Most taxpayers lack 1099 forms for reporting crypto transactions
The Internal Revenue Service is including a question at the top of Schedule 1 of the Form 1040 this year asking taxpayers whether they received, sold, sent, exchanged or acquired a financial interest in virtual currency in 2019, but most taxpayers won’t have any record from a Form 1099 about their cryptocurrency transactions.
Only two crypto exchanges are known to provide investors with 1099 tax forms: the Winklevoss twins’ Gemini and Paxos, according to a new report from tax and accounting compliance technology providers Blox and Sovos. The report predicts that two-thirds of cryptocurrency investor clients could face underpayment penalties on their 2019 returns.
“We definitely have heightened scrutiny of taxpayers this year as opposed to the last few years,” said Sovos solution principal Wendy Walker. “Having watched this evolution the last couple of years, there is a lot more concern this year than in past years. It’s not only that new question [about virtual currency] that has been added to the 1040, but also because last year, the IRS mailed 10,000 enforcement letters presumably to Coinbase users that they had summonsed previously, and recently a Bitstamp summons went out. In general, people are more aware that there could be obligations. Various tax professionals like myself are still clamoring for more guidance and clarity from the IRS so taxpayers don’t continue to be concerned that they’re going to risk a penalty when they are attempting to report transactions based on the limited guidance that we have.”
Last October, the IRS issued guidance on cryptocurrency transactions after not saying anything official since 2014, despite the growing popularity of cryptocurrencies like Bitcoin and Ethereum. However, that guidance still left many tax practitioners wanting more.
“I think it produced more unanswered questions unfortunately,” said Walker. “While there was some clarity in the guidance in maybe the way the IRS viewed, for example, how you should obtain the value of an asset, generally the revenue ruling that came out around the hard forks and airdrops was the sort of thing you don’t see that often. In fact, the last couple of years we’ve been talking with a lot of folks, and we’ve been documenting the transactions that we’re seeing, and there are so many more than what were focused on here. The IRS hasn’t even tried to tackle some of those transactions.”
The IRS revenue ruling and the more informal frequently asked questions page may still be useful to some taxpayers, however. “While the frequently asked questions aren’t published guidance, they do provide a lot of insight into how the IRS was thinking about this,” said EY Global blockchain tax leader Michael Meisler during an interview last month. “Between that and the revenue ruling that was issued in 2019 dealing with hard forks, I think that many taxpayers or their advisors looking at that guidance might find that they have taken positions in the past that are inconsistent with some of this guidance. The revenue ruling in particular dealing with hard forks is published guidance and does establish authority for the position that any receipt of tokens pursuant to a hard fork previously — for example, Bitcoin cash at the time of the Bitcoin hard fork back in 2017 — that revenue ruling makes it clear for 2019 to 2024 that the new tokens that are received following a hard fork in a blockchain should be recognized as ordinary income at fair market value. I believe that taxpayers had inconsistent tax positions with that one. There was a diversity of views, including not recognizing any income at all, excluding the basis from the original asset, or taking a zero basis in the new asset and just not recognizing income at the time.”
Blox and Sovos surveyed U.S.-based CPAs who offer cryptocurrency accounting and taxation services to businesses and individuals that interact with digital assets. More than 50 percent of the CPAs polled believe most of their crypto clients probably owe back taxes.
Missing data from clients was the biggest pain point cited by the survey respondents, with 90 percent of the CPAs polled identifying missing data as one of their biggest challenges. That concern surpassed manual calculation and cost basis (67 percent), and government regulation (55 percent).
However, the problem of missing data isn’t under the control of most cryptocurrency investors. Less than 50 percent of crypto tax clients have access to their complete crypto transaction data. While some crypto exchanges have tried to make it easier for users to get these records, others don’t have automated reporting or regulatory content management, and it’s hard for many crypto investors to retrieve their records. When asked how many of their clients understand taxable crypto events, most of the CPAs polled believe only 16 percent completely understand them.
“One of the biggest challenges is to consolidate the data,” said Blox CEO Alon Muroch. “We have so many different types of transactions happening on different blockchains and exchanges, and they’re not exported in the same standardized format. Just consolidating all of the data to get to a point where you have a complete normalized data set is a challenge. That definitely extends the day-to-day and the yearly report that a company or an individual needs to submit. The data is definitely a big challenge, especially with the amount of new transactions, protocols and instruments being created every month.”
“We heard that the exchanges are telling the IRS they don’t have access to all of the data to provide the cost basis reporting,” said Walker. “There are so many exchanges operating, and only covering certain types of assets that are out there. Being able to keep up with that data themselves is certainly difficult for any one exchange, let alone a taxpayer jumping across multiple exchanges. That’s why getting the data they need is probably the number one issue they cited.”
The cryptocurrency market has been characterized by huge volatility, but that’s also being seen now in the traditional stock and bond market this year due to the coronavirus pandemic. “The crypto market was just a bit more volatile than the traditional market, which says a lot about the traditional market and what happened in the past month or two,” said Muroch. “I think that we are at a point where Bitcoin and Ethereum are becoming more widespread, so what we are seeing is maybe people adopting them as just a hedge. Volatility is definitely part of it, but it was not as volatile if you go back in history, especially if you compare it to traditional markets.”
The extension of the income tax filing and payment due date until July 15 as a result of the coronavirus added another level of complexity for taxpayers with cryptocurrency and other types of assets. “When you get into the 1099 filing due dates, retirement account filing due dates and income tax filing due dates, all these different due dates are intertwined with one another,” said Walker. “One of the issues we’re having is that the IRS extended the income tax filing deadline, but it’s intertwined with when the payer is required to file information with the IRS, and also at the state and federal level. So whether the retirement account is invested in crypto assets or traditional assets, we’re having that problem.”
The IRS guidance on the proper tax treatment is worth examining to glean some answers, according to EY Global’s Michael Meisler. “All of this guidance, along with the frequently asked questions, which give you insight into the Service’s views on accounting methods, the fact that they would default for FIFO or allow you to use specific identification, may warrant looking at previously filed returns and considering both not only how you file for this year, but whether or not there’s a reason to look at previously filed returns and amend,” he said. “In all circumstances, I think everyone should be aware that the IRS is interested in enforcing compliance in this area. Taxpayers, if they engage in transactions with cryptocurrencies, should consult with an appropriate advisor and make sure that they are reporting their gains and losses accurately.”