Expectations of the new IRS crypto guidance

June 7, 2019, | AtoZ Markets Upcoming guidance from the U.S. tax collection agency Internal Revenue Service (IRS) is expected to address longstanding questions about the tax treatment of cryptocurrency and touch other crypto-related issues including whether investors owe taxes on free crypto they get from a fork.

The crypto community highly anticipates the new IRS crypto guidance which expected to clarify a number of other matters, including the tax implications of airdrops, staking and crypto stored at overseas exchanges.

IRS on its new crypto tax guidance

Currently, most of the cryptocurrency traders rely on a tax advisory service including tax collection agency IRS, to determine their tax liability. By 2019 there is only one statement on the tax principles that apply to cryptos issued in 2014 by IRS.

This original notice described how existing general tax principles apply to transactions using virtual currency and provided answers to frequently asked crypto-related questions. In the document, the IRS stated that for tax purposes, crypto is treated as property and not as currency. The authority left a number of key questions unanswered, such as how to value cryptocurrency received as income.

However, last month, the IRS announced soon issuance of the new guidance on the tax treatment of crypto. Tom Emmer, IRS Commissioner Charles P. Rettig did not say exactly when new IRS crypto guidance will come out. Emmer noted that the new guidance would address issues related to crypto-related phenome like:

  • crypto airdrops – commonly used as a marketing strategy for blockchain start-ups when​ ​a​ ​blockchain project distributes​s free​ coins or​ tokens to​ ​the​ cryptocurrency ​community.
  • crypto forks – another crypto phenomena that essentially gives people free crypto and raise new questions about tax liability.

The major areas where the crypto community is looking for more clarity from the taxman include the following aspects.  

How taxpayers should determine the fair market value of crypto they have earned?

One of the most important crypto-related questions bothering taxpayers is how they should determine the fair market value of cryptocurrency they receive as income.

Kirk Phillips the author of “The Ultimate Bitcoin Business Guide,” and a certified public accountant (CPA), states, that unlike securities or property cryptocurrencies can vary in price widely between different exchanges. Phillips added:

every exchange can have its own pricing methodology, and if you’re using ten different exchanges there will be ten different pricing models.

The American Institute of Certified Public Accountants (AICPA) in its turn has suggested that taxpayers should be allowed to use the average rate of the day and the average price of different exchanges to calculate the value of their crypto.

AICPA noted in comments submitted last year to the IRS, that taxpayers may have one method applied to one wallet and another method applied to another exchange when determining the fair value of all the bitcoin transactions. James T. Foust, a senior research fellow at the industry advocacy group CoinCenter, suggested a similar approach in a recent report.

What types of crypto did you spend?

Another issue for crypto traders to resolve is determining the cost of each unit of cryptocurrency that was spent in a taxable transaction, such as a sale.

Lisa Zarlenga, a partner at the law firm of Steptoe & Johnson, outlined the importance of the specific identification of the fraction you’re selling to calculate a gain or loss. Zarlenga emphasized, that the simplified approach when taxpayers apply the average cost basis or the “first in, first out” (FIFO) assumption,

doesn’t apply to other types of property, except to stock.

Steptoe & Johnson attorney noted, that “one thing the IRS could do is extend it to cryptocurrency, which would be very helpful.

Kirk Phillips however, noted that in crypto mining when the price of the earliest acquired coin is zero, “first in, first out” assumption can be a problem. In this case, he said, the mined bitcoin, which later bought and immediately sold, won’t bring its owner any profit.

If the cost basis is defined by the first coins this person ever acquired they will have to report a capital gain. Philips noted, that ” FIFO principle might become a trap and create a fictitious gain that doesn’t match the economic substance.”

Phillips made an assumption, that the best option, in this case, would be to leave for users to decide what method to use for calculating taxes on their crypto.  

Forks, airdrops, staking-new crypto phenomena

There is a list of other events that need clarification for tax purposes, such as crypto forks, airdrops, and staking. All aforementioned activities involve crypto holders receiving one cryptocurrency because they already own another.

According to Foust’s report for Coin Center, in case of a crypto fork, owners of the original cryptocurrency can make no effort to take possession of the new coins and never get them. In this case, the report outlines, there should be no tax effect.

However, if crypto holders get their portion of the splinter currency and sell it, the tax should be applied at the time of the sale.

Foust emphasized that it is important to consider how much control taxpayers have over the situation when they keep their crypto with custodial exchanges.

The American Bar Association in its turn proposed in its document submitted to IRS the following :

taxpayers who owned a coin that was subject to a Hard Fork in 2017 would be treated as having realized the forked coin resulting from the Hard Fork in a taxable event and the value of a new coin should be zero.

Lisa Zarlenga, a partner at the law firm of Steptoe & Johnson concluded, that forks

can be treated by analogy with traditional financial and business events, and it depends on which analogy the IRS will see as more appropriate.

Staking is considered a new concept. It involves using one’s coins to participate in transaction validation on proof-of-stake (PoS) blockchains.

AICPA suggests, that stacking should be treated as ordinary income, as mining already is because these two activities bring taxpayers new coins in a similar way.

If there are any expenses on staking, it should be deducted from such income as ordinary expenses, i.e. expenses that are common and accepted in a certain business.

Other crypto-related issues

There are several others that crypto tax experts hope the new IRS crypto guidance will address.

One involves the question of whether keeping, buying and selling cryptocurrencies on exchanges registered overseas should be reported under the rules for foreign bank accounts.

Another issue that deserves clarification is the status of small transactions when people use cryptocurrency to buy goods and services. As they also have to be reported as taxable events, it may discourage spending crypto and exempt transactions up to a certain threshold could eliminate this problem.

And last but not least- charitable donations. If you’re donating any property valued more than $5,000 you need to get a qualified appraisal, an expert estimation of that property’s value. AICPA offers to exempt crypto from this rule.

Zarlenga concluded: “This is going to be the first time they are speaking in five years. A lot has happened in the industry, and people are eager for some input.

The exact date of the new IRS crypto tax guidance remains unclear. However, as the extended due date for individual returns is October 15, and for pass-through businesses, it is September 15, “they may shoot to have guidance out before those extended deadlines,” said Kirk Phillips.

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