Individuals and businesses all over the world are dealing with cryptocurrencies either for investment purposes, as a part of their businesses, or for fun. Regardless of the reason, many of these crypto transactions are taxable events. This includes crypto-to-crypto exchanges, income from mining and yield farming, staking, receipt of new tokens or airdrops, and income from other De-Fi activities. It also includes any appreciation in value upon the sale or disposition of your cryptos. Failure to report your income or gains from these transactions or falsely reporting crypto transactions could lead to an Internal Revenue Service (IRS) investigation.
To protect yourself, many individuals and businesses are seeking the services of a crypto-certified public accountant (CPA). That said, the experience of CPAs in the crypto industry is severely lacking due to the novelty of this field. As a result, it is critical to do your due diligence before hiring a crypto CPA—whether your crypto CPA is preparing your business taxes or acting as your authorized representative before the IRS. This article outlines the most important factors to consider before hiring a crypto CPA.
10 Points of Consideration
In 2014, the Internal Revenue Service (“IRS”) issued first guidance on cryptocurrencies that concluded that crypto transactions are taxable events and are to be treated as “property” for federal income tax purposes. Over the years, the IRS has been both encouraging and then aggressive in reminding individuals to report and pay taxes on their crypto transactions. Starting in the tax year 2019, the IRS added a new question on Form 1040 that specifically asks taxpayers whether they received, sold, sent, exchanged, or otherwise acquired any financial interest in any cryptocurrency, or “virtual currency.” The next few tax years have been both confusing and unsettling for taxpayers. Individuals are uncertain how the IRS will respond to their interpretation of the tax code regarding their crypto transactions. Therefore, CPAs knowledgeable in cryptocurrencies are in great demand. Below are ten things to consider before hiring a crypto CPA:
Ask your crypto CPA about how the IRS is currently treating cryptocurrencies for tax purposes.
Since 2014, the Internal Revenue Service (IRS) has made clear that it is treating transactions in cryptocurrencies—or “virtual currencies”—as property. This means that the receipt or purchase and the sale or disposition are taxed similarly as would be a car or a house. Cryptos are not a currency. Your crypto CPA should explain this and the consequences thereof to you.
Understand and take the approach that every cryptocurrency transaction may count as a taxable event and ask your crypto CPA to give you a broad overview of cryptocurrency taxation.
Selling virtual currencies or cryptos is not the only time crypto transactions are taxed. Any time your cryptos are transferred out of your wallet, exchanged for fiat or other cryptocurrencies or otherwise changes wallets are all examples of taxable events. Improper recording and tracking of these FMVs at the date of purchase, sale, and disposition could be devastating.
Make sure you are aware of how to calculate your tax basis and how your CPA uses the basis to record crypto transactions.
Your cost basis in your crypto is the amount you spent to purchase the crypto, including fees. Over time, your adjusted basis increases due to expenses and decreases by credits and deductions. When you sell your crypto, your gain or loss is calculated by subtracting your adjusted basis from the FMV at the time of the sale. IRS Publication 551, Basis of Assets, provides further information.
Federal agency views on cryptocurrencies are inconsistent and uncertain. Crypto CPAs must accept this, stay abreast of legislative changes, and guide their clients accordingly.
The IRS and the SEC are the two main federal agencies releasing guidance and interpretations on cryptocurrencies. When it comes to blockchain technology and cryptocurrencies, the SEC´s perspective focuses on investors, investment advisers, broker-dealers, capital markets and exchanges, and transfer agents. The IRS tends to focus on using cryptocurrencies as a medium of exchange, a unit of account, and a store of value as well as the various tax reporting and disclosure requirements for crypto transactions. Crypto CPAs should be knowledgeable about the current approaches, interpretations, and enforcement processes for these two federal agencies.
Inquire about the difference between crypto transactions that are generally ordinary income and crypto transactions that receive capital treatment. Make sure your crypto CPA can convey this information.
Generally, anything that is mined, staked, earned from free token giveaways, airdrops, or initial coin offering (ICO) proceeds is an ordinary income. Once you hold any of those items and then later sell or otherwise dispose of them, the crypto transaction now gets capital treatment—which will be either a long-term or short-term capital gain/loss depending on the length of time you held them.
Ask about how, when, and under what circumstances you would have to recognize a gain or loss when you sell your cryptocurrency for real currency.
When a taxpayer sells cryptos, they must recognize capital gains and capital losses on the sale, subject to the limitations for deducting capital losses. This amount, as your crypto CPA must be able to explain, will be the difference between your adjusted basis in the crypto and the amount you received in exchange for the virtual currency. The IRS´s Publication 544, Sales and Other Dispositions of Assets provides more info on this topic.
Ask about the cryptocurrency software your crypto CPA uses, including how they reconcile gains and losses for their clients.
Cryptocurrencies and blockchain applications are novel technologies that not all investors, federal agencies, and CPAs have fully grasped. A good CPA will tackle such new technology applications with specialized software tailored to cryptocurrency tracking. If your crypto CPA says they reconcile crypto transactions by hand, consider that a red flag. Tracking FMVs across multiple exchanges for numerous cryptocurrencies is virtually impossible without specialized technological software.
Crypto transactions could open the door to various additional reporting and disclosure obligations under federal law.
Some cryptocurrencies will satisfy the SEC´s definition of “security” and will therefore have to be registered or exempted. Additionally, if you host an online platform that sells cryptocurrencies that are deemed “securities,” the SEC may want your platform to be registered as an “exchange” and the individuals operating and managing the platform to be registered “broker-dealers” or “investment advisers,” in certain circumstances, under the federal securities laws and the Investment Advisers Act.
Depending on what you or your business does with cryptocurrencies may necessitate additional obligations above and beyond IRS tax reporting and SEC registration. Your crypto CPA should thoroughly convey this to you.
If your business involves certain crypto transmitting services undertaken on behalf of buyers and sellers, you may have to apply for a money transmitter license under the Bank Secrecy Act and FinCEN rules. However, if you are merely using your cryptos to expand your business or pay employees, this requirement may not apply. Lastly, if you hold cryptos in a foreign exchange account, you may have to file an FBAR report on FinCEN Form 114, Report of Foreign Bank and Financial Accounts.
Ask and make sure you understand, and your crypto CPA can explain how federal agencies such as the SEC and IRS are going after individuals and companies engaging in crypto transactions.
There is no uniform or comprehensive piece of legislation on cryptocurrencies. Instead, federal agencies are using already-existing statutes for regulating and investigating crypto transactions as well as for their enforcement efforts. Notably, the SEC has released a framework that helps it and individuals understand how and when registration applies to coins, tokens, and other virtual assets.
“The IRS takes the position that crypto income is severely underreported or falsely reported by U.S. taxpayers. As a result, it has responded by increasing its investigations for tax evasion and false income tax filing. Taxpayers failing to file or falsely filing tax returns are facing fines and criminal penalties. In addition to the IRS, the IRS often works in conjunction with other federal agencies such as the SEC or the DOJ and FBI where the taxpayer engaged in criminal conduct. If you need help with your taxes or need a representative to act on your behalf before the IRS, it is important to do thorough due diligence when selecting a crypto CPA.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.
Hiring a crypto-certified public accountant (CPA) is an important event—whether you need tax preparation services that involve complex crypto transactions or whether you have been flagged by the IRS for an examination and need a CPA experienced in crypto transactions to act as your authorized representative. Your crypto CPA must be knowledgeable of tax laws and must be able to explain the basic IRS strategy and approach towards cryptocurrencies as well as advise you on which of your crypto transactions trigger tax liability. Individuals and businesses who undertake various cryptocurrency transactions should think carefully about the crypto CPA they retain such as by considering the ten tips in this article.
Oberheiden P.C. © 2022 National Law Review, Volume XII, Number 104