The Internal Revenue Service announced yesterday that the 2022 filing season will open January 24, and tax returns for individual U.S. taxpayers are due on April 18. Tax season is especially cumbersome for those who buy, sell, trade or invest in digital assets such as cryptocurrency and Non-Fungible Tokens, or NFTs. Unlike your average brokerage account at Edward Jones, until now, most cryptocurrency exchanges haven’t provide a 1099 or other information reporting form that accurately reports gains and losses from transactions entered into in a given year. Calculating basis, gains, and losses was incredibly cumbersome and expensive for investors in digital assets.
Today, TaxBit announced a new network that will provide free, unlimited federal information returns needed for cryptocurrency and NFT investors for 2021 for transactions that were conducted on exchanges that belong to the TaxBit Network.
Tax Reporting for Digital Assets Like Crypto and NFTs – 101
In general, cryptocurrency and NFTs are taxed like property. You can read more about how to properly report these assets here. But investors in cryptocurrency and NFTs do not currently get the kind of information reporting forms that holders of publicly traded securities receive. The lack of routine and uniform information reporting makes it extremely costly and time consuming for taxpayers to prepare their federal income tax returns and report virtual currency or digital asset transactions.
Say you bought 3 shares of Microsoft
With the passage of the Infrastructure Investment and Jobs Act (Public Law 117-58), cryptocurrency will be defined as a security and subject to increased information reporting requirements by “brokers,” which will now include “[a]ny person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Put differently, once the new law takes effect in December of 2023, all digital asset brokers, exchanges, or sellers will be required to provide information reporting forms for digital asset transactions, including cryptocurrency and NFTs.
A New Approach – TaxBit Network
TaxBit’s network will revolutionize tax return preparation for digital asset investors and users now, and just in time for 2021 filing season. It will offer every user of a certified TaxBit Network company the option to receive a free 2021 tax information form, including IRS Form 8949, which is required to report property exchanges, sales, and dispositions, as well as forms that will provide an income report.
According to TaxBit, “In tandem with the launch of TaxBit Network, many participating platforms will be incorporating a one-click, free TaxBit sign up within their native applications to further simplify access to 2021 tax forms and year-round access to TaxBit’s industry-leading software.”
TaxBit CEO Austin Woodward, who is a Certified Public Accountant, created TaxBit together with his brother Justin Woodward, who is a tax attorney. Austin Woodward describes the TaxBit Network as similar to a health insurance network that will provide services free of charge to the end-users (customers) who use the in-network providers. In fact, the TaxBit “network” will operate much like a health insurance network. In-network exchanges will now include a feature that allows clients to press a button and produce the tax information reporting form associated with all of the transactions in that account, free of charge. TaxBit’s computation and tax form preparation services can still be used for years prior to 2021 and for out-of-network exchanges or private wallets, but taxpayers will have to pay a fee for those services. The TaxBit Network includes well-known cryptocurrency exchanges such as Coinbase and is growing every day.
“With the recent passing of the cryptocurrency tax provision in the Infrastructure Bill, proactively providing our users with the tax reporting and forms they need is an important step in our commitment to safety and compliance. Binance.US is excited to make the tax reporting process simple and free to our users through the TaxBit Network,” Brian Shroder, CEO of Binance.US, said in a statement.
“TaxBit solves a critical challenge for our clients, cryptocurrency investors and digital asset companies, through increasing consumer confidence, which is a win for the industry at all levels, said Thomas Kane, CEO of Kane Capital Group. “Cryptocurrency investors of all magnitudes will be provided an element of standardization for the tax reporting process where there is not a clear precedent. These types of services are essential to retail and institutional investors as U.S. lawmakers determine how to best implement a regulatory framework for this industry.”
Digital Asset Tax Compliance Issue
The IRS has made no secret that it is aggressively pursuing taxpayers who engaged in cryptocurrency transactions and failed to accurately report and pay tax on those transactions. Moreover, the IRS has confirmed that it is not considering a global voluntary disclosure program specifically designed for taxpayers who engaged in digital asset transactions but failed to disclose them.
“We expect compliance with the rules to properly report activities involving any property or currency to include virtual currency. While the technology can be complex, the taxation is much simpler: spending or disposing of virtual currency is generally a taxable event. At the end of the day, when you sell or trade something for more than you paid for it, you can expect to trigger a tax,” according to the IRS. Indeed, not only is the technology complex, but so too is maintaining the relevant information needed to calculate and report federal income taxes based on those complex transactions. The unlimited wallet and unlimited transaction product that TaxBit is offering for free will certainly make it easier for taxpayers to correctly prepare and file their taxes for 2021 and 2022, ahead of the new reporting required by the Infrastructure Bill.
What about Private Wallets? Yes, the IRS can see you.
As a tax controversy attorney, I often hear from people who think that crypto held in a private wallet is just that – private. And these same people think that they can disclose crypto held on a public exchange, such as Coinbase, without having to disclose the existence of a private wallet. This is a terrible idea. First, the simple act of disclosing part of the story is far worse from a criminal tax perspective then just about any other course of action possible. The taxpayer demonstrates an understanding of what is required, but only does some of what is required. This is textbook criminal tax evasion.
Second, just because something is in a private wallet does not mean that the IRS cannot see it. Indeed, according to the IRS, “[i]t’s certainly feasible to track virtual currency as it enters an address, even when the address is held in a private wallet. Then, when the wallet owner `spends’ virtual currency by engaging in a transaction, the tracing process can resume and follow the progression of transactions, either backward or forward along the blockchain, to obtain both the history of transactions leading to the private wallet and the disposition of virtual currency when it leaves the wallet. The phrase we live by at the IRS, ‘Follow the money,’ works as well in the virtual currency world as it does in the fiat one. It’s just that in IRS parlance, we now think of ‘Following the property,’ as virtual currency is defined by IRS.”
When asked about whether the IRS can trace funds held in a private wallet, the IRS responded affirmatively, “IRS has deployed various software tools to agents working cases involving virtual currency transactions. We are able to trace transactions and taxpayers on the blockchain as well as through various data sources we have, which we can then use in evaluating whether a particular taxpayer is tax compliant. It’s always important to keep in mind that any transaction has two sides, not just one. There is always both a sender and a receiver. In addition, there is always a transmission of the value between the sender and receiver and this is where many transactions become visible on the blockchain. When the blockchain, which is by definition, a `public, distributed ledger’ is used, the transaction trail is visible and can be traced.”
TaxBit’s new Network won’t allow individuals to generate free reports that go back to years prior to 2021. But for anyone who engaged in cryptocurrency transactions without reporting them in past years, now is the time to consider paying for services like what TaxBit is offering to get ready to come into compliance. Just be sure to do so with a qualified tax lawyer who can advise on the best way to come in without getting criminally prosecuted.