CPAs are frustrated with cryptocurrency, and rightfully so. The industry is complicated, fluid, and by design, completely decentralized. For CPAs and crypto wallet holders or “hodlers,” there is confusion around what constitutes a crypto transaction and what Form 1099 should be used to report it to the IRS.
The IRS generally relies on tax information from Forms 1099 filed by payors in order to verify the information reported by CPAs on income tax returns. But for most cryptocurrency transactions, the IRS has failed to provide consistent and clear Form 1099 guidance to payors; and as a result, a recent survey of crypto CPAs found that more than 35% of crypto investors do not receive Form 1099 information related to their crypto transactions.
Below are the top five tax reportable events you’re most likely to encounter from cryptocurrency hodlers and the Forms 1099 that should be issued by the payor.
1. Buying and selling cryptocurrency assets
The most common cryptocurrency transaction is buying and selling cryptocurrency assets for investment purposes. Whether the crypto hodler is a business or individual taxpayer, there are existing tax rules applicable to ‘property’ transactions that are generally followed for calculating gain and losses associated with capital assets. Without consistent and accurate tax information reporting of transactions, the IRS struggles to substantiate claims related to crypto assets. Last summer, the IRS sent letters to more than 10,000 crypto taxpayers asking for revised income tax returns and documentation to support claims made on information previously filed. In lieu of receiving Forms 1099 to substantiate if the income tax returns filed by crypto investors were in compliance, the IRS received thousands and thousands of data pieces that now need to be correlated to return information, manually.
Because of this, the IRS announced in June that it’s seeking third-party contractors to assist with calculations of cryptocurrency users’ transactions in order to properly audit and evaluate the tens of thousands of reported cryptocurrency gains and losses.
To remedy these issues for the longer term, the IRS also announced at a global forum of crypto exchange payors in March, its intent to draft regulations under tax code Section 6045. Returns of brokers, which signal some version of Form 1099-B reporting will be required by crypto exchanges and businesses for dispositions of crypto assets. Hopefully the IRS releases that guidance soon—the year is already half over and payors will need time to implement systems and process changes for the 2020 reporting due dates.
2. Buying goods and services using cryptocurrency
Any time someone makes a purchase using cryptocurrency or any type of crypto transaction in exchange for goods or services, it is considered a taxable event. This is the most broadly understood aspect of cryptocurrency among CPAs: any type of buying, selling, or trading with cryptocurrencies constitutes a disposition of the crypto asset which gives rise to income tax.
What complicates this is consumer transactions, like purchasing your morning Starbucks with Bitcoin. Are exchanges supposed to report a 1099 every time that BTC leaves the wallet for a couple of bucks worth of coffee? Yes. But few do. Since the IRS is prioritizing crypto enforcement and guidance, we anticipate more specific IRS guidance (and more crackdowns on payors) in the coming year as using cryptocurrency becomes more and more mainstream.
3. Staking rewards
Similar to how banks incentivize new customers with rewards when they maintain a certain account balance, crypto exchanges often provide rewards to investors that maintain a certain amount of crypto assets on their platform. Banks report Form 1099-INT for these rewards because the IRS treats the rewards as interest income. But for crypto rewards, the IRS opined in Revenue Ruling 2019-24 that rewards are ordinary income when the gifts are made available to the hodler. But, they failed to articulate how crypto payors should report it on Form 1099. On Form 1099-MISC some payors are reporting the rewards as rental income in Box 1 while others are reporting the rewards as a gift in Box 3.
So how should CPAs treat this reward for the crypto investor’s income tax return? Deductions from a rental property and the income it generates is not the same as the deductions from payments reported as rewards. For example, if a CPA decides that the staking rewards income should be treated as gift income but their client receives a Form 1099-MISC with Box 1 (rental income) populated, the CPA will need to help the taxpayer explain to the IRS why they are taking deductions or reporting income differently than how the 1099 was reported.
4. Wallet-to-wallet transfers
A common practice among crypto hodlers is shifting crypto from one exchange to another, say Coinbase to Binance. This is called a wallet-to-wallet transfer and it constitutes a taxable event. Right now, there’s generally no tracking for Binance to know the taxable details related to those assets that are transferred from Coinbase (or other exchanges). So when the hodler disposes of the crypto assets at a later date, Binance only knows the value of the assets at the time it was transferred in by Coinbase, not necessarily the value of what the asset was actually purchased for.
This is critical information for calculating gains and losses and generally, payors like Binance would report those details on Form 1099-B. Since the IRS does not require exchanges to report these details, the taxpayer is currently assuming the burden of keeping track of all of the dates and amounts of every crypto asset that is bought and sold. And their CPA is left trying to sort through all of those details to calculate gains and losses for tax purposes.
5. Hard forks and airdrops
Last year, the IRS released guidance around forked transactions and airdrops. But like many who don’t trade crypto and think it sounds like a foreign language, most CPAs don’t understand these terminologies. Forked transactions occur when the blockchain splits and new rules are introduced that are not compatible with the old network. In a hard fork transaction, one type of cryptocurrency splits into two types of cryptocurrencies. Air drops are free cryptocurrencies deposited into hodlers accounts, usually in order to drive adoption of the specific crypto.
Generally, the IRS opined that when a hard fork transaction occurs, the new cryptocurrency is taxable when the taxpayer actually receives (and has access to) the new cryptocurrency asset. The ruling also detailed that a taxpayer that receives an airdrop in connection with a hard fork, should treat the air dropped assets as a gift and report that as ordinary income.
Payors of hard fork transactions where new cryptocurrency assets are deposited to the hodler should report the value of the new assets on Form 1099-MISC. Payors of cryptocurrencies as a result of an airdrop should report Form 1099-MISC reflecting the value of the crypto units gifted.
CPAs are swimming in uncharted waters with cryptocurrency. With just a few exceptions, many exchanges are not providing investors with the correct Forms 1099 for reportable transactions, making the income tax process taxing and time-intensive. And crypto investors are feeling the consequences through increased IRS enforcement and scrutiny around their tax information reporting.
Hodlers and their CPAs deserve the same tax treatment they receive as investors in any other capital asset. With looming regulations on the horizon for payors, the time to get in compliance with Form 1099 reporting is now.
This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.
Wendy Walker is the principal of tax information reporting solutions at Sovos. She has more than 15 years of tax operations management and tax compliance experience with emphasis in large financial institutions, having held positions with CTI Technologies (a division of IHS Markit), Zions Bancorporation and JP Morgan Chase. Wendy has served as a member of several prominent industry advisory boards. She graduated with a Bachelor of Science in process engineering from Franklin University and earned her MBA from Ohio Dominican University, in Columbus, Ohio.