Crypto Tax Day Cometh

Editors’ Note: MarketMinder does not make individual security recommendations. The below merely represents a theme we wish to highlight.

The Treasury wants a slice of your dogecoin gains.

That is right, today is Tax Day, and if you sold bitcoin or any of the 10,000-plus other cryptocurrencies in existence for a profit last year, Uncle Sam wants YOU … to pony up. One might think this should go without saying, but apparently crypto tax compliance is so spotty that the IRS has issued summons to two crypto exchanges, requiring them to turn over customer records in hopes of catching folks who “forgot” to voluntarily declare transactions to the IRS. Now, we are sure all of our dear readers are fine, upstanding citizens whose tax reporting and paying is above reproach. That includes even the (likely small) percentage who dabble in bitcoin, et al. But given the ongoing crypto frenzy, we think a quick look at the complex tax treatment is in order, because even well-intended people might end up as accidental tax evaders if they aren’t careful.

Much of the complexity stems from the IRS’s decision to treat cryptocurrencies as property, rendering them subject to capital gains taxes. In our view, this should be a primary consideration on anyone’s pro/con list when they consider buying a cryptocurrency, particularly if part of your thesis is that cryptocurrencies are the future of money.

When you buy something with normal money, like dollars or pounds, the only tax you pay is sales tax. When you pay with bitcoin, it is quite different. A payment is a disposition—aka, selling your bitcoins. That means—you guessed it—your transaction is subject to capital gains taxes. It wouldn’t surprise us if this, not environmental concerns, were really behind Tesla chief Elon Musk’s widely discussed decision to stop accepting bitcoin as payment for cars. Not just because it would add tax headaches for customers, but because every transaction would complicate the company’s own taxes—each one would add a new lot with a different cost basis to Tesla’s own bitcoin stake. Have fun calculating that tax bill. 

Considering one of the most prominent questions on IRS Form 1040 aims to discover all taxable crypto transactions, you might think we are stating the obvious. But the IRS still wins the gold medal for unnecessary confusion, so the relevant question reads: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” We can kinda see how someone who bought a car with bitcoin would see that question and think, “Does this apply to me? I didn’t sell my bitcoins on an exchange. I didn’t swap them for dogecoins. I didn’t send one to my aunt for her birthday.” If the form actually, clearly stipulated that paying for goods or services was a taxable transaction, we reckon there would be a lot less confusion—both in the world of tax compliance and about cryptocurrencies themselves. Then again, that could create a scramble to comply.

The other obvious solution here is to require cryptocurrency exchanges to file 1099s and report to the IRS, akin to traditional US brokerage houses. But that is a matter for the relevant parties, not your friendly MarketMinder editors.

Regardless, if we ran the world, cryptocurrencies would be called cryptocommodities. Then maybe people considering them would have a more sound understanding of what they are buying—speculative securities, not money. We aren’t inherently against them, mind you, but we are 100% in favor of investors making fully informed decisions—and staying off the Taxman’s naughty list.