A new report has found that most crypto holders are “alarmingly unaware” of both the taxes they owe on their investments and the deductions they are entitled to claim.
In many cases, cryptocurrency accounting platform Blox and tax software provider Sovos said, that will end up costing them money.
The scale of confusion and uncertainty surrounding crypto taxation is so great that half of the American accountants surveyed revealed that they believe most of their clients who own digital assets are likely to be audited and owe back taxes.
Beyond that, more than 45% said many of their clients “know very little or nothing at all when it comes to understanding taxable crypto activity,” according to the 2020 “Crypto Tax Report,” prepared by Wendy Walker, a solution principal at Sovos, and Michael Soussan, senior marketing manager of Blox.
Only 16.7% of those clients completely understand it, the survey found.
Even though bitcoin has been around for over a decade, this is only the first tax year that the U.S. Internal Revenue Service has included language about digital assets in its standard filing form. Taxpayers are now asked whether they held “any financial interest in any virtual currency” in 2019.
Walker and Soussan paint a picture of confusion and multiple failings—some of which aren’t the fault of crypto investors or the accountants who serve them.
Notably, the report criticized “the lack of IRS guidance and enforcement related to crypto investments,” and said that even the main guidance it released in 2014 “did not fully address how crypto should be reported.”
That’s something even tax professionals struggle with, said Curt Mastio, CPA, the founder of Founder’s CPA. “There is a lot of uncertainty with respect to how to handle specific tax matters for digital assets and we don’t have historical precedent to refer to,” he said, according to the report.
The price of confusion
Another problem many tax professionals have warned about is that they haven’t been able to provide an accurate representation of their client’s activities because of a lack of recordkeeping, with many investors failing to keep track of their transactions. Most accountants who were polled estimated that less than half of their clients have access to this data—and in some cases, it is irretrievable because it cannot be recovered from exchanges.
The failure to report crypto gains can also hit traders in the pocket whenever they make losses.
The report notes that many investors sold their bitcoins at high prices during the crypto bull run of 2017 and 2018, only to buy substantial volumes of inexpensive altcoins that quickly became worthless. A lack of guidance meant that many entered into hundreds of transactions without considering the tax implications, creating “confusing and expensive” headaches during their reports years later.
“Many tax professionals believe that if the IRS and government had acted sooner, businesses and investors could have saved millions of dollars,” Walker and Soussan added.
The crystal ball
The 45 CPAs specializing in cryptocurrency taxes who were polled for the report also gave some predictions for the coming 12 months. Nearly 90% said they believe the U.S. will have the toughest crackdown on crypto taxes over the next year or so—with China and the U.K. in distant second and third place respectively.
While 92.6% said fines and penalties are the likeliest approach the IRS will take to deal with crypto holders who don’t pay their taxes, 7.4% believe that it is possible the taxman will attempt to seize assets. Separately, 59.3% of those polled believe that future IRS guidance will ultimately increase the tax burdens of their clients.
Concluding the report, Walker and Soussan suggested that it is highly likely that the U.S. will end up “setting the standard for cryptocurrency accounting and tax for the rest of the world”—with other major economies such as the U.K. appearing to take a “wait and see” approach until America releases its guidance.
In the meantime, there is one important thing cryptocurrency trading platforms can do to protect their clients against tax problems down the road, said the appropriately named Paul Banker, general manager of tax and regulatory reporting at Sovos.
“While tax regulations continue to take shape,” he said in the report, “crypto exchanges should be providing [Form] 1099s to their clients now to help them understand taxable crypto events and avoid improper or under reporting of their income to the IRS and applicable states.”