Cryptocurrencies can offer major rewards, but this often entails navigating significant risks, and the path to success is littered with those who failed to properly handle them. These risks can come from a wide variety of places depending on factors like who is holding the cryptoassets, where they come from, what they're being used for, when they're being used, and to (or from) whom they're being sent. Making things even more complicated is that people are often entirely unaware of these risks or, worse, severely underestimate them.
Where the accounting professional comes in is by explaining these risks and helping their clients factor them into whatever it is they plan to do. Whether about taxes, accountants or government regulations, accountants understand that it is better to have these essential conversations with their clients early, before regulatory authorities do it for them.
Accounting
In terms of accounting for cryptocurrency — things like classification, calculation and presentation — Phil Drudy, managing director and tax practice leader of the New York tax department of Top 25 Firm CBIZ, said that a lot of clients either don't think they have to report transactions at all or, if they do know, have no idea how to do so properly. A lot of this is because of the complexity of the cryptocurrency landscape itself, which can confuse the issue even for close observers of the sector.
"Between hard forks and soft forks and dealing with how they're transacting within the platform, and if they're bitcoin or ethereum or name your flavor — it's just getting our arms around the data. If they're into investing actively in crypto, that could be a lot of transactional analysis that they don't necessarily understand," he said.
Even when clients know what needs to be accounted for, they can struggle to track the cost basis appropriately. Patrick Camuso, leader of cryptocurrency and blockchain specialist accounting firm Camuso CPA, said this is something he frequently harps on with clients, as not getting it right can have dire consequences. "Is it being done correctly in terms of applying a consistent price methodology? Some part of that is having the right software and some of that is your source of pricing information on an asset-to-asset basis. Tracking is important for a variety of reasons. If it's on the balance sheet, investors need to know how you arrived at that cost basis if they want to make any interpretation of those assets. And for taxes, if you're not tracking that, if and when you sell or spend those assets, it will obviously hurt you and it ends up being a pretty big disaster," he said.
Another pitfall that accountants steer their clients around is the idea that cryptocurrencies are fungible, as is their accounting treatment, according to Mike Andrusko, managing director of Centri Business Consulting's digital asset practice. "We want to understand the nature of the entity itself. The classification will vary depending on what type of entity you're talking about. If it's an investment company versus a noninvestment company, that can have different ramifications. It could be more of an investment or a financial instrument versus an intangible asset. How those classifications occur also affects how they're held," he said.
More recently, accountants in this sector have also been having conversations about the proposed cryptocurrency guidance from the Financial Accounting Standards Board. Its first-ever proposal on the topic, the FASB draft was developed due to feedback that the current accounting for holdings of crypto assets in most cases as indefinite-lived intangible assets — which is a cost-less-impairment accounting model — doesn't provide investors with enough decision-useful information.
With this in mind, the board proposed that cryptocurrencies be accounted for at fair value, with changes recognized in net income each reporting period. Cryptoassets will be measured at fair value separately from other intangible assets in the balance sheet, and changes in the fair value measure of cryptoassets, similarly, will be done separately from changes in the carrying amounts of other intangible assets in the income statement.
Mark DiMichael, digital assets practice leader at Top 100 Firm Citrin Cooperman, said that this change will remove a lot of the tedious challenges of cryptocurrency accounting. "It will make accounting much easier because you used to have to consider each lot separately, whether it's impaired in value, and maybe some of that bitcoin you bought wasn't impaired and some was. You'd need to write down pieces of that and track it. That was a hassle, so this is a more consistent system," he said.
While this does mean simpler accounting, Markus Veith, who leads Top 10 Firm Grant Thornton's digital asset practice, noted that simpler does not necessarily mean simple.
"I would say fair value is much easier to handle and account for. I would say a lot of companies are struggling to get the accounting right on a cost basis because if you have a cost basis you always have the issue of costing … . You have the same issue on fair value basis, but it's a shift between realized and unrealized; the only uncertainty is realized versus unrealized, but if you can't track the cost accurately, your financial statements could be materially wrong. You're supposed to track the batches and follow the method you pick," he said.
Tax
Cryptocurrencies come with a bevy of potential tax consequences as well. DiMichael, however, said that some people are unaware of what does and does not constitute a taxable event or, even worse, they have a misconception that gives a false sense of security. He works hard to impress upon clients the fact that anytime one buys or sells cryptocurrency tokens, it is taxable or, at the very least, creates basis.
"It's gotten better, but a few years ago the mindset of the crypto industry was. 'Oh, it's not taxable until you cash out back into dollars.' I don't know how that rumor got started but it was out there and there have been many, many people who come to us to help clean up years and years worth of erroneous recordkeeping when it comes to crypto assets, or they may not have been keeping a record at all because [they thought] it only matters when they cash out, which is not the case," he said.
CBIZ's Drudy, meanwhile, said that while currently the consensus is that wash sale rules — which bar taxpayers from deducting losses on the sale of a security that they replace within 30 days — do not apply to cryptocurrencies, the Internal Revenue Service proposed in March to place them within its scope. While he wasn't sure if it would pass, he noted that there is traction within the IRS to do so.
This plays into another point he raised: Don't lie to the IRS. He pointed to the question that is now at the top of tax returns asking about the taxpayer's cryptocurrency transitions. He has heard some worry that disclosing their activities will open a taxpayer up to IRS scrutiny, but he said that not answering can do the exact same thing. He theorized that the question is there for the IRS to study how many people do not report transactions the agency knows happened, noting it did a similar thing with foreign bank accounts before. Considering this scrutiny, he felt it was not a good idea to get on the service's bad side.
"We believe the purpose is to start harvesting information to see how many people actually report transactions compared to what they think should be reported. It's been on the form the last few years, right on top of the return, so it's a light being shone on that," he said.
He also noted that while there is a debate over whether cryptocurrency from mining activities represents compensation for a service, the IRS has come out squarely on the side that it is, and should therefore be taxed.
"There is a position saying it's almost like an artist where you create a piece of art and so why pay tax when you're the one who created it? You should only pay tax when you sell it. The position people grapple with is, if I create a token, shouldn't I only pay tax when I monetize that token? And the IRS position is no, you performed a service [of validating a blockchain], you got paid for that service with this token and therefore it should be income," he said. While there is an ongoing court case on this question in Memphis, he said that if a miner wants to play it safe, they'll count the token as income.
Beyond just cryptocurrencies, the introduction of nonfungible tokens or NFTs has raised a host of new tax questions that may not be entirely straightforward. The IRS has suggested using a look-through approach where the tax treatment of an NFT is contingent on the underlying asset connected to it. So, for example, if the NFT is a concert ticket, it is taxed like a concert ticket; if it's linked to a security, it is taxed like a security; or if it's linked to a collectible, it is taxed like a collectible.
In many cases this analysis is clear and simple, according to Citrin Cooperman's DiMichael, who noted that if he had a client who had an NFT that conferred equity in a company, he would treat it like equity from an accounting standpoint, as the NFT is merely proof of ownership. That this proof is a digital file versus a paper stock certificate makes no difference.
However, there are other areas where things remain ambiguous, such as digital art. He noted that IRS regulations say any work of art can be counted as a collectible; at the same time, however, the agency also refers to "tangible personal property" in the same section.
"This word: tangible. Does the line imply the writers of this section meant that all of these must be tangible? Does a work of art implicitly mean tangible? Does this apply to everything? If it does, a collectible must be tangible and the Bored Ape would not qualify. However, if this line is a standalone and does not imply this must be tangible, that is a different story. That is currently the biggest item," he said. (The Bored Ape is a limited NFT collection where the token itself doubles as membership in "a swamp club for apes.")
Camuso echoed the concerns regarding the classification of digital art. To this he added that there is also ambiguity over the taxability of an NFT unto itself if all it does is confer ownership of a connected asset. The question of whether or not it is taxed separately from the asset carries a lot of digital tax implications, he said.
He also noted that there are serious sales tax considerations that few seem to consider (see sidebar on p. 20). He noted that, already, there are 31 states that apply sales taxes to digital goods, which would likely include NFTs. Washington, Pennsylvania, Wisconsin and Minnesota have explicitly said so over the past few years, and he expects others to in the future. What's more, he said that Washington State said in its guidance that NFTs have always been taxable.
"So now they're stating they can go after retroactive sales taxes. So if someone has sold an NFT in the past, well, the statute of limitations in Washington is six years, and most people haven't been selling NFTs that long, so now there is a huge risk of states coming after you for uncollected sales taxes, plus penalties on top of that, and most NFTs sellers did not collect these sales taxes. This is a huge, huge, huge issue," he said. He noted there could be similar issues with value-added tax in several European countries (though he noted that Italy has said it will not apply VAT to them).
Regulation and organization
If only accounting and taxes were the only things to worry about! However, cryptocurrencies are also subject to a number of financial regulations on the federal and state levels. Veith from Grant Thornton said that the past year has seen a major uptick in activity from regulators like the Securities and Exchange Commission. He said the agency has landed on a standard where if a token acts like a security, it must be registered like a security. He noted that certain players in the market didn't like this because doing so is costly, and so there has been some talk of possible moving offshore. He said that this likely won't make much difference, however: "You hear a lot of chatter about companies moving offshore to avoid getting drawn into this regulatory scrutiny, but if you deal with U.S. persons you're still subject to it. You can't just say, 'I'm moving my headquarters outside the country.'"
He also noted that it is not only the federal government that people need to concern themselves with — several state governments, such as New York's, have instituted regulatory requirements of their own. Many of these regulations have to do with controls to prevent things like money laundering or terrorist financing. Many advisory engagements, he said, have to do with getting things like a client's anti-money-laundering process up to code.
Not that strong controls should only be implemented for regulatory compliance. DiMichael noted that companies need to also consider the possibility of theft. "You don't want an employee to go running off with your crypto," he said. "So it's important to have good internal controls in place, like multisignature wallets and policies on who can control the keys and who has the keys. You may want to use a custodian or an exchange and build controls and a plan around that so your company can operate in a safe way and not lose the crypto."
All of this is part of the overall practice of keeping everything as organized as possible. Centri Business Consulting's Andrusko said this is the main thing they communicate to cryptocurrency clients: "What are your recordkeeping processes, do you practice good wallet hygiene, what is your current accounting software, what blockchains are you on, what exchanges are you on, and how do you track all of that? It could be in Excel for some. We've had some in the past where it was nothing, which was why they were talking to me."
