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Take a wild guess: Crypto confusion reigns as tax deadline nears

Take a wild guess: Crypto confusion reigns as tax deadline nears
Bitcoin mining is under way at BitFarms in Quebec, Canada. Many accountants consider bitcoin mining to be taxable as ordinary income. (Lars Hagberg / AFP/Getty Images)

If you thought trading bitcoin was wild, try figuring out how to pay taxes on it.

Cryptocurrency investors are wrestling with spotty records, tangled blockchain addresses and rudimentary guidelines issued back in the ancient days of 2014. After last year's boom in values, many people are likely disclosing transactions for the first time, adding to confusion.

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Digital-coin enthusiasts and tax professionals are "freaking out" before Tuesday's filing deadline, said David Siegel, co-founder of a company that's building a digital wallet for crypto investors. They're scrambling to track down even basic information in a murky world where tokens are traded on multiple exchanges with limited record-keeping.

"The big unknown is, who owns what, when and in what jurisdiction," said Siegel. "That's really hard to determine in a surprising number of cases."

Last year's 1,400% surge in bitcoin lured droves of investors into the virtual currency and competitors such as Ether and Ripple. Since bitcoin reached its peak of around $20,000 in December, before losing roughly half its value in 2018, many of those who sold last year would have gains to report.

For investors in need of help, it can be difficult to find someone who can adeptly take on the filing challenge. Many tax preparers are put off by the industry's lack of records, as well as its association with criminal activity, said David Klasing, an accountant and tax lawyer in Irvine who specializes in digital currencies.

Others simply don't have the expertise.

"There's a lot of professionals that are coming in and trying to figure out how to provide services — attorneys and CPAs and accountants," said Irina Litchfield, an Austin, Texas-based advis​​​​​​​or for blockchain startups and initial coin offerings. "Not a lot of them actually know how to do it well."

The Internal Revenue Service's only guidance on digital tokens came in 2014 — before the industry hit breakneck growth. It said that in general it treats cryptocurrencies like property, which means most sales and trades are subject to capital-gains tax.

Simply buying digital coins and holding onto them shouldn't trigger a tax bill. But just about every other crypto transaction could, at a welter of rates.

Think mining, which many accountants consider taxable as ordinary income and possibly self-employment tax. Or using bitcoin to buy a sofa on Overstock.com — cue capital-gains taxes. Swapping one digital currency for another seems to be tax-free for this year's return, though that will change next year with the new tax law.

But then there are trickier scenarios like "air drops," when coins magically appear out of nowhere in your digital wallet. Or "hard forks," when a cryptocurrency splits in two. Many accountants say the latter two are taxable like ordinary income.

Tax preparers are worrying about those newer types of crypto transactions, according to Klasing. They're also spooked by the spate of ICOs that may have skirted U.S. Securities and Exchange Commission rules, he said.

"The government is basically just telling practitioners to take a wild-ass guess," he said.

An IRS spokesman said that in addition to the agency's 2014 guidance, taxpayers should look at other rules governing an exchange or transfer of property and find the "factual scenarios that most closely resemble their circumstances."

Paying the tax man is relatively new for an industry built on anonymity and avoiding government control. For this filing season, many investors who have been trading for years will "come out of the woodwork" and disclose crypto on their returns for the first time, according to Jeffrey Kahn, a tax lawyer in Irvine who works with digital-currency holders.

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Popular exchange Coinbase told about 13,000 users in February that it would be turning over their account data to the IRS after losing a court fight to keep records private.

The government is warning crypto investors that they must own up to their purchases. The IRS said in March that if taxpayers don't "properly report" their transactions, they could face penalties and, in extreme cases, criminal prosecution.

Accountants need to be mindful as well. If they sign off on a return that understates a tax bill due to "unreasonable" arguments or "willful or reckless conduct," they can face penalties of as much as $5,000 or 50% of the fee paid.

For do-it-yourselfers, tax-prep companies offer resources for digital-currency buyers. TurboTax's support site has 15 pages of questions tagged to "bitcoin," a help center and a brief crypto tips page.

H&R Block Inc. has a four-part explainer on the topic, as well as an online community forum for crypto queries. In it are hairy questions such as whether taxpayers are eligible for deductions if their bitcoins are stolen.

Luis Guerra, a copywriter in Seattle, tackled his return on his own and says he's still wondering if he did it correctly. He, like many others, bought cryptocurrency in December after watching a friend get rich quick, but hadn't considered the tax implications.

After a lot of Googling — and getting a lot of misinformation — Guerra ended up using a website that could generate a report of his buys and sells across exchanges, and uploaded it to TurboTax. He followed the instructions to a T, but said the process was still confusing — so much so that he almost gave up on trying to figure it out.

"Then the angel on my shoulder just pops up and is like, 'Dude, do it right," he said. "You don't want to owe anybody any money, and you definitely don't want the IRS knocking on your door.'"

Katz and Browning write for Bloomberg.

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