Although the crypto market is rapidly growing, guidance regarding the tax treatment of crypto remains minimal.
The only clear guidance from the IRS came in the form of Notice 2014-21, released almost four years ago, stating the IRS position that a virtual currency is a digital representation of the value that functions as a medium of exchange but does not have all the attributes of real currency, such as legal tender status in any jurisdiction. Accordingly, the IRS treats crypto as property, not as another currency.
In addition to potentially sizable tax liabilities incurred on the sale or exchange of crypto, taxpayers may also bear significant tax accounting burdens with respect to their holdings, depending on the number and frequency of crypto transactions in which they engage. As noted above, users of crypto must calculate gain or loss every time they transact. Taxpayers that are transacting at a high frequency using a trading bot, or mundane transactions such as buying cups of coffee with a crypto debit card, can rack up significant amounts of taxable transactions that they will have to individually account for.
Taxpayers will need to identify those transactions that represent a sale or an exchange of crypto for a good or service (and are thereby taxable) and those that are merely transfers into an account that the taxpayer controls, such as another wallet or a payment channel (and are potentially not taxable). They will then need to determine the value in dollars of each transaction.
Determining this dollar value is relatively straightforward for sales of cryptoassets for fiat currency, but exchanges of crypto for other property may present a challenge. Taxpayers will need to determine the dollar value of the good or service received from the counterparty less the dollar value taxpayer paid for the crypto used to buy that good or service, which presents two potential issues:
The availability and relative merits of each method of tax accounting should be assessed by taxpayers at the outset of their participation in the crypto marketplace.
Custodial business models will trigger compliance obligations with respect to cryptoassets. Generally, if a company holds crypto on behalf of others and facilitates transactions, the company should consider whether certain tax information reporting (usually on IRS Form 1099) is required with respect to the person for whom the crypto is held. If a company pays service providers with crypto, other tax reporting rules may apply depending on whether the service provider is an employee.
Further, companies should be aware that they may be subject to withholding tax obligations on payments to service providers even if the payment is made in crypto. As a general matter, these reporting and withholding requirements require companies to request, at a minimum, the tax identification or social security number of customers, service providers, and other payees. However, the pseudonymous nature of crypto presents a challenge. A primary role of tax advisers should be to assist companies in simplifying and automating tax reporting and withholding compliance procedures in order to prevent these requirements from disrupting the market. This will reduce the burden on individuals and organizations such that taxpayers may freely transact with cryptoassets.