With all the drama surrounding the crypto sector lately, CZ's recent departure from Binance, and the resulting fines and scrutiny that will prevent the company from continuing to operate, tax compliance may seem like a dull concept by comparison. Finally, discussing cryptocurrency taxes has never been easy for investors of any size, and recent events in the crypto sector have made it even more complicated.
Wrapped tokens, decentralized funding options, cryptocurrencies, and non-slinging subsets of cryptocurrencies have made the tax conversation more complex and time-consuming. As the IRS continues to prioritize tax revenue related to crypto investors, the proposed changes will exacerbate already existing problems.
The open statutory amendments to Section 6045 (more on this below) have generated considerable debate and conversation since the amendments were originally proposed. After receiving more than 100,000 comment letters during the comment period, the IRS appears ready to implement these changes as originally written. With the beliefs (or at least the beliefs) of two of the industry's most successful operators, FTX and Binance, the IRS appears poised to continue applying existing rules to an ever-growing and changing asset class.
Let's look at two main things that will make cryptocurrency tax compliance more difficult than ever.
Reporting requirements are constantly changing
Deregulation may sound like a good thing, but it's only part of the conversation. In the discussion of cryptocurrency, especially as PayPal expands its offerings in this area, the revised 1099-K reporting requirements for the second year in a row, with the legislation already delayed until 2021, are notable. Taking a closer look at the changes and amendments, the reporting requirements for issuing a Form 1099-K for the 2024 tax year will increase from $600 to $5,000 for the 2025 report. If no further changes are made, the reporting threshold will return to $600 for the 2025 tax year. It is estimated that if the $600 is invested, an additional 44 million 1099-K forms will be generated this year.
This year, it will lead to less burdensome tax reporting requirements for crypto investors and entrepreneurs, as well as other entrepreneurs who rely on payment apps like Venmo and PayPal. Despite this relief, the fact remains that the IRS needs more information about payments made through these payment systems. Combined with the much stricter reporting requirements placed on crypto exchanges, investors will face more complex tax negotiations in the future.
Investors should continue to work with tax professionals who are aware of these changes and familiar with the nuances of the peer-to-peer payments ecosystem.
Trading revenue will be hard to track
Incomes from business and other activities make up the majority of the determination of taxable income. This is one area where the proposed changes to section 6045 will make tax reporting more complicated. Most crypto-investors are already familiar with the widely used first-in, first-out method; This is a cost-based method and often involves the largest tax liability because older investments are (usually) worth less than newer investments. Another option is special identification, in which the investor tracks certain assets sold, potentially reducing outstanding liabilities for tax purposes.
This seems like a simple solution, but discovering a specific identity for encryption purposes seems almost impossible. To implement this approach, specific assets must be identified before they are sold, not after the fact. This seems like a simple process, but centralized crypto exchanges like Coinbase do not currently support this type of tracking. To complicate matters, if investors have previously used alternative tracking methods and also received FIFO returns from exchanges, the manual reconciliation process will be time-consuming for investors and tax advisors.
In other words, stricter reporting requirements result in either higher than expected tax liabilities or much more work than originally anticipated.
Tax season is upon us, and no matter which side of cryptocurrency you look at, the next year promises to be a busy one for investors, practitioners, and entrepreneurs alike.