It is time for the IRS to answer open questions about cryptocurrency
A decade on, six major issues remain unresolved.
Today we are publishing a report on the application of federal income tax laws to cryptocurrencies. The report is focused on the tax uncertainties faced by everyday Americans who use cryptocurrencies.
On the last day of 2008, exactly two months after Satoshi Nakamoto distributed the original Bitcoin whitepaper, the Internal Revenue Service’s Taxpayer Advocate Nina Olson published her annual report to Congress. In it, she identified the lack of IRS guidance on the taxation of “virtual worlds,” and their associated “virtual economies” and “virtual currencies,” as one of the “most serious problems facing taxpayers” and noted:
As the tax administrator, the IRS has a duty to answer all of the basic questions about transactions undertaken regularly by significant numbers of taxpayers, such as those involving virtual items, especially if the questions are difficult for taxpayers to answer on their own.
. . .
More broadly, the IRS needs to produce specific early guidance on difficult issues confronted by taxpayers on a regular basis in emerging areas of economic activity. Otherwise, it risks turning these taxpayers into unintentional tax cheats, establishing noncompliance norms in the industry, and leaving IRS employees without clear guidance about how to do their jobs.
This passage resonates a decade later as taxpayers stare down yet another tax return deadline without any meaningful guidance on how they should calculate and report the tax consequences of cryptocurrency transactions.
Although the Internal Revenue Service has been examining issues related to the taxation of “virtual property” and “virtual currencies” for over a decade, it has only issued one piece of guidance about them. That six-page guidance, published in early 2014 and applicable only to “convertible” virtual currency, fails to answer basic questions like:
- How should taxpayers distinguish between convertible and non-convertible virtual currency, and what is the significance of that distinction for tax purposes?
- How should taxpayers calculate the fair market value of virtual currency?
- How can taxpayers determine the cost basis of virtual currency dispositions?
- How should taxpayers substantiate the value of cryptocurrency donations?
- How should taxpayers account for tokens they receive from a network fork or airdrop?
- How should taxpayers account for cryptocurrency when filing information returns?
Our new report lays out recommended actions the IRS could take to resolve these open questions. In doing so, it adds to a body of exhortations for the IRS to act from numerous stakeholders, from both within and without the government, who have also noted the 2014 guidance’s failure to address these and other basic tax questions and repeatedly requested that the IRS issue clarifying guidance.
Unfortunately, rather than indicating any intention to provide additional guidance, the IRS seems to be ramping up enforcement activities against taxpayers who “misreport” the tax consequences of their cryptocurrency transactions. Rather than targeting “unintentional tax cheats,” we are hopeful that the IRS will adopt our common-sense recommendations, including:
- Making clear how taxpayers can determine the fair market value of cryptocurrency, and allowing them to choose different methods of doing so for different cryptocurrencies so long as each method is consistently applied.
- Extending to cryptocurrency dispositions the same methods for determining basis that are available for dispositions of other commonly traded financial assets.
- Making clear that if a taxpayer never exercises dominion over tokens that result from a fork or airdrop, that fork or airdrop should have no tax consequences for the taxpayer.
- Allowing taxpayers to use readily available exchange rate data to substantiate the value of tax-deductible cryptocurrency donations, rather than requiring a costly appraisal.