Coronavirus may revitalize cryptocurrencies, but issues remain
It’s become a near-daily occurrence: Practically every morning, Americans awake to find the next batch of luminaries — everyone from scientists to civic leaders — asking the world to consider the “new normal” in the age of COVID-19. Whether it’s regular mask wearing, the re-imagining of office spaces, or the permanence of telecommuting, it seems some of society’s basic tenets will be turned on their heads in the not-too-distant future.
That, too, will almost certainly lead to more widespread adoption of digital payments as an alternative to cash.
Cash hasn’t been king for some time. While an overwhelming majority of Americans still believe cash should be accepted, their habits say they’re not too attached to their paper money. In fact, according to the Federal Reserve, cash is used in just 26 percent of all transactions, and 49 percent of those are under $10.
Now, in the midst of a global pandemic brought on by the spread of COVID-19, the gravitational pull toward digital transactions has been amplified. Customers are happily leveraging their debit and credit cards, as well as mobile payment vehicles like Venmo and PayPal, to avoid handling communal money. It’s the same environment that has shot virtual currencies like bitcoin back to the forefront of the public consciousness.
After its explosive jump in December 2017 to trading at nearly $20,000 per coin, bitcoin has been on a rollercoaster ride with more valleys than peaks. But the pandemic could change that for not only bitcoin, but all cryptocurrencies, as both banks and regulators could flock to crypto as a useful way to steady an uneven economy, propping it up once again as the must-have asset in everyone’s portfolio.
Even as it regains steam, though, the nature of cryptocurrency still remains largely niche, and it could severely complicate tax matters for investors who simply can’t keep track of the comings and goings.
Take, for example, the IRS’s own thoughts on the subject. In October 2019, the IRS released additional guidance that spoke to the technological side of cryptocurrency. In it, the IRS addressed some major points of contention, specifically the difference between hard forks and soft forks.
If an investor has existing virtual currency, and the distributed ledger of the cryptocurrency is changed, that’s a hard fork. An example of this is when bitcoin, in an effort to facilitate faster, cheaper transactions, forked to “Bitcoin Cash” in August 2017. According to the IRS, if a hard fork does not result in new units of cryptocurrency, the transaction is not taxable. If it does, it is taxable.
Meanwhile, soft forks — when investors are given new units of crypto in the same currency — are not taxable at all because taxpayers are in the same position as they were before. Sound confusing? Don’t worry, it is.
What’s more, if the dates don’t quite line up for you, you’re not alone. The guidance came more than two years after the first bitcoin fork, leaving investors and practitioners to completely fly blind. Not only are we asking for advisors to take on a heavy lift in understanding some relatively new and very nuanced terminology, the difference between the two could have major tax consequences.
Additionally, the cryptocurrency market offers other products (futures, retirement accounts invested in crypto assets, and interest paid on crypto deposits). Currently, the IRS offers no guidance on those. As virtual currency becomes more popular, practitioners will struggle with the tax treatment of these items, and again, struggle to make recommendations to their clients that will ensure their compliance.
So, as the world envisions itself free of physical cash and rushes to pump money into digital tokens, these complex issues will trickle down to more unsuspecting practitioners and investors. And with the ramifications of a misstep being potentially huge, it will be of the utmost importance to demystify the jargon and to get timelier guidance to help keep an audit at bay.