As the calendar continues to roll through 2022, and tax season gets firmly underway, there are a lot of conversations around how cryptoassets will influence the outcome of this filing and payment season. The Internal Revenue Services (IRS) is, of course, facing the regular hurdles with regards to reviewing and processing returns – recent reports indicate a multi-million return backlog that will take months to clear. On top of these paperwork issues, there is also the looming uncertainty with regards to how different cryptoassets and crypto activities will be treated, both now and going forward.
The crypto tax conversation has moved far beyond simply acknowledging that crypto is treated and taxed as property by the IRS; investors and business owners alike need to be aware of just how complicated this conversation has become. Additionally, the issues and questions around crypto reporting and taxation are no longer a niche issue; recent surveys and data analysis illustrates just how widespread crypto investing, trading, and utilization has become.
According to these surveys, 48% of American investors moved into cryptocurrency during 2021, and 16% of all Americans (approximately 53 million people) have used, invested, or traded cryptoassets. One simply need to look at headlines, and review the list of organizations investing and utilizing cryptoassets to realize that – as large as these figures are – they are most likely incomplete.
With all of this investment, however, invariably comes tax considerations. The 2021 tax season might already by underway, but it is never the wrong time to 1) plan tax strategies, 2) position portfolios for reduced tax liabilities going forward, and 3) make better informed decisions for 2022 investing. Let’s dive into some of the factors.
Almost every crypto transaction is taxable. Any Certified Public Accountant (CPA) or tax professional that provides tax advice to investors, as well as investors/entrepreneurs who operate in this sector should be aware of this fact. Given the classification of crypto as property – a simplified representation but accurate for this purpose – transactions that involve crypto are generally going to incur a tax reporting and payment obligation. This includes paying for goods and services in cryptoassets, being paid in crypto for services provided, or trading one crypto for another.
That last point is especially important as stablecoins and other newer iterations of crypto become increasingly mainstream. Trading stablecoins, or swapping newly issued tokens for other tokens will incur tax liabilities for those individuals and institutions involved. This also carries over into another area that can result in some unpleasant surprises.
It is also worth pointing out that the IRS is very serious, and proactive, about enforcing tax compliance and collection around crypto transactions; ignorance of tax treatment is not an excuse for non-compliance.
Crypto gamification creates tax obligations. Even if taxpayers are not directly buying, selling, or trading cryptoassets the increased gamification of almost every virtual activity can result in crypto related tax liabilities. As online gaming and virtual reality opportunities (not to mention the looming ascension of the metaverse) continues, the number of individuals and organizations involved in rewards, game tokens, and other virtual assets continues to increase. Cryptoassets are almost a perfect fit for a virtual payment ecosystem since the instruments are both virtual in nature, as well as being secured by an underlying blockchain.
The issue arises if and when these individuals and firms participating in e-sports or other online gaming environment are not aware of the 1) nature of these virtual tokens and assets, and 2) the associated tax implications of using these virtual tokens. With both categories – esports and the gamification of online activities – increasing rapidly, the potential for significant tax surprises is not something to be taken lightly.
Put simply, if these virtual tokens or rewards have “real world” value, they will also result in real world tax liabilities.
Crypto taxes are becoming more complex. As if the crypto tax conversation was not complicated enough, as new products and services are introduced to the ecosystem this conversation will continue to become more complex. Decentralized finance (DeFi) opens a whole new spectrum of tax considerations and concerns linked to staking, rewards, and other passive/semi-passive questions that remain murky for investors, business owners, and the IRS.
Non-fungible tokens (NFTs), and the continued proliferation of decentralized exchanges – with no central point of contact for questions or customer service activities – are continuing to create even more complicated tax questions and situations. Drilling in on NFT issues for a moment, which have rapidly expanded in market presence, the tax implications for these assets can be different depending on how the taxpayer is involved with NFTs and the adjusted-gross-income (AGI) of that taxpayer.
In other words, an investor and organization buying or being gifted some of these rapidly appreciating assets might also lead to extra headaches.
The tax conversations and debates surrounding crypto taxes is already complicated, and will invariably become more complicated as these financial instruments will become more mainstream. Outside of the technical and operational factors that accompany cryptoasset transactions and operations, the sheer pace of change in the space makes tax planning and reporting even more complicated. Complicated, but not impossible, and the sooner that investors, entrepreneurs and tax professionals realize that the sooner greater clarity will come to the sector