Unusual Proposed Exclusion for Crypto Gains

HB 453 introduced in the Montana Legislature on February 11, 2025 calls for the Department of Revenue to create a program to allow state income taxes to be paid with cryptocurrency through arrangements with one ore more third party payment processors. That isn't unusual as at least one other state already does this - Colorado. 

What is unusual is that HB 453 would also make the payment of Montana income taxes with crypto tax free!  That is, if a taxpayer used bitcoin with a basis of $10 to pay state income taxes of $2,500, the realized gain of $2,490 ($2,500 liability satisfied with an asset with a basis of $10), would be tax free.

There is no tax policy justifying this treatment. The appreciation in the crypto used to pay state income taxes is a realized gain.  It is the same result if the holder sold the $10 basis bitcoin for $2,500 and used that money to pay their income taxes - a taxable gain. If someone had to sell stock to pay their taxes, any gain would be taxable.

Of course, if a state wants to exclude such a gain, it can certainly change its income tax to do so. The gain would still be taxable for federal purposes and likely a reason why few would take advantage of this state offer should HB 453 be enacted.

If enacted, I wonder if people would reduce their withholding, such as from paychecks and increase their estimated tax payments made with crypto to maximize their exclusion (but still taxable for federal purposes). Would others in Montana ask if they can pay their taxes with appreciated assets such as stock or gold, and also get an income exclusion? After all, what is so special about crypto, particularly if a third party is going to do the conversion of that asset to cash and get the cash to the Department of Revenue?

The revenue estimate for HB 453 is about $70,000 per year which minor. I suppose people with little gain in their crypto might take advantage as the federal tax consequences would be small. But individuals with large gains would most likely not be interested as they can also avoid the federal income tax gain if they die holding the appreciated crypto (which is a much greater tax policy flaw in our tax system - excluding gains at date of death).

What do you think about providing a special state rule for paying your taxes in crypto and avoiding state tax on that gain?

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?

Helpful Crypto Taxation Report From Kansas

This month, the Kansas Legislative Division of Post Audit, a "non-partisan audit arm of the Kansas Legislature, released a very good background report on cryptocurrency and tax issues - Reviewing Issues Related to State Cryptocurrency Tax Policies. The Division's website also has a link to a 16-mimnute audio file that is about the best I have heard on the basics of cryptocurrency tech and tax. I recommend it if you feel you are missing the basics on these topics.

Appendix B is a helpful glossary of terms such as airdrop, blockchain, hard fork and staking.

A few interesting items from the report:

• 16% of people in the US have invested in or used cryptocurrency (per Pew Research Center).
  
  
• When there is not third party reporting (such as a 1099), only 45% of taxpayers accurately report their income. I have heard this before. Per the IRS (page 14), for income subject to substantial information reporting and withholding, there is only about 1% underreporting. In contrast, for income subject to little or no information reporting and no withholding, compliance is only about 55% (45% non-compliance).
  
  So if you wonder why IRC §6045 on broker reporting was expanded by the Infrastructure Investment and Jobs Act (PL 117-58, 11/15/21) to include virtual currency sales by exchanges (and perhaps by others), that the underreporting of transactions without third party reporting, is the key reason.
  
  
• "State governments have yet to agree on a set of best practices regarding the taxation of cryptocurrencies." There are no uniform laws. There have been a good number of legislative proposals (tax and non-tax) including per the NCSL, 43 bills in 22 states since 2015.

Some of the open issues in most states regarding cryptocurrency include:

• For states that subject digital goods and electronic transmissions to sales tax, are cryptocurrency and non-fungible token (NFT) transactions subject to sales tax. Recently, Pennsylvania confirmed that NFTs are subject to sales tax.
• How does a business source income and gains from virtual currency?
• How do unclaimed property laws apply to cryptocurrency and other digital assets?

At the virtual currency and blockchain website I maintain, search for "state information" and you'll see a long list of various rulings and legislation in states regarding cryptocurrency.

What do you think?  Any particular guidance you are waiting for on cryptocurrency from a state?

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. 

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?

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?