Cryptocurrency and NFT Services
Jan discusses the impact of onshore and offshore ownership of cryptocurrency and Non-Fungible Tokens or NFTs from a tax and accounting perspective. What are some of the common misconceptions US citizens tend to believe regarding IRS compliance, tax reporting and Crypto / NFTs? How will the IRS find out about your onshore and offshore cryptocurrency and NFT exchange accounts and transactions? What happens if you check the “no” box on the IRS Form 1040 regarding cryptocurrency when you actually own crypto or NFTs and have conducted transactions? Why is it a big deal to neglect to disclose crypto and NFT information to the IRS on your US tax return? How would a US taxpayer come into compliance with their responsibilities as a US taxpayer and why should they consider taking action to do so immediately?
Jan
Welcome to AB Cast, Integrating Legal Tax, Accounting and Business Solutions. I’m Jonathan Allen. This episode is about cryptocurrency and NFT services.
Neil
Jan, on this episode of a ABCast, we’re going to dive into cryptocurrency and NFTs. Let’s start with an overview of in general terms, what is a cryptocurrency?
Jan
I think probably the easiest way to define cryptocurrency is to define what it isn’t. Although there is the term currency in the name under current US law, cryptocurrency is not defined as a currency. Currency you think of as something fungible or a fiat currency such as the US dollar or perhaps the English pound. But cryptocurrency is really property as it’s currently defined by the Internal Revenue Service Code. And so cryptocurrency is the ability to go online, go onto a platform, take your fungible fiat currency and convert into a platform that says that you own so much of this particular currency. There are lots of different cryptocurrencies currently in the market. There are differing kinds, There are differing places in the world that these cryptocurrencies exist, and it becomes important for you as an individual particularly to know where your platforms and your currency resides because one of the issues that we’re seeing is the convergence of foreign platforms and US platforms and the foreign platforms create reporting nightmares because of the foreign asset reporting requirements under the code. So cryptocurrency is an asset. It’s property, but it’s not currency as we know it.
Neil
And just quickly, what is an NFT or non-fungible token? What’s an example of that?
Jan
A non-fungible token is really a picture of an asset that is put into the cryptocurrency platform that allows you to monetize virtually anything. I think the most famous example was Melania Trump had taken a picture of a dress and made an NFT out of that and goes back and puts it into the cryptocurrency world and then has the ability to go back and monetize that picture.
Neil
So there are a lot of misconceptions about being able to hide crypto and NFT assets from the IRS. What are some of the most basic misconceptions for US taxpayers and what do they need to know about how the IRS is viewing crypto assets?
Jan
I think from the beginning, the creation of cryptocurrency was, was really to create a sense of security that the asset could never fail or disappear. And from that, there was the idea that sprung up that essentially because you went on to a platform, you weren’t identified, there was no way to identify you, that there was a secrecy that was associated with cryptocurrency. But in this day and age, and with the governmental regulations, not only here in the States but worldwide, what’s happening is governments have access to these crypto databases and the individuals that are participating in them. So the idea that you can go on to a currency or onto a platform and purchase cryptocurrency and remain anonymous is really a misnomer. And it’s not true because of the ability of governments, US and other governments throughout the world that have the ability to go in and force the identification of the individuals that are participating in that platform.
Neil
So unlike foreign currency investors or people with assets or money offshore, cryptocurrency investors may not be aware of FATCA and the huge impact that FATCA had upon the transactional world. Can you share with us a little bit about the history of FATCA, what it is, why it came about, and then how that impacts the ability of the IRS and other sovereign tax agencies to actually see more of these transactions?
Jan
FATCA was a US government, actually US treasury process where they reached out to other worldwide governments and was looking for exchange of information. And so FATCA became the methodology whereby governments exchange information about individuals living within their countries. So for example, if I were to move to France and I were to go and open a bank account in France and I had to give them my US information, that US information from that French bank is then shared with the US government. So it’s the exchange of information that’s been created under FATCA worldwide whereby governments exchange information about foreign individuals or foreign born individuals living within their countries so that the countries are put on notice that there are individuals, citizens that are living in foreign countries and thereby will likely have foreign assets as well.
Neil
Or if there are US citizens who have assets in a foreign entity or exchange?
Jan
Yes.
Neil
And so let’s take the example of Swiss banks. For many years, one of the greatest tax havens was to put your assets and investments into a Swiss account. And part of what FATCA created was the ability of the IRS to pierce the wall of the Swiss banks. And they now provide, as do financial institutions around the world, information directly to the IRS and other sovereign tax agencies about those who have accounts and even transactional data. Is that accurate?
Jan
The US was successful in suing Swiss banks in order to obtain information relating to US citizens. That’s true. US citizens are required to report their foreign assets. And because these Swiss bank accounts were numbered accounts, there were no names or social security numbers associated with them. It was very difficult to associate a particular account with an individual. What the US managed to do was to force the banking regulators in Switzerland to divest themselves of US investors because of the requirement to obtain the information relating to those US citizens. So what that did was essentially made it nigh on impossible for US citizens to go anywhere in Europe, Switzerland is only one country, but the same regulations that apply to Switzerland apply worldwide. And what you’ll find is if you go to France or England or Ireland or anywhere in Europe, Singapore, virtually anywhere, and you walk into a bank and say, I want to open up an account and you address the fact that you’re an American citizen, most of the times you’ll be refused the opportunity to open an account because most banks don’t want the regulatory nightmare that’s associated with the reporting requirements of FATCA.
Neil
And so in effect, people that think they’re hiding these assets offshore, the IRS is, is receiving direct information which identifies who they are as taxpayers and the types and nature and amounts of their investments and assets offshore
Jan
If they are in compliance with FATCA, that is true, but I think the more common way that the IRS obtains the information is through the transferring of assets from one country to another by the individuals themselves. So because there’s a requirement of anything over $10,000 to be reported if it’s coming in from a wire or a transfer from a foreign bank, that’s always reported to the Department of Justice and Treasury. So it’s very difficult for people to maintain accounts offshore and then be able to utilize those funds in the us. And what people don’t recognize is if you get a wire in, if you’ve wired in from a foreign account, the IRS and treasury are aware of that transfer. And oftentimes that will lead to potential audits looking for foreign assets that are unreported.
Neil
So specific from a cryptocurrency point of view, if I invested in exchanges that were offshore that I thought were secret and I hadn’t disclosed the existence of that asset or my activities and I needed to get the money back into the United States to buy a house, for example, just the act of repatriating those funds is going to place me immediately and squarely on the radar of the IRS,
Jan
It’s certainly going to complicate one’s life. That’s true. I have a client that routinely goes back and uses US currency, puts it into the crypto market, transfers it outside of the United States, the crypto comes back, it’s really sort of arbitraging cryptocurrency. And that becomes a very difficult transaction to go back and report simply because the frequency with which the transactions are occurring. But going back and identifying the foreign exchanges where the crypto is being transferred and then returned back to the states. But essentially the other reporting mechanism is on the US tax return itself. Now the return asks whether or not you have engaged or purchased any sort or type of cryptocurrency. And of course, because you sign the US tax return under penalties of perjury if you are to lie on that return and say, Well, no, I don’t have any transactions at crypto, and the IRS were to find out, you can be criminally prosecuted because you lied when you said you didn’t have crypto, when in fact you did.
Neil
So Jan, can you give me a little bit of historical perspective on how do we get into this situation with cryptocurrency and how long has it been going on and what’s the evolution of this story?
Jan
Well, the first cryptocurrency was really established about 2010, 2012, and the IRS was behind the eight ball for a number of years. And it wasn’t until 2017 when the question was first presented on the individual tax return that the IRS from the responses in the 2017 tax year filing, I think 800 people were brave enough or honest enough to actually admit that they had been dealing with or purchase crypto what the IRS did. Then as it went back and it subpoenaed the exchanges, the crypto exchanges, what it found was there were hundreds of thousands of people that had actually been purchasing and dealing in crypto. And as a result of the subpoenaing of the information from the cryptocurrency exchanges themselves, the IRS has subpoenaed several hundreds of thousands of taxpayers that are now going to be caught up in this issue of having lied on their tax returns because they answered that question in 2017 erroneously.
Neil
And so this isn’t just a financial exposure, this isn’t just a tax exposure, this is a criminal exposure.
Jan
Anytime you lie on a tax return, and again, every time you sign a tax return, you do so under penalties of perjury. That is the mechanism that the IRS can go back and assess huge civil penalties and criminally prosecute the individual as well.
Neil
So let’s address those hundreds of thousands of people. Jan, what do I need to do to come into compliance? If let’s just say I didn’t report it. I didn’t think I needed to, I didn’t think they’d be aware of it. Now that I understand where we are, what do I need to do to get into compliance?
Jan
I think the most important thing is to ensure that the compliance and any return that is erroneously prepared is rectified. And that means going back and amending the returns normally because the statute of limitations with the Internal Revenue Services three years, I would go back and amend at least three years worth of tax returns, but the IRS actually keeps the statute of limitations for fraud open for seven. So to be ultra safe, if an individual was dealing in cryptocurrency from its inceptions, say, 2012, I would go back and amend seven years worth of tax returns in order to bring those returns into compliance with the US reporting requirements.
Neil
And if they are investing in an exchange that is not US based, then FBAR considerations come into play.
Jan
All of the foreign reporting requirements come into play. That can mean FBARs and Form 8938s. Of course, you have capital gains and losses which need to be calculated. And I think that one of the reasons for the non-compliance was early on, the information that was obtained from these exchanges was fairly rudimentary. There were some exchanges that were quite sophisticated, but there were others that just aren’t. And the information that’s being pulled from them is difficult to go back and obtain the information that’s necessary for complete compliance under the code.
Neil
So you’re talking about basically the calculation of basis, whether it’s a short term or long term capital gain or loss. Can you help us understand the basics relating to, let’s start with capital gains or losses and short versus long term. How are those rules established?
Jan
Well, I think we need to start with basis, and basis is the cost of something. So if you go in, for example, on purchase a hundred dollars worth of crypto, then what ends up occurring is that’s your basis. That transfer of fiat currency into the crypto asset is a hundred dollars. As you hold that, and let’s say you were to have invested a hundred dollars in 2017 and you held it ups and down in the market of crypto, it could be that the crypto that you were holding has appreciated in value far more than the original a hundred dollars that you invested. To go back and convert that into a capital gain or loss, you have to obtain the values of the cryptocurrency on any given day. So for example, if you were to purchase that a hundred dollars worth of crypto and then exchange it at the end of the year in order to come up with the gain or loss, we have to know what the value of the crypto was at the end of the year in order to determine whether or not you had a capital gain or a capital loss. In most instances, you will have a capital gain, and whether it’s long-term or short-term, depends on the amount of time that you’ve held that crypto. So if you’ve held it for less than a year, then it will be a short-term capital gain. If it’s longer than a year, then you’ll have a long-term capital gain. But understand that the transactions in crypto occur every time there’s an exchange. So you can take that same $100 of investment, invest it into a platform, transfer it to a wallet, transfer it back to a platform, and back to a wallet. And every time you transfer from one place to another, that is deemed to be a transaction and a capital gain or loss needs to be calculated on every transaction. So it becomes quite complex, especially for those that are moving crypto from wallet to wallet, from platform to platform, from cryptocurrencies to other cryptocurrencies, it can become quite complex in terms of determining what is it that’s really reportable at the end of the year for that crypto owner.
Neil
And so a fundamental tax issue is an understanding of if you’re investing, you need to understand that a short term gain is taxed at a much different rate than a long term gain, which might affect your decision to transact. What’s the difference in the tax rate, Jan, for a short-term gain versus a long-term gain?
Jan
Short-term capital gains are taxes, ordinary income, so the highest individual rate that you have for your taxes for that particular year that you’re reporting will be the percentage of tax controls. If the gain is a long-term capital gain, then the long-term capital gains tax amount is different than the ordinary income and can be as low as 15%. At the federal level in the state of California, State of California doesn’t recognize capital gains, and so the taxing amount or the tax percentage for long and short-term gains is the same as the ordinary income tax rate in California.
Neil
So now that we know that crypto assets are unfortunately well on the radar of the IRS, and there are many people who have exposure, tell us about the services that Allen Barron provides to crypto investors and those who hold the asset.
Jan
What we’ve done is we’ve gone back and we’ve researched what are called aggregator platforms, and what the aggregator platforms do is they take the raw information, the raw data from cryptocurrency accounts and converts them into the reporting required for preparing a tax return. So for example, if the individual gets on the aggregator accounts and downloads the information from their varying crypto accounts, it will actually do the calculation of the gains or losses for the individual. Some of the more sophisticated cryptocurrencies themselves already have started and begun providing that information to their clients. The complexity arises when you go from one type of cryptocurrency into another type of cryptocurrency because then you have to go back and you have to establish the valuation as of the date of transfer. Some programs are sophisticated enough to do that, others are not, but that’s what these aggregator systems go back and provide in order to get the reporting requirements necessary to file a return.
Neil
And what do our Cryptocurrency and NFT services do from there?
Jan
From there, we go back and utilize the information coming from these aggregators, and we can complete the tax return and the schedule these in 4797, depending on whether or not the gains are long-term capital or short-term capital. On the other hand, we also provide the ability to create the aggregated information and put together the reporting required information ourselves, although that is far more costly because of course that’s very, very time intensive, and you have an individual going through Excel spreadsheets aggregating the necessary data with which to go back and complete the gain and loss calculation.
Neil
So Jan, you’ve been working directly with the IRS and its auditors for decades. How do you perceive the risk for a crypto investor with the IRS?
Jan
I think the risk of crypto is probably the same as with most other assets that an individual holds. I think there is more opportunity to fail in terms of reporting because of the complexity of the crypto transactions, which of course makes it a very challenging and very lucrative spot for the IRS to go back and audit. So to the extent that individuals have checked the box in the return that says that they are indeed trading or purchasing crypto, I think it’s going to increase the potential for audits, again, depending on dollar amounts and the size of the investments. And I think it’s really critically important that the audit papers relating to the crypto transactions are as clean and as precise as can be made.
Neil
And how do you perceive the risk for those that choose not to divulge their activities and don’t check the box or check the no box?
Jan
I think those individuals are probably at the highest risk for audit, particularly in light of the information that the IRS and the Department of Justice are able to obtain from the regulatory agencies that are currently utilizing crypto here in the States for those that choose to go offshore. Of course, the issue that you have is because in some parts of the world, there is no regulation. The chances are the loss of the investment to begin with is always first and foremost, but by the same token, the transfer of the funds to a platform of foreign platform will leave a reportable trail that can come back and haunt an individual in the event that the IRS picks it up.
Neil
So Jan, if one of our listeners is really concerned about potential exposure regarding cryptocurrency or NFTs, what could they do?
Jan
Well, I think the easiest thing to do is to call our office. We offer free consultations and we can assist the individual and assessing the potential risks that they have depending on the type and number of transactions in crypto that they may have. It’s always better to know what it is that you may be liable for than to put one’s head in the sand and suddenly fund the IRS knocking on your door thinking that you are going to be able to avoid the unpleasantness of an audit when in fact that’s probably not likely going to be the case.
Neil
It’s a safe way for them to find out where they really stand.
Jan
It is.
Neil
Thank you, Jan.
Jan
Learn more about cryptocurrency and NFT services and our integrated legal tax, accounting and business solutions, and visit allenbarron.com or call (866) 631-3470 to schedule a free consultation.
Contact Us To Learn More About Allen Barron's Services
For more information or to discuss your tax, legal and accounting needs contact Allen Barron or call 866-631-3470 for a free and confidential initial consultation. Learn about the importance of integrated business strategy and coordination across legal, tax and accounting systems.
Offices of Allen Barron, Inc.
Main Office
16745 West Bernardo Drive, Suite 260
San Diego, CA 92127
Phone: 858-304-0947
Phone: 866-631-3470
Fax: 858-376-1410
San Diego Office
5720 Oberlin Drive
San Diego, CA 92121
Phone: 866-631-3470
Fax: 760-741-1410
Las Vegas Office
333 South Sixth Street, Suite 230
Las Vegas, NV 89101
Phone: 702-749-4430
Fax: 702-933-1748
San Diego Office
750 B Street, Suite 2610
San Diego, CA 92101
Phone: 619-702-8356
Fax: 619-923-8356
San Francisco Office
300 Montgomery Street, Suite 410
San Francisco, CA 94101
Phone: 415-481-0475
Fax: 415-762-1539
Phoenix Office
40 North Central Avenue
Phoenix, AZ 85004
Phone: 602-903-7018
Fax: 602-357-1655