And then report that all of that information in your tax return.
And that’s just for ‘normal’ transactions.
Crypto tax recording requirements for investments
Imagine if you want to use crypto in lieu of fiat to make a loan. Let’s say you want to lend 100 Bitcoin at 10 percent interest. Theoretically, your transaction should result in a capital gain of 10 Bitcoin. Thus, you should be liable for taxation on that amount.
However, since you must record transactions in US dollars, it’s even more complicated. Imagine if the price of Bitcoin rises (or falls) during that time. That simple transaction could render you with a much higher (or lower) capital gains liability. This holds whether or not you ever realized that gain in dollars.
Applying archaic asset classification to this new asset class has created a significant disconnect between what’s happening on paper versus what’s happening in reality.
US taxation of ICO/STO investments
While conventional cryptocurrencies like Bitcoin are treated as property for federal tax purposes, the treatment of initial coin offerings (ICOs) and security token offerings (STOs) isn’t so clear cut.
Since the IRS has not yet released an official tax statement on token sales, there is some general confusion on how ICOs and STOs should be taxed. However, just as the SEC tries to apply 80-year-old securities law to crypto, the IRS will also likely attempt to apply traditional tax law to the taxation of ICOs and STOs.
Crypto taxes for STO investors
In the case of STOs, it’s clear that the tokens are sold as part of a securities offering. As a result, these tokens can be classified in the same way as traditional securities. If the STO represents equity, its tokens will be taxed like equity. If the STO represents debt, its tokens will be taxed like debt. The fact that the offering is handled through an STO as opposed to a traditional security offering does not garner it special tax treatment.
Crypto taxes for ICO investors
Until very recently, the SEC had a clear stance that it considered all ICOs to be security token offerings as well. However, last month, the SEC chairman said that some ICOs may have initially been securities offerings, but over time they could have become something else. Even more recently, the SEC indicated that not all ICOs will be securities offerings.
These leaves purchasers of ICOs in a complicated situation. Are the tokens securities or property? And if they are securities, which type?
The SEC’s case-by-case treatment of individual ICOs and tokens will continue to make it a difficult and daunting task for those looking to stay on the good side of the IRS.
US taxation of ICO/STO projects
Another key area of debate is the tax liability projects face when they raise money via token offerings. Again, the distinction between whether the token offering qualifies as a security offering is critical.
Crypto taxes for STO Issuers
According to existing tax law, when a company engages in a security offering and raises capital, this is not considered taxable income under US accounting standards. With STOs, this means that issuers don’t face any tax liability from the initial sale of tokens. But when those tokens are bought or sold thereafter, traders are liable for taxes on the capital gains.
Crypto taxes for ICO Issuers
For ICOs, their tokens are considered ‘goods’. This means they do not qualify as securities offerings. As a result, issuers may be liable for income tax from the moment the initial sale of tokens takes place.
The distinction between token offerings
Not surprisingly, how a project handles its tax liability when launching a token offering, is becoming a significant matter of debate.
A few months ago, Kik, the Canadian instant messaging app, was notified by the SEC that its token offering was an unlawful securities offering. Unwilling to back down, Kik responded with a comprehensive letter that outlined why it’s offering should not be considered a securities offering. One of the many arguments Kik made in its defense was that it had paid taxes on its token offering, thus demonstrating that Kik did not treat its token offering like a securities offering.
If the tokens were securities, Kik would not have had to pay taxes. Essentially, if the SEC wins then the IRS loses, Kik will should get a major tax refund. (Side note: Is it bad if I root for both the SEC and IRS to lose?)
Similarly, any projects trying to make the case that they did not hold an unlawful securities offering, should have declared income on their token offering and paid the subsequent income tax. For projects that raised $20M in an ICO, you might owe 35 percent (or ~$7M) in taxes.
If you think your token offering might be classified by the SEC as an unregistered securities offering, click here to learn what you need to do to minimize the penalties.
What does this mean for Crypto Law Insiders?
One of the biggest challenges facing crypto today is regulatory uncertainty. Unsure of the law and how it applies to their projects, many crypto entrepreneurs are hesitant to take action. After seeing other projects fined hundreds of thousands of dollars for being out of compliance, they are understandably nervous about making the same mistakes.
The bottom line is that making a good faith effort to be in compliance is 9/10ths of the battle.
I’ve spoken to many crypto traders who haven’t filed returns on their crypto taxes because they’re scared they will mess it up. But not filing tax returns is not the right approach and will leave you exposed to criminal penalties.
For Insiders, I recommend you instead do your best, act in good faith, let your CPA file the return, and keep your fingers crossed.