4 common challenges tax pros face with cryptocurrencies

July 16, 2019 9:04 AM

Cryptocurrency is treated as property for tax purposes in the U.S., not as currency. As a result, the tax reporting requirements for cryptocurrency look very similar to traditional stock trading: Owners incur capital gains and losses that must be reported on each taxable event. However, due to the nature of cryptocurrency and how it is transacted with, complications arise for tax professionals. This guide walks through the four most common challenges faced in cryptocurrency tax compliance.

A chart of bitcoin prices against Japanese yen is displayed on a computer monitor via software for trading virtual currencies in Tokyo, Japan, on Wednesday, Aug. 30, 2017. Stock of Bitcoin, the best-known digital currency, has surged 358 percent this year. While staggering, lesser-known competitors have seen even bigger gains, such as the more than 4,000 percent increase for ethereum. Photographer: Tomohiro Ohsumi/Bloomberg

Tomohiro Ohsumi/Photographer: Tomohiro Ohsumi/Bl

1. Assigning cost basis

Cryptocurrency is most commonly bought, sold, and traded on cryptocurrency exchanges like Coinbase, Gemini, Bittrex and others. In a sense, these exchanges look similar to stock broker sites like Etrade or Charles Schwab that allow users to buy and invest in stocks. Instead of stocks, cryptocurrency exchanges allow users to buy and invest in digital currencies. The difference from a tax reporting perspective is the limitations that exchanges face. Because cryptocurrency is a transferable asset, and users can send and receive it fluidly from their exchange wallets, the cryptocurrency exchanges are generally unable to give users an accurate 1099-B form at year end. This form traditionally breaks down each taxable event, cost basis, and gain/loss necessary for creating Form 8949.

Because of this reporting inability, tracking cost basis across multiple different cryptocurrency platforms becomes extremely difficult for tax professionals. If your client has not been keeping detailed records, it can be helpful to use crypto tax software to automatically pull historical cost basis and fair market value for all trades and transactions.

2. Loss of access to transaction data

It is not uncommon for users to have completely lost their transaction data needed for tax purposes. In the past, exchanges like Mt. Gox and Cryptopia have shut down due to liquidity issues and left users without historical transaction data. Other times users simply lose access to accounts.

There is very little that the tax professional can do if a client has lost access to their exchange or wallet account(s) and does not have a record of the historical transactions. The best approach is to work with the client to attempt to put all the pieces together as accurately as possible, then at the end, post a manual adjusting entry to zero out the ending balances for each “lost” account. In order to do this, all the ending balances for each existing account that the client still has access to must be reconciled first.

3. Lack of clear regulation

The cryptocurrency industry is still in its infancy, and regulators still have yet to address how some of the core scenarios seen with cryptocurrencies like forks, air drops, and splits should be treated from a tax perspective. The only official guidance came from the IRS with Notice 2014-21.

Because of the lack of clarity, it is up to tax professionals to interpret the law and draw parallels when able. In terms of events like air drops, many professionals who are well versed in cryptocurrency side on classifying the received cryptocurrency as income using the fair market value in U.S. dollars at the time the crypto is received.

According to IRS Commissioner Charles Rettig (pictured), further cryptocurrency tax guidelines will be released in the near future. The guidelines will focus on providing clarity for “acceptable methods for calculating cost basis, acceptable methods of cost basis assignment, and the tax treatment of forks.”

4. Difficulties with cryptocurrency tax software

Cryptocurrency tax software can be used to automatically associate historical cost basis and fair market value to crypto transactions. Tax preparers generally use these tools to import their clients’ historical trade data from cryptocurrency exchanges to then generate the reports that contain the necessary information for forms like the 8949.

Not all tax software is built equally, and common issues are seen across the board. One of the biggest challenges lies with the vast amount of exchanges and other platforms that are available for crypto users to trade or exchange tokens on. There are dozens of such platforms today, and if the tax software you are using does not directly support one, getting the historical data into the program can be tedious and require a significant amount of spreadsheet work. Manipulating data and trying to get it into the right format can chew up hours of a tax preparer’s time. Many platforms also limit the amount of data that can actually be imported. If a client has thousands or tens of thousands of trades, the software can get expensive.

Other issues deal with the actual functionality of these software platforms. As the industry continues to grow, the software tools will continue to get better and better.

In conclusion

The cryptocurrency industry is growing at an incredibly fast pace. This growth provides accountants servicing the space with a great opportunity to grow their businesses. However, before taking on clients, you should generally be aware of the implications of cryptocurrency taxes as well as the common challenges that you are likely to face when servicing clients.