This year was like no other. Now that it’s over and we’re looking at the promise of a better 2021, it’s time to think about taxes. While there were many other notable things in 2020, there were some fiscal points to savor – and some to fear.
Gains and losses
It is difficult to look at crypto and 2020 without commenting on gains and losses. The price of Bitcoin (BTC) has skyrocketed, leaving many investors happy. Of course, if you took short positions, you are less satisfied. And if you invested in XRP, the news that the United States Securities and Exchange Commission is dissatisfied with XRP has caused some price impact in the unwanted direction. When it comes to real and perceived value and purchasing power, these developments are important. But what about taxes?
Related: SEC vs. Ripple: Predictable but undesirable development
Tax Day Delay: IRS more tolerant?
Tax returns for 2020 are due on April 15, 2021, which is not far off. Don’t count on a delay like last year. In 2020, the Internal Revenue Service gave all of us a 90-day extension on filing returns and payments, until July 15, 2020 (IRS Notice 2020-17). The world may still be in the grip of COVID-19 during the next tax reporting season, but most observers don’t expect the same type of latitude from the IRS when it comes to 2020 tax returns.
The same can be said for the IRS by facilitating many of its enforcement activities. In early 2020, IRS Commissioner Chuck Rettig announced the “Initiative First”. Need to split your taxes? The IRS will help because it has a well-used process for calculating benefits. In addition, the installments due between April 1 and July 15, 2020 were suspended, as well as the tax burden. Even new passport debt certifications when defaulted tax debts exceed $ 50,000 were on hold, and most new tax audits were also on hold.
How about now, in the beginning of 2021? Many IRS employees are still working remotely, but don’t assume it means that you will have some time off in the early or mid-2021 that taxpayers received in 2020. It is highly unlikely. How about arguing with the IRS or in court that you shouldn’t have to pay fines from the IRS because you were adversely impacted by the pandemic? You can try, but the IRS commissioner has already strongly rejected suggestions that the IRS should have a special fine pandemic grant. Again, don’t count on it.
IRS forms for cryptographic taxes
Two years ago, the IRS transformed cryptography into a kind of tax issue for everyone, adding a question to everyone’s tax return, and so did tax returns for 2020. That means, from tax returns of 2019 presented in 2020, the IRS asks a simple question:
“At some point during 2019, did you receive, sell, send, exchange or acquire any financial interest in any virtual currency?”
It is very simple: just yes or no; he does not ask for numbers or details, although that goes elsewhere in his tax return.
This addition to the 2019 tax returns is being continued for the 2020 tax returns you file in 2021. In fact, you should assume that it will be a standard feature of tax returns from now on. Since the IRS classifies cryptography as property, any sale will produce a gain or loss, and a yes or no box can be very important. In fact, given the IRS ‘track record with offshore bank accounts, this could even mean major penalties or even imprisonment.
The Department of Justice’s Tax Division has successfully argued that the mere failure to check a box related to foreign account reporting is intentional. Willful failure leads to higher penalties and a greater threat of criminal investigation. The IRS Criminal Investigation Division is even meeting with tax authorities in other countries to share data and enforcement strategies to find possible cryptocurrency tax evasion. This seems reminiscent of the foreign bank account issue included in Appendix B.
If a taxpayer answers “No” and is later found to have made cryptocurrency transactions during the year, the fact that he explicitly answered No to this new question (under penalty of perjury) could be used against him. What if you only have a kind of “signing authority” over encryption belonging to your parents who don’t understand computers or other relatives? That way, you can help them manage their encryption.
If you sell a parent’s encryption on your behalf, at your request and / or for your benefit, should you answer “Yes” or “No” to the question? Various guarantee and trust agreements – some informal, others not – flourished. They can be sensitive, especially now with the IRS’s much greater access to information. But be careful who is selling and how these activities are reported.
Should you attach an explanatory statement to the return explaining your relationship with digital currency? There are probably no perfect answers to that question, but what is clear is that answering “No” if the truth is “Yes” is a big mistake. Ignoring the boxes completely may not be so bad, but it is also not good if the truth is “Yes”. If the truth is “Yes”, say so and remember to disclose and report your income, gains, losses, etc. Perhaps that is the point of the question: to be an important reminder.
Other tax forms
Do not think that your tax return is the only tax form you will see. Although encryption still escapes some report forms, this is much less true today than it was before. How about the IRS Forms 1099-MISC, 1099-K, 1099-B or Schedule K-1? There is even the new Form 1099-NEC for the 2020 tax reporting season.
All of these forms can report encrypted payments and transactions. These forms arrive around the end of January for reports of payments or transactions made in the previous fiscal year. Wages paid to employees in digital currency must be reported on Form W-2 and are subject to withholding federal income tax and payroll taxes.
Salaries made in digital currencies for independent contractors are taxable for them, and payers involved in business must issue Form 1099-NEC. A payment made in digital currency is subject to the Form 1099 report, as are any other payments made on property. This means that if an entrepreneur pays encryption worth $ 600 or more to an independent contractor for the services, a 1099 form is required.
If you receive any Form 1099, check them. Each is reported to the IRS (and state tax authorities). If you do not report or otherwise address the revenue reported on your tax return, you can expect the IRS to follow up.
Transactions trigger taxes
In 2014, the IRS announced that encryption is proprietary. If you have 100 BTC and sell 10, which 10 have you sold? There is no perfect answer to this question. Most tax legislation considers stocks, not cryptocurrencies. Specific identification of what you are selling, when you bought it and at what purchase price it is likely to be the cleanest. But that may not be possible. Some people use an average convention, in which you basically average your cost over a series of purchases. Consistency and record keeping are important.
IRS audits and access to information
The IRS uses software to track encryption and has also gained access to records through other sources. In addition, with forms 1099 and K-1 being issued, many reports are now being left on the IRS lap. This should be of concern to taxpayers.
The IRS now has cryptography training for its auditors and agents in the criminal investigation division. Should the latter scare you? I think so. The IRS and the Department of Justice still file criminal charges mainly involving the use of cryptography for illegal purposes involving other crimes, such as money laundering or child pornography. But that is no guarantee.
In addition, most criminal tax cases have historically resulted from past civilian audits by the IRS. The IRS auditor sees something he considers suspicious and invites criminals to the IRS for a look. It’s called referral and you don’t know if it’s happening. In fact, you usually don’t know until it’s too late. If you forget to report your encryption gains in recent years, you should reconsider this. Do not wait for the IRS to find you, even if you have not received one of those 10,000 crypto warning letters from the IRS.
Taxpayers may think they will not be caught, but the risks are growing – and the best way to avoid penalties is to disclose and report as accurately as possible. IRS commissioner Chuck Rettig even acted to increase criminal investigations as well, so be careful.
The views, thoughts and opinions expressed here are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
This article is for general information purposes and is not intended to be and should not be taken as legal advice.
Robert W. Wood is a tax attorney representing clients worldwide at Wood LLP’s San Francisco office, where he is a managing partner. He is the author of several tax books and frequently writes about taxes for Forbes, Tax Notes and other publications.