Important Effective Date Item in Preamble to Digital Asset Broker Reporting Prop. Regs.

The proposed regulations on broker reporting of digital assets released August 29, 2023 (REG-122793-19) included more than guidance under IRC section 6045. They also included related proposed regulations under section 1001 on amount realized and section 1012 on basis. I think that generally, the 1001 and 1012 proposed regulations are fairly straightforward and tie to the general rules at these provisions.  

One clarification they offer is that in a transaction where a taxpayer exchanges, for example, X coin for Y coin and pays a transaction fee, 50% of the transaction fee is treated as a reduction to the amount realized for the disposition of X coin and 50% is added to the basis of the Y coin acquired.

Unlike the virtual currency FAQs #39 - #41, Prop. Reg. 1.1012-1(j) provides that in applying the specific identification method to know which digital asset was disposed of (when the taxpayer has more than one unit or code representing their digital assets), the taxpayer must apply specific identification on a wallet by wallet or exchange by exchange system. In contrast, the FAQs allow (or at least do not disallow) use of a universal tracking approach where the taxpayer transferring, for example, 2 Xcoin out of wallet 1 to buy goods, could specifically identify to say they used the basis of 2 Xcoin in T's wallet 2. This would not be allowed under the proposed regulations. The long list of questions in the proposed regulations include though, whether there are alternatives to this approach (questions 44 & 45 at page 59616 in the Fed. Register).

Prop. Reg. 1.1001-7(c) and 1.1012-1(j)(6) provide that these proposed regulations are effective on the January 1 following when final regulations are published. However, page 59616 in the Fed. Register states that the 1001/1012 proposed regulations are reliance regulations. That is, per the preamble, taxpayers "may rely on these proposed regulations under sections 1001 and 1012 for dispositions in taxable years ending on or after August 29, 2023, provided the taxpayer consistently follows the proposed regulations under sections 1001 and 1012 in their entirety and in a consistent manner for all taxable years through the applicability date of the final regulations."

Since the broker reporting regs under section 6045 won't be effective for reporting of gross proceeds until sales on or after January 1, 2025 (basis reporting for sales on or after January 1, 2026), if a taxpayer follows the date of the proposed 1001/1012 regulations starting for 2023, they would also do so for 2024.

But, I don't think most taxpayers can follow the 1001/1012 proposed regulations until the 6045 regulations are effective because taxpayers might not be able to get the exchanges they use to help them with the specific identification called for in the proposed regulations.

But, practitioners need to present the effective date choice to clients because the decision is theirs to make. But before making it they should check if any exchange they use will allow them to specifically identify the digital asset they are transferring at the time of the transfer and document that for them (and apply FIFO if they do not give the exchange specific identification information at the time of a transfer). For unhosted wallets, the taxpayer handles that specific identification on their own, likely by sending themselves an email to document what they are doing and have the date verification from the email.

Also, would be a good idea to let your client know that the final regulations might have a different approach then tracking basis wallet by wallet and exchange by exchange. 

Not sure why the 1001/1012 proposed regulations were offered as reliance regs when there are reasons it is either impossible or unwise for taxpayers to start applying them for 2023 and 2024. Also, given the latitude in the virtual currency FAQs, if a taxpayer were tracking on a universal approach, they should be able to change going forward to wallet by wallet and exchange by exchange (with no need to get help from the exchange for that until the regs are finalized). The IRS notes in the preamble to the regs (page 59611 of the Federal Register) and at Prop. Reg. 1.1012-1(j)(4) that such a change is not a method of accounting as the method is still specific identification.

So, something to think about and find a way to present to your clients with digital assets so they can make the decision the IRS offers all taxpayers regarding the effective date of the 1001 and 1012 proposed regulations.

What do you think?

Colorado Now Accepts Crypto for Tax Payments

On 9/1/22, Colorado became the first state to accept cryptocurrency for all tax payments. There are many ways this could have been structured and I think the state picked an interesting one which I assume makes it easier for the state.

Payments have to come from PayPal Cryptocurrencies Hub. The PayPal account has to be a personal one rather than a business one. Per the DOR website on this:

"A sufficient amount of cryptocurrency to cover the tax, obligation and fees is converted to dollars and remitted to DOR to complete the online transaction. Service fees include an additional $1.00 plus 1.83% of the payment amount. You must have the entire value of your invoice in a single cryptocurrency in your PayPal Cryptocurrencies Hub. Effective on the date initiated, USDs will transfer in 3-5 business days." [also see https://www.colorado.gov/revenueonline/_/#1]

Per the PayPal crypto website, you can buy, transfer or sell Bitcoin, Bitcoin Cash, Ethereum, and Litecoin.

So, sounds like if I owe $100 to the Colorado DOR, I can only pay in crypto if I have at least $103 worth of one of the four cryptocurrencies in my PayPal account. If I have $50 of Bitcoin and $53 of Litecoin, that won't work. I'd need to acquire more of one of those cryptocurrencies via my PayPal account to do the transaction.

Tax considerations: Per the website, PayPal is converting my crypto to dollars and remitting to the DOR. So, any broker reporting falls on PayPal. The taxpayer has a barter transaction per Notice 2014-21 and needs to calculate gain or loss using the value of the crypto used less their basis in that crypto.

Why might Colorado be doing this? Well, this question has been posed by many people for years - can I pay my taxes in crypto? I think this is only of interest to someone who happens to have sufficient crypto in an account to make the payment or doesn't want to convert it to cash first to pay. I think few crypto owners will pay taxes this way, but it is good to have the option. And it looks like for Colorado, they are just getting the cash as they typically would.

And Colorado will know which taxpayers have crypto because they received payment via PayPal Cryptocurrencies Hub.

But the state has to devote resources to explaining this. At 10/2/22, they even have 10 FAQs on this payment technique. 

FAQ #5 is interesting - Taxpayer changed their mind mid-transaction but realize afterwards that their crypto is gone from their PayPal account. What happened? "If you leave the process after selling your cryptocurrency in your PayPal Cryptocurrencies Hub, but before completing the entire checkout process, your cryptocurrency will still have been sold and the US dollar equivalent deposited into your PayPal balance."

So, be sure you want to pay via crypto before starting your tax payment transaction.  The FAQ should add here (and other places) - and you need to calculate the gain or loss from that conversion (whether or not it resulted in cash used to pay your taxes or for a transaction cancelled mid-point, cash in your PayPal account).

FAQ #10 - If I need a refund, will it be based off the current exchange rate of the cryptocurrency? "If a refund is to be provided for any reason, this will only be provided in US dollars for your invoice amount."

A few observations on FAQ #10:

• Why not just make it really clear on the website that taxpayers are converting crypto in their PayPal account to cash with PayPal submitting that cash to the DOR?  And adding that you are really paying in cash and creating a gain or loss from the conversion of your crypto to cash. Then it would be more clear that, of course, any refund is going out from the DOR in US dollar. But perhaps taxpayers might think that the DOR will send the dollars to PayPal who would use it to buy more of the crypto that had been converted to US dollars to pay the tax.
• If a person pays too much to the DOR and the value of the crypto converted to cash to pay the tax bill goes up, they lost out on that value by converting too much (or even using any of it to pay their taxes) and don't get any relief because the refund is NOT done by having that same quantity of crypto that was overpaid going back to them as a refund.

What do you think? Should more states and even the IRS do what Colorado DOR is doing?  Or allow another payment structure or just take the crypto directly and hold onto it?

Challenges of Defining Virtual Currency - Recent Observations from FASB

At its August 31, 2022 meeting, the FASB discussed the scope of its digital asset project (see meeting handout here). This FASB project was adopted in May 2022 with the objective "to improve the accounting for and disclosure of certain digital assets." Well a good question is - what are digital assets and which should be addressed in the FASB project.

One part of the handout aims to identify characteristics that can help distinguish among various digital assets. It notes that specifying that the assets are "created or reside on blockchains and are secured through cryptography" will distinguish cryptocurrencies or crypto assets form other digital intangible assets such as software and data.

FASB also notes that terms such as "store of value" and "medium of exchange" are often used but "may not be helpful in defining" the scope of the FASB digital assets project because:

"(a) Other assets share these characteristics (real estate may be viewed as a store of value and money is a medium of exchange).

(b) A medium of exchange may depend on the perspective of the holder.

(c) A digital asset may not be considered a medium of exchange by some in practice because of limitations of networks.

(d) Evaluating whether an asset is a medium of exchange or store of value is subjective. For example, relative volatility may lead some stakeholders to conclude that a digital asset is a poor store of value."

There is more analysis in the handout.

I think the observations are interesting because in Revenue Ruling 2019-24, the IRS defines virtual currency as "a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the United states dollar or a foreign currency."

It does not define the terms "medium of exchange," "unit of account" or "store of value."

The instructions to the 2021 Form 1040 virtual currency questions also used the three traits above only it used OR rather than AND as used in Rev. Rul. 2019-24 (for more on that, see this 8/29/22 letter submitted to the IRS by the AICPA with suggestions to improve the ability of taxpayers to understand the question).

So, if FASB wasn't able to reach a clear understanding of cryptocurrencies per the terms "medium of exchange" and "store of value", how are individual taxpayers to do so?

When the word "or" is used for the three terms, non-fungible tokens (NFTs) seems to be a virtual currency for the Form 1040 question in 2021, but since they are non-fungible, they likely are not a virtual currency (not a unit of account perhaps) for the definition in Rev. Rul. 2019-24.

And the IRS definition makes no reference to a blockchain or distributed ledger for tracking the currency.

So, how should virtual currency be defined?

What do you think?

Arizona HB 2204 proposes unusual tax breaks for crypto

The Arizona House and Senate approved HB 2204 and sent it to the governor on June 29. This bill adds new reductions to Arizona gross income for the value of virtual currency and non-fungible tokens (NFTs) received from an airdrop. Apparently though any future appreciation would not be subtracted from gross income. While not clear, I assume these tax-free airdrops will have zero basis for Arizona and a gain when disposed of.

In addition, gas fees not already added to the taxpayer's basis in virtual currency or NFT is also a subtraction from gross income. I'm not clear what this means for basis.

HB 2204 includes definitions for gas fee, NFT and virtual currency. The virtual currency one matches the IRS definition in Rev. Rul. 2019-24 on hard forks - "s a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the United States dollar or a foreign currency."

These changes, if enacted, would be effective after 12/31/22.

What is the purpose? I assume it is to encourage Arizonians to own virtual currency and hope for an airdrop of virtual currency or an NFT. It seems like an unusual way to encourage ownership of virtual currency particularly given that airdrops are not that common.

While IRS Rev. Rul. 2019-24 deals specifically with hard forks, it refers to hard forks following an airdrop. I think the IRS view of the tax treatment of receiving an airdrop is that once it is available for the taxpayer to access, even if the taxpayer doesn't want to access it, it is included in income at its FMV when received.

So, HB 2204 will create federal-Arizona differences in basis and gross income for owners to track.

If the lawmakers really want to encourage ownership of virtual currency, why don't they:

1) Add a de minimis rule to exclude gains.

2) Give all Arizonians some virtual currency. Or perhaps something like Miami did with MiamiCoin (4/21/22 FastCompany article and Citicoins info).

3) Give a tax break to miners and stakers residing in Arizona.

What do you think?

Addendum (8/4/22) - Thank you to John Schoenecker and Miles Fuller at TaxBit for raising an issue on my comment in the original post (above) on HB 2204 requiring Arizonians to track different basis for federal and Arizona.  I assumed that if the virtual currency or NFT is received tax free, it has a zero basis while it will have a federal basis equal to the revenue reported when received.

But I was thinking with a California perspective. John and Miles pointed out that Arizona follows federal AGI and then only makes additions and subtractions as noted in the statute (HB 2204 adds a new subtraction for the gross income picked up for federal from the airdrop and the gas fee adjustment).  So, if no addition or subtraction is provided for the disposition of the virtual currency seems to be the same gain or loss as for federal. Hopefully the Arizona DOR will clarify HB 2204.

Thanks John and Miles!

I still puzzle as to the purpose of HB 2204 as it applies to very few people unless there is some upcoming activity to provide lots of virtual currency or NFTs to Arizonians (unlikely, but you never know). Some ideas on the purpose:

1. Get some attention in the virtual currency/NFT arena as a tax friendly state.

2. Remove any tax issue on what the value is of the virtual currency or NFT received from an airdrop and exactly when it is income. This is weak though because the recipient still needs to do this for federal purposes.

3. Encourage Congress to enact something similar. Again though, seems weak as Congress has many other items on its agenda and this would be a revenue loser.

Thoughts?

How should a virtual currency exclusion work?

A frequent proposal for taxation of virtual currency is to add an exclusion similar to IRC section 988(e) for gain "by reason of changes in exchange rates after such currency" for personal transactions. This is a simplification measure as not records need to be kept such as when one is traveling and using a foreign currency. It is likely infrequent that the conversion gain exceeds $200.

H.R. 6582 (117th Congress), Virtual Currency Tax Fairness Act of 2022, would add section 139J to not include gain up to $200 due to changes in exchange rates, from disposition of virtual currency in a personal transaction (defined per section 988(e)). [also see rationale from the sponsors]

In contrast, the Responsible Financial Innovation Act, introduced by Senators Lummis and Gillibrand in June includes a different version of section 139J. This version says no gains or losses of $200 or less are recognized from the sale or excahnge of virtual currency in a paersonal transaction for goods and services. If the gain or loss is from an exchange of one virtual currency for another and the gain or loss is $200 or less, this exclusion does not apply. [see page 11 of the bill + see sponsor explanation of the entire bill]

So, which is the better version?

I think it is the Lummis/Gillibrand version.  If the purpose of any exclusion is simiplification, it should apply to gains and losses. Otherwise, the individual needs to track records for transactions to see if a loss was generated to be recognized, defeating simplification. Of course, if the virtual currency is only used for personal transactions without any investment intent, the loss of any amount would not be allowed.

And I think the exclusion should only apply when the virtual currency is used to acquire personal goods and services (as with the Lummis-Gillibrand bill).  If the virtual currency is used to acquire another virtual currency, it likely is for investment and all records of gains and losses need to be kept.

What do you think? 

1040 Virtual Currency Confusion from Two Years Ago Is Still Confusing

Happy Valentine's Day!

Just posting a reminder today of an IRS website added two years ago on February 14, 2020 about virtual currency.  Here is the link and here is the entire text:

"The IRS recognizes that the language on our page potentially caused concern for some taxpayers. We have changed the language in order to lessen any confusion. Transacting in virtual currencies as part of a game that do not leave the game environment (virtual currencies that are not convertible) would not require a taxpayer to indicate this on their tax return."

Prior to this 2020 post, the IRS website on virtual currency stated (thanks to the Wayback Machine for the information!):

"Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin, Ether, Roblox, and V-bucks are a few examples of a convertible virtual currency."

Today (since 2/14/20), that website reads:

"Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency."

I think the website post of 2/14/20 added to the confusion because convertible virtual currency per the IRS is "a digital representation of value that functions as a medium of exchange, a unit of account, and /or a store of value. They refer to "convertible virtual currency" as something that acts as a substitute for real currency.

V-Bucks and Robux are obtained with US dollars and can be converted back. They arguably act as real currency because they are needed in order to play these online games. So, why did the IRS remove them from the virtual currency website and imply that they are not virtual currency?  Not clear.

And, the 1040 instructions (page 17) on the virtual currency question* also raise issues with the 2/14/20 website because they (as well as IRS FAQ 1) states:

"Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes."

Query: How can that gaming currency not meet this broad definition of virtual currency?

I think the likelihood of tax consequences of obtaining, using and converting most gaming currency back to US dollars yields no accession to wealth (income) so has no tax consequences (the gaming currency seems to be more of a stablecoin with a set value in USD). But, that is not part of the 1040 virtual currency question. It is enough to dispose of the currency (convert it back to US dollars) that seems to warrant a "yes" answer to the question.  The instructions do state that if all a person did was acquire virtual currency, they can check "no", but disposing of it warrants a "yes."

One more observation: When the 2/14/20 virtual currency item was posted by the IRS, they already had a website of FAQs. Why wasn't that added as an FAQ? Why set it out on an isolated website where few will ever find it?

What do you think?  

*The 1040 virtual currency question for 2021 is: At anytime during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?  

Crypto and §1031 - Still Relevant in California!

In 2019, California only partially conformed to the section 1031 changes made by the Tax Cuts and Jobs Act. For individuals below speified AGI levels in the year an exchange begins, the pre-TCJA version applies. These levels are under $500,000 of AGI for MFJ and HH and under $250,000 for single.

Besides real property, what might individuals exchange? Well today, the most common non-real property exchanged by the roughly 95% of Californians who are still subject to section 1031 is cryptocurrency! Many types of virtual currency can only be acquired with bitcoin or another virtual currency.

Of course, few people are dealing with virtual currency, but the number grows each day. 

What are the factors that should be considered to know if one virtual currency held for investment or business is like-kind to another?

Recently, Roger Royse, James Creech and I, wrote a paper for the California Lawyers Association Taxation Section's Sacramento Delegation project. We presented it to FTB and legislative staff on October 15. The paper provides background on section 1031 and intangibles including CCA 202124008 where the IRS found that these exchanges are not like kind: BTC and ETH, BTC and LTC, and Ether and LTC. We don't agree with the BTC and LTC conclusion as both run on the blockchain and LTC was designed based on BTC.

Our paper suggests some factors to consider and we request that the FTB provide guidance to help individuals and practitioners deal with section 1031 and virtual currency. This is an important issue given that section 1031 is a mandatory provision and there are frequent exchanges of virtual currency held for investment.

Of course, another solution is for California to completely conform to federal section 1031. That would be simpler. 

You can find the paper here.

What do you think?  Comments very welcome. 

More Necessary But Overlooked Tax Changes

Well, back to what I started with a June 21, 2021 post where I'm sharing my ever-growing list of what I think are necessary but usually overlooked tax changes. It would be terrific to see these in the next tax reform bill or even some picked up in other legislation. I hope you'll review my first list and this one, check back for future posts (I have more reform ideas on my list) AND please post a comment with your reaction and your tax reform ideas.

• Reform the personal income tax to its basic framework where reasonable deductions to produce income are deductible (they are not limited to 2% AGI or disallowed for 8 years (2018 through 2025)).
  
  
• Modernize §197 to include 21st century intangibles – see page 5 of my 2017 article.
  
  
• Update §170(f)(11) on qualified appraisals to expand situations where an appraisal is not needed because there are public listings of value, such as for most virtual currencies.
  
  
• Update §7503, Time for performance of acts where last day falls on Saturday, Sunday, or legal holiday – Some language here is outdated, such as reference to “internal revenue district.” Also, to avoid confusion regarding state holidays or those celebrated in the District of Columbia, consideration should be given to just using the national list of holidays at 5 USC 6103. This change will avoid confusion particularly when a DC or state holiday falls on the weekend so is possibly celebrated on Friday or Monday instead. For example, see Notice 2006-23 where the IRS had to clarify tax due dates where Patriots’ Day (relevant in Maine, Massachusetts, New Hampshire, New York, Vermont, Maryland, and DC) fell on Monday April 17, 2006 (Patriot’s Day is the third Monday of April and an April 15 Saturday makes April 17 Monday the date with Patriot’s Day then making the due date for those states April 18 Tuesday).
  
  
• Update §7523, Graphic presentation of major categories of Federal outlays and income, to not only include them in the 1040 instructions but have them on the IRS website, those of elected officials and other agencies. Consider having a more interactive tool to help taxpayers understand all federal taxes they pay, info on the taxes, marginal rates, etc. See Nellen, “Time to move Sec. 7523 budget information into the Digital Age,” AICPA Tax Insider, 11/8/12.

More later ...

What do you think? and please post your tax reform ideas in the comment box. Thanks!

Necessary But Overlooked Tax Changes We Need

I've been maintaining a list for several years of overlooked improvements I think are needed for our federal tax system. I keep adding to the list including based on oddities found in current court cases.  For the next few weeks, I'll post most of these suggestions. I hope you'll comment on them and add some of your own. It would be terrific to see these included in any tax reform legislation of the 117th Congress and Biden Administration.

1. Create a de minimus rule for personal use of virtual currency similar to §988(e) for foreign currency which excludes personal gains under $200. This is needed for simplicity. It should exclude bitcoin acquired after a certain date though due to the tremendous gains that exist with very low basis bitcoin (too much of a windfall rather than only simplification).
   
   
2. Repeal the §280A(g) exclusion when one's home is rented out for under 15 days (there is no purpose for this exclusion that mostly benefits high income individuals who own a home to rent for a high rental amount).
   
   
3. Replace §280A rental limitations with §469 limitations. There is no need to have two different rental expense limitations and the §469 one is easier and has more guidance.
   
   
4. Fix §6050P and regs (and perhaps consumer protection laws) to be sure a Form 1099-C is only issued if the debt is truly cancelled. A recent example of this issue is Gericke v. Truist, No. 20-3053 (DC NJ 3/26/21). This is a problem for the fisc and for borrowers. For example, in Stewart, TC Summary Opinion 2012-46, the borrower received a 1099-C in 2008 and did not report it. The court found that the debt was discharged in 1999 “when it was clear that the debt would not be repaid.” So it was too late to pick up the income. There are several cases involving mismatch of receipt of 1099-C and discharge of debt.  See my 5/10/21 blog post.
   
   
5. Fix §6050I to apply to governmental entities and units too. PLR 202118003 (5/7/21) held that a state liquor store was excluded from having to file Form 8300 as it was not a “person” for purposes of this Code section.

More later...

What do you think? 

Virtual Currency Question Gains Prominence on 2020 Return - Why?

Draft 1040 for 2020 dated 8/18/20

The 2019 Schedule 1 (Form 1040), Additional Income and Adjustments to Income, included a new question at the start of the form:

 "At anytime during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency."

On August 18, 2020, the IRS released the draft 1040 for 2020 and it shows this question has moved to page 1 of Form 1040 right below where you put your name and address.

For 2019, this seemed like an odd question since few individuals out of 150 million have any virtual currency (11% per a 2019 article by CoinTelegraph), and there are better questions to ask that affect far more people and potential income. For example, why not ask:"Did you receive any funds from any web-based or Internet-based activity?"

And either question should have follow up questions, such as:

If yes, is the income reported on the return?

If yes, where?  If no, explain why not, with space provided to do so.

My question would cover virtual currency, renting out property via a web-based platform but not receiving any Form 1099, earning ad revenue from your website, selling goods on eBay or Etsy or similar site.

The form instructions are not yet out but hopefully the IRS will explain the question better for 2020. Some questions and issues:

• What is “virtual currency” given IRS lack of clarify on this?
• Why doesn’t IRS use “convertible virtual currency”? Per Notice 2014-21 and other statements, it seems that this is what the IRS is focused on.
• What if you only moved your VC from one wallet to another, should you check yes?
• What if you receive VC by gift or something else with no tax consequence? Or receive it as wages and reported it on the wage line?
• Is IRS expecting a “yes” answer to mean that VC shows up on Schedule D or Form 8949
• Should you attach an explanation if you check yes but have no reporting obligation?
• What if a passthrough entity owns it? You need to ask the entity apparently?
• What if your VC had a fork or airdrop and you didn’t know that?

In February 2020, the IRS modified its answer to a website question "What is Virtual Currency?" Between October 2019 and February 11, 2020, it stated "Bitcoin, Ether, Roblox, and V-bucks are a few examples of a convertible virtual currency." [See IRS website at 1/14/20 from The Wayback Machine.] Afterward, the gaming currency was removed. The IRS explanation was posted on a different website (2/14/20) to note that the change, which they don't describe on this website, was done to "lessen any confusion."  But Roblox and V-Bucks and likely other game currency seems to be convertible virtual currency as you need it to play the game and you get it and can redeem it using USD. So confusion, arguably, is increased with the change.

For more on virtual currency - click here.

What do you think?

Confusion Abounds - What is Virtual Currency? Issues for Your 2019 Federal Return

Likely, most people think of bitcoin, now over 10 years old, when they hear "virtual currency."  If you look at CoinMarketCap, you'll see over 2,000 cryptocurrencies listed with bitcoin at the top given its market value. Others at the top include Ethereum, Bitcoin Cash, Litecoin, and Monero.

Well, what makes something a virtual currency in the eyes of the IRS? This is even a more important question for this current tax filing season due to a new question 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?

Schedule 1 is used to report other income, such as business and rental income, as well as deductions for AGI. So a lot of people file it. According to page 81 of the 1040 instructions, if the answer to the question is "no" and you don't otherwise need Schedule 1, you don't need to attach it.

This question raises a lot of questions, such as:

• What if move your VC from one wallet to another?
• What if receive VC by gift or something else with no tax consequence? Should you attach an explanation?
• What if a passthrough entity owns it? Need to ask apparently.
• What if your VC had a fork or airdrop and you didn’t know that? Per Rev. Rul. 2019-24, the IRS views that as receipt of something and arguably that is correct although you might not have income at that time or the value of what you received may be zero (but this still seems to warrant a “yes” answer).
• What if your child plays online games and there is some type of currency used in the game? Is this a virtual currency? (see more on this below and IRS activity on this question during the week of February 10, 2020)
• What if your child has unearned income subject to the kiddie tax and parent elects to report it on parent return AND child though has "yes" answer to the Schedule 1 question - must the child file return on own? I don't think so as IRS can override the statutory provision at IRC Section 1(j)(7) that parent can elect to report child unearned income on parent return if all specified requirements are met.

Additional issues:

• What happens if person doesn’t know about question such as because doesn’t otherwise need a Schedule 1?
• What if you don’t otherwise have a filing obligation but the answer would be “yes”?
• What if you are paid in VC and keep it rather than convert it or spend it? Should you attach an explanation?

If the answer is "yes" for you but there is nothing reported on the return to indicate any tax consequence because there were none, such as for someone who received virtual currency as a gift or had an airdrop even of zero value, it is likely a good idea to attach an explanation to the return. So, at that line, add "See Statement 1" and attach the explanation as Statement 1.

What about the gaming question? When the IRS issued Rev. Rul. 2019-24 on hard fork of a virtual currency and about 40 FAQs in early October 2019, it also expanded what had been a short paragraph on its website on virtual currency. With the expansion, the following paragraph was present (obtained from the Wayback Machine for 10/12/19 since removed from the IRS website around February 12, 2020):

"Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin, Ether, Roblox, and V-bucks are a few examples of a convertible virtual currency. Virtual currencies can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies."

After the change around February 12, 2020, that paragraph now reads:

"Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies."

Notice that the reference to the gaming currency - Roblox and V-bucks, is gone.  The IRS added an explanation in a statement added to its website (but not added as part of the FAQs or a news release, but instead added where hard to find)"

"February 14, 2020

The IRS recognizes that the language on our page potentially caused concern for some taxpayers. We have changed the language in order to lessen any confusion. Transacting in virtual currencies as part of a game that do not leave the game environment (virtual currencies that are not convertible) would not require a taxpayer to indicate this on their tax return."

That doesn't fully answer the question for all gaming currency because some of it can be sold outside of the game for dollars (and it is obtained for USD typically as well). See Geek.com post of 2/15/18 about selling Roblox for real money. What are people willing to pay for it? Does it have a fixed exchange rate or does it fluctuate?

What about certain gift cards or merchant point systems? Might they be a virtual currency?

Why doesn't the IRS clarify the definition of virtual currency and be sure it is something that is a substitute for real currency, and does not have a fixed exchange rate to USD (as most gift cards do). The IRS definition works to keep many gaming currency out (including when playing Monopoly with digital cash!), but not all.

Seems more is needed to help people with the new Schedule 1 question such as the questions I note above.

What do you think?

And, more on this later, but this same week, the GAO released another report on tax and virtual currency: Virtual Currencies: Additional Information Reporting and Clarified Guidance Could Improve Tax Compliance, GAO-20-188 (2/12/20).

And for more on virtual currency, please see tax and other information at my virtual currency/blockchain website - http://www.21stcenturytaxation.com/virtual-currency-and-tax.html.

Guest Post - Will Bitcoin Ever Be Regulated?

This post is provided by Albaron Ventures and raises a question relevant to application of laws, reporting requirements, and more, to virtual currency, aka cryptocurrency. Many laws such as those dealing with taxation, banking, and credit card usage and liability are based on a third party handling most transactions such as to resolve problems that may occur between a merchant and customer regarding a credit card charge. How can such rules work in a decentralized system? What happens when they cannot so work? Read on ...

Albaron Ventures notes: 
"Before diving deeper, it’s worth asking whether Bitcoin can be regulated in the first place.  The cryptocurrency was built with the primary purpose of being decentralized and distributed– two very important qualities that could make or break Bitcoin’s regulation."

Please visit their website for the complete article.

And, consider that technology and smart contracts can create new opportunities for decentralized transactions such as matching a buyer and seller or service provider and service recipient.

What do you think?

Tax, Tokens and the Blockchain - H.R. 2144 of 116th Congress

Introduced on April 9 2019, the Token Taxonomy Act of 2019 (H.R. 2144) would “amend the Securities Act of 1933 and the Securities Exchange Act of 1934 to exclude digital tokens from the definition of a security, to direct the Securities and Exchange Commission to enact certain regulatory changes regarding digital units secured through public key cryptography, to adjust taxation of virtual currencies held in individual retirement accounts, to create a tax exemption for exchanges of one virtual currency for another, to create a de minimis exemption from taxation for gains realized from the sale or exchange of virtual currency for other than cash, and for other purposes.”

The proposed di minimis exemption is worded as follows:

“SEC. 139G. GAIN FROM SALE OR EXCHANGE OF VIRTUAL CURRENCY.

“(a) In General.—Gross income shall not include gain from the sale or exchange of virtual currency (as defined under section 408(m)) for other than cash or cash equivalents.

“(b) Limitation.—

“(1) IN GENERAL.—The amount of gain excluded from gross income under subsection (a) with respect to a sale or exchange of virtual currency shall not exceed $600.

“(2) AGGREGATION RULE.—For purposes of this subsection, all sales or exchanges which are part of the same transaction (or a series of related transactions) shall be treated as one sale or exchange.

“(c) Inflation Adjustment.—In the case of any taxable year beginning in a calendar year after 2018, the dollar amount in subsection (b) shall be increased by an amount equal to—

“(1) such dollar amount, multiplied by

“(2) the cost-of-living adjustment determined under section 1(f)(3) for the calendar year in which the taxable year begins, determined by substituting ‘calendar year 2017’ for ‘calendar year 2016’ in subparagraph (a)(ii) thereof.

Any increase determined under the preceding sentence shall be rounded to the nearest multiple of $50.”

Sec. 10(c) of H.R. 2144 provides:

“Reporting Of Gains Or Losses.—The Secretary of the Treasury shall issue regulations providing for information returns on transactions in virtual currency (as defined under section 408(m)) for which gain or loss is recognized.”

Proposed new §408(m) defines virtual currency as: “For purposes of this subsection, the term ‘virtual currency’ means a digital representation of value that is used as a medium of exchange and is not currency (within the meaning of section 988).”

Also see sponsor Rep. Davidson’s press release of 4/9/19 on the proposal.  It addresses the token and blockchain aspects of the proposal but not its tax proposals.

Observations/Queries: How broad are the reporting regulations intended to be? More should be specified in the bill.  For example, are the sponsors aiming to be sure exchanges that exchange virtual currency for other virtual currency or U.S. dollars issue a reporting form?  Or is this broader and any merchant would be issuing a report that it received virtual currency and the value it assigned to it (generally, the selling price of the goods or services exchanged)? Also, how broad should a $600 exclusion for gain from transactions be applied?  After all, $100 of bitcoin in 2010, was worth about $4.3 million in fall 2017.  And it is still worth a lot today.  The exclusion would incentivize these holders to only purchase goods and services from merchants who take bitcoin and to never spend more than $600 at a time. This would enable them to exclude the gain although it might take a long time to fully exclude the gain on that $100 cost basis of bitcoin. A policy goal of an exclusion is to simplify tax reporting by not having to figure out the gain or loss when virtual currency is used to buy low-value items.  The foreign currency exclusion at Section 988(e) is $200. Why not use that same amount for virtual currency? Also, consideration should be given to not allowing the exclusion for bitcoin acquired before a specified date due to the tremendous inherent gain that exists in it that arguably defeats the policy reason for a de minimis reporting rule. Also, I suspect including all of this highly appreciated virtual currency will make this bill cost too much and possibly not get enacted, when it can provide a helpful benefit to avoid tracking small gains and losses that might many times be less than $5.

For more on virtual currency and blockchaing, please visit my website on these topics.

What do you think? 

Blockchain, Cryptocurrency, Cannabis - and Taxes

"Since cryptocurrencies are decentralized and unregulated for the most part, they enable cannabis businesses to accept secure, cashless, and fast payments that can be converted into greenbacks or sent anywhere around the world at competitive speeds."*

I like to research and write about emerging technologies and trends in how we live and work. A long time ago, that is how I gov involved in tax policy and technical matters related to the Internet and e-commerce.  For almost ten years now, it has led me into interesting topics of marijuana (cannabis if that sounds better), virtual currency (or cryptocurrency), and the blockchain. And there is overlap in all of these topics.

Here is a *recent article from Made by Hemp - Utilizing Blockchain Technology in the Cannabis Industry by Alex Moskov, Editor-in-Chief of CoinCentral. He notes the benefit of greater transparency in connecting transactions and payments via blockchain technology. It can also help with payment processing.

Congress sometimes gets involved with these topics as well. Hearings usually either look at problems with marijuana and crytocurrency, but some look at the opportunities in these fields. On 2/13/19, the House Committee on Financial Services held a hearing - Challenges and Solutions: Access to Banking Services for Cannabis-Related Businesses. Legislation called The Secure and Fair Enforcement Banking Act of 2019 (SAFE banking) has been re-introduced in the 116th Congress. One of the witnesses was California State Treasurer Fiona Ma, also a CPA. She noted data on continued growth in the cannabis industry and challenges of businesses not being able have bank accounts. She also noted that she and her predecessor had engaged studies for solutions including a state-run bank. However, the conclusions reached was that "the only effective long-term solution that would produce acceptable results for the financial services sector was to change federal laws and regulations related to offering basic banking services to this growing industry."

Taxes - there are certainly many tax matters in these topics. For the cash in the cannabis industry, it makes non-reporting easier as there may not be a sufficient paper or digital trail. There are safety issues of having large piles of cash around and of taking it to the local, state and IRS offices to make tax payments.

What do you think?

Congressman Brady Asks IRS To Issue More Guidance on Virtual Currency

On 9/19/18, Congressman Kevin Brady (R-TX), chair of the House Ways and Means Committee sent a letter to the IRS asking them to issue more guidance, as it had promised in 2014, on taxation of virtual currency. Chairman Brady also refers to the 2018 letters from the ABA and AICPA requesting guidance.

In the letter, Brady states:

"While the Committee appreciates the IRS’s need to undertake enforcement actions to ensure that taxpayers generally meet their tax obligations, in this case, we are concerned that the IRS is seeking to enforce guidance that does not adequately advise taxpayers of their tax obligations when using virtual currencies.  Furthermore, while the issues surrounding virtual currencies are complicated and ever evolving, a key component of the IRS’s duties as the nation’s tax administrator is to assist taxpayers in understanding what their tax obligations are and how they may best meet them.  A failure to put forth adequate guidance severely hinders taxpayers’ ability to do so.  The IRS has had four years to work through these issues since its preliminary guidance was issued, providing more than adequate time for the IRS to thoughtfully consider what additional information is needed.

We therefore strongly urge the IRS to expeditiously issue more robust guidance clarifying taxpayers’ obligations when using virtual currencies. We also ask that you provide a written response outlining where the IRS is in its efforts to issue updated virtual currency guidance, what the IRS intends to cover in this guidance, and a timeline for its release.  In addition, to assist the Committee in better understanding this issue, we will be asking the Government Accountability Office to undertake an audit on this matter."

I hope this can occur before the extended due date for 2017 returns (10/15/18).  Let's see.

What do you think?

Virtual Currency Tax Issues & AICPA Suggestions to IRS

It is not uncommon for the tax law to lag behind changes in how we live and do business. A good example is virtual currency, such as bitcoin. Bitcoin started in 2009 and the IRS first issued guidance in early 2014 (Notice 2014-21) stating to treat it as property rather than as a real currency. As bitcoin grew in value and use, hundreds of other virtual currencies came into existence and the types of transactions grew, we needed more guidance.

In 2014, the IRS asked for input on where more guidance was needed and it did receive some. But we have no more guidance from the IRS. Some of the transactions are complex without obvious answers and the IRS has a lot on its plate.

On May 30, the AICPA submitted a letter to the IRS with 27 Q&As covering the following 12 topic areas where guidance is needed. The AICPA provided answers to the questions to help the IRS with issuing additional formal guidance.
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1.      Expenses of Obtaining Virtual Currency

2.      Acceptable Valuation and Documentation

3.      Computation of Gains and Losses

4.      Need for a De Minimis Election

5.      Valuation for Charitable Contribution Purposes

6.      Virtual Currency Events (such as splits/forks, airdrops and giveaways)

7.      Virtual Currency Held and Used by a Dealer

8.      Traders and Dealers of Virtual Currency

9.      Treatment under Section 1031

10.  Treatment under Section 453

11.  Holding Virtual Currency in a Retirement Account

12.  Foreign Reporting Requirements for Virtual Currency

For example, for topic 1 the AICPA suggests that since mining virtual currency produces ordinary income at that time, the expenses of mining should be deductible against that income, similar to what a service provider does.

Hopefully this will help the IRS in thinking through some challenging issues. Guidance is very much needed as many people own and use virtual currency and some of the transactions involve large values.

What do you think?

Tracking Cryptocurrency Transactions for Tax Compliance

I was surprised to see today a survey result that 46% of cryptocurrency traders don't plan to report the transactions for income tax purposes (TeamBlind survey - see 4/17/18 article in The Wealth Advisor). There is, of course, no reason for not reporting income. The IRS is well aware that people have virtual currency transactions. It is also an agenda item for the Criminal Investigation Division of the IRS per their 2017 annual report.

To help track crypto transactions, there are a few software tools readily available.  A recent entry to this market is CryptoTrader.Tax.  Here is information from their recent press release (with permission of the company):

"CryptoTrader.Tax released a web-based tool developed with the intention of helping users calculate the capital gains and losses associated with their cryptocurrency investment endeavors. The tool is currently in the ‘beta’ phase of development, and can be accessed from their website at, www.CryptoTrader.Tax. CryptoTrader.Tax aims to provide its users with an easy and accurate tool to use when it comes time to do their taxes. It properly considers the user’s set time zone, trades across all exchanges, and the sale of their uploaded cryptocurrency income.

CryptoTrader.Tax uses a safe, streamlined workflow to gather the data needed to accurately calculate gains and losses. Users upload trade data via exported .csv files from supported exchanges or manually using the provided template. They can also upload several types of cryptocurrency income, such as mining, gifts, etc. The tool then generates detailed reports using the uploaded information. User’s can view an IRS 8949-esque form showing gains and losses for each sell of a coin or view a detailed breakdown of each sell with even more information. There are also views for income items and coins still being held at the end of the year. Future updates planned for the tool include: population of IRS forms, automatic trade importing from a wide variety of exchanges, and more."

You can find a few others out there as well. What is important is to check these out and use one. 

What do you think?

Cryptocurrency tax lessons

In March 2014, the IRS issued Notice 2014-21 to let us know that virtual currency should be treated as property (rather than as a currency). That helped answer a lot of questions, but not all.

I've got a short article in CoinDesk's Crypto and Taxes 2018 Series on lessons for the "taxman" based on virtual currency guidance and needs.

Please check it out - What the Taxman Can Learn From Crypto.

What do you think? What cryptocurrency tax issues are you dealing with?

Virtual currency - recent tax matters

First - On 11/8/21, the Treasury Inspector General for Tax Administration (TIGTA) released a report (dated 9/21/16) – Rising Use of Virtual Currencies Requires IRS to Take Additional Actions to Ensure Taxpayer Compliance. Per the release:

“Alternative payment methods, such as convertible virtual currencies, have grown in popularity in recent years and have emerged for some people as a potential alternative to using traditional currencies like U.S. dollars.  Virtual currencies offer potential benefits over traditional currencies, including lower transaction fees and faster transfer of funds for services provided.  However, some virtual currencies are also popular because the identity of the parties involved is generally anonymous, leading to a greater possibility of their use in illegal transactions.  Recently, many types of virtual currencies have been created for use in lieu of currency issued by a government to purchase goods and services in the real economy.  The overall objective of this review was to evaluate the IRS’s strategy for addressing income produced through virtual currencies."

In the report, TIGTA recommends the following actions for the IRS:

“1) develop a coordinated virtual currency strategy that includes outcome goals, a description of how the agency intends to achieve those goals, and an action plan with a timeline for implementation;

2) provide updated guidance to reflect the necessary documentation requirements and tax treatments needed for the various uses of virtual currencies; and

3) revise third-party information reporting documents to identify the amounts of virtual currencies used in taxable transactions.”

TIGTA also notes that in Notice 2014-21, the IRS sought comments and received many, but has not issued any additional guidance. One of these letters was from the AICPA and listed ten areas where additional guidance would improve compliance and provide clarity (6/10/16 letter).

Second - Also this month, the IRS filed a petition in District Court to obtain two years of records (2014 and 2015) from Coinbase (U.S. v. John Doe, No. 3:16-cv-06658-JSC (ND CA 11/17/16)). The 16-page petition explains how virtual currency works and what Coinbase does. The IRS believes that some of its customers have not complied with the tax laws. See Stan Higgins, “The IRS is Seeking Data on Coinbase’s Bitcoin Customers,” CoinDesk, 11/18/16.

The IRS notes the following bitcoin usage: “As of January 2016, it was reported that more than 100,000 merchants globally were accepting bitcoin payments with businesses such as Overstock.com, Home Depot, DirectTV, Dell, Microsoft, Amazon, and Expedia topping the list. By Fall 2016, the number of merchants is forecast to grow to 150,000. With bitcoin, a user can buy webhosting services, cars, homes, and even pizza and manicures. In 2015, there were 125,498 bitcoin transactions per day. Using the total bitcoins traded in 2015 and the 2015 bitcoin average price, I calculated the 2015 annualized transaction value in U.S. dollars to be $10,116,817,608.”

IRS concerns include no information reporting for the transactions, articles about people using bitcoin to avoid tax reporting, exchanging money for virtual currency through foreign banks, and use for crimes including money laundering.

Update - The District Court granted the summons on 11/30/16. Also see the US Department of Justice press release of 11/30/16.

For more on virtual currency and the blockchain, see my website.

What do you think? Any virtual currency tax issues you see?