Crypto Tax Reporting Rule Could Turn Unwitting Investors Into Criminals
The collapse of cryptocurrency markets couldn’t seem worse for clients invested in digital assets. But for some it is.
A less-noticed provision in a $1 trillion law passed last November requires certain taxpayers who receive more than $10,000 in digital assets a year to tell the Internal Revenue Service who sent them.
Beginning in 2024, recipients must report the sender’s name, address, and social security number within 15 days. Civil penalties for those who accidentally neglect the requirement can be as high as $3 million. Those who intentionally neglect this requirement can be charged with a felony and face up to five years in prison and heavier civil penalties. Offending companies face fines of up to $100,000 per transaction.
It’s not just wealth management advisors who seem to ignore this requirement and its potential impact on clients. Many entrepreneurs who own small businesses that accept payments in bitcoin, ethereum, or other digital currencies, or frequently trade crypto assets, don’t either.
Ric Edelman, the founder of the Digital Assets Council of Financial Professionals, an education and advocacy group, said the new law created concerns for “anyone involved in the transfer of digital assets”. One problem, he added: The law does not clearly define what it means to “receive” digital assets.
Bitcoin has lost about two-thirds of its value since hitting a record close to $69,000 last November, its worst moment since 2011. Two US dollar-pegged stablecoins, TerraUSD and luna, crashed in May. Last month, a hedge fund investing in cryptocurrencies, Three Arrow Capital, went bankrupt. Some exchanges have halted trading and withdrawals.
Digital freeze aside, some investors have made their fortunes. But winners or losers, they now have to tell the IRS.
Why advisors should care
The new reporting requirement comes as bitcoin and other digital currencies appear to be increasingly used. One in five Americans have invested, traded or used cryptocurrency as a form of payment, according a May 2022 poll by NBC News. One in five small businesses surveyed by Visa expect offer digital payment options this year. While only 20% of financial advisors currently advise clients on crypto, a third plan to do so by the end of this year. according an Arizent survey.
The IRS is concerned that cryptocurrencies could be used for tax evasion and other criminal activities like money laundering, drug trafficking, and ransomware. Federal coffers lose over $50 billion a year to crypto traders not paying taxes on gains according an estimate from Barclays in May. The seized tax collector $3.5 billion worth of digital currencies in its last fiscal year, which ended last September, a figure representing 93% of all monies seized for 2021.
The reporting requirement covers people who receive crypto through a trade or business, a concept that the Internal Revenue Code frequently refers to but does not define.
While his explanation includes many day traders and business owners who accept crypto as payment for goods or services, it excludes ordinary investors. Yet the requirement may affect a much larger number of people.
“The mere act of using digital assets can meet the ‘commercial or commercial’ requirement” wrote Abraham Sutherland, a lecturer at the University of Virginia School of Law and an adviser to the Coin Center, a nonprofit research and advocacy group, in an article last year.
The disclosure requirement is in addition to another requirement of the new law, a spending package for bridges, roads and power lines known as the Infrastructure Investment and Jobs Act. The 1,039 pages right treats brokerages like Fidelity Investments, Vanguard, and Robinhood as “brokers” that transfer digital assets to investors. Starting in 2023, this requires them to send clients and the IRS an annual form detailing a client’s digital transactions for federal tax returns to be filed in 2024.
This rule has drawn criticism that many investors will receive inaccurate forms, as crypto exchanges generally do not track the original price at which a customer purchases a digital asset. Bloomberg reported on June 29 that Treasury officials could delay its start date.
The other requirement governing recipients, not senders, expands a longstanding rule on disclosure of cash transactions. The new requirement for digital assets, including non-fungible tokens, effectively treats cryptocurrencies like cash, even if the IRS considers crypto to be taxable property like a stock or bond.
The rule covers people who “carry on a trade or business”. The IRS is vague on this concept, which it defines as “an activity carried on for a living or in good faith to make a profit”. The concept is intended to help the country’s tax collector crack down on people who falsely claim business deductions for their part-time hobbies – horse breeding or photography, for example. Under tax law, leisure expenses can only be deducted up to the amount of a taxpayer’s leisure income. In contrast, business expenses can be deducted from a taxpayer’s total income.
Sutherland wrote that the new reporting requirement “demands the impossible” from taxpayers. “Digital assets may not be ‘received’ from an individual whose personally identifiable information can be verified and reported.”