This article was written by Mark Elsaesser, CPA, Senior Accountant.
Whether you are a tax professional, accountant, financial advisor, cryptocurrency expert, or individual investor, it is safe to say that you have your hands full trying to stay current with the most recent regulations, reporting requirements, and market trends of the digital asset space.
It is clear that virtual assets like cryptocurrency and NFTs are growing in popularity at a rapid pace. Cryptocurrency capital gains globally, reached $103+ billion in 2021. Bitcoin’s capital gains globally were $95 billion with the United States representing $30 billion of that figure. More than 80% of Bitcoin transactions are related to crypto exchanges, only around 2% is used in commercial transactions. Less than 1% of funds are sent to illicit addresses. However, there is no denying that this new asset class is most certainly catching the attention of individuals and businesses globally. It is important to highlight that the most active investors in Blockchain Companies are Google ($1.5 billion), BlackRock ($1.1 billion), Morgan Stanley ($1.1 billion), Samsung ($979 million), Goldman Sachs ($698 million), BNY Mellon ($690 million), PayPal ($650 million), and Microsoft ($477 million). Given this recent increased interest in cryptocurrency, it is crucial to understand the tax implications that come along with it. So, the million-dollar question that everyone is asking, what needs to be reported to the IRS and what does not?
The IRS recently released a draft version of the 2022 Form 1040 for next tax season, with an expanded question about virtual currencies now referred to as digital assets – (See below the 2021 language vs. 2022 language):
- “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”
- “At any time during 2022, did you: (a) receive (as a reward, award, or compensation); or sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?
The expansion of the first question of the Individual Form 1040 in conjunction with the expansion of the IRS under the Inflation Reduction Act (87,000 new IRS agents), should reinforce the importance of understanding this new financial asset class including the proper reporting requirements that go along with it. Updating the terminology from “virtual currency” to “digital assets” has been implemented to encompass other forms of digital assets besides cryptocurrency, such as nonfungible assets, or NFTs, many of which rose rapidly in value last year before seeing sharp declines.
From a U.S. tax reporting standpoint, the current tax law treats convertible virtual currency, such as Bitcoin and other cryptocurrencies, as property for federal income tax purposes. The term “virtual currency” refers to “a digital representation of value that is not government-issued legal tender. A cryptocurrency transaction may be subject to both income and capital gains tax, depending upon the event. Cryptocurrency is taxed as a capital asset and the gain or loss of every taxable event must be reported on Form 8949 of an individual’s income tax return. Additionally, any cryptocurrency received from staking, air drops, rewards, etc., may need to be reported on Schedule 1 of an individual’s income tax return at Fair Market Value (FMV) upon receipt.
The following events that can trigger capital gains or losses, can be summarized as any disposal of your cryptocurrency for proceeds that are different from cost basis:
- Selling, exchanging, or swapping (into another digital asset or into a stablecoin, like USDC), paying a vendor, minting, or selling NFTs.
Some cryptocurrency transactions are non-taxable. It is important to note that if an individual simply purchases cryptocurrency, they do not have to check the box “yes” on their individual income tax return. None of the related transactions below will contribute to tax liability for you individually or as a business:
- Buying crypto with fiat (i.e., USD), gifting and/or donating, transferring like-for-like crypto assets between your exchange, hardware and/or software wallets (i.e., personal wallet to personal wallet transfers).
Currently, from a business perspective, there is not any authoritative guidance tailored to digital assets under U.S. Generally Accepted Accounting Principles (GAAP). Therefore, companies must look at existing guidance allowing them to bridge the gap. The AICPA published their opinion that digital assets should be treated as intangible assets with an indefinite life for accounting purposes under U.S. GAAP. With an intangible asset classification, businesses must assess and carefully track all their individual digital asset acquisitions and the associated book value of these assets. Each time a company acquires a new unit, multiple units, or a fraction of a unit of cryptocurrency, those new units acquired are referred to as “lots”. A lot is simply a batch of units, or divisible fractions of units, with the same acquisition date and the same acquisition price. There are three main components that businesses holding digital assets must recognize when it comes to impairment:
- Impairment events occur in any instances where the price of an asset dips below the initial purchase price or impaired book value.
- Businesses must book impairment for each individual unit or fraction of a unit, and once the impairment event has been identified and the associated unit value has been written down on the businesses balance sheet, you can’t write the impaired unit back up under the current accounting guidance, even if the price rebounds before the end of the reporting period.
Individuals and/or businesses that are looking to diversify into this new financial asset class should not go at this alone. The number of manual hours required to aggregate the appropriate data for reporting purposes is tedious and complex. Consulting with your tax professional, accountant, financial advisor, or cryptocurrency expert is imperative prior to making any decisions.
If you need further guidance or have any questions on this topic, we’re here to help. Please do not hesitate to reach out to our trusted experts to discuss your specific situation.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.