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Feb 06, 2020

Just in Time for Tax Season: Exploring the Rules of Cryptocurrency Taxation

The emergence of cryptocurrencies has introduced a whole new dimension to finance and taxation, and the IRS is jumping into the fray, including guidance on a new compliance measure to report on activity involving cryptocurrency. To get tax practitioners caught up during an adventurous new tax season, we talked to Shehan Chandrasekera, a PICPA member and head of tax strategy at CoinTracker in San Francisco.

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By: Jim DeLuccia, Manager, Learning Content

Podcast Transcript

In October 2019, the IRS issued guidance on a new compliance measure, which is a checkbox on Schedule 1 of Form 1040 to report on activity involving cryptocurrency. Tax practitioners will need to address this issue as they prepare 2019 tax returns for their clients. I'm happy to be joined by Shehan Chandrasekera, CPA, who is a PICPA member and head of tax strategy at CoinTracker, which is based in San Francisco.

I wanted to begin with a brief overview of that guidance that I mentioned that was issued by the IRS, which I believe was issued on October 9, 2019. What exactly did the agency release on that day?

[Chandrasekera] It's interesting timing, especially if you take 2019 has been a very eventful year for cryptocurrency taxation. As you mentioned, October 9 of 2019, IRS issued a guidance after five years of issuance of 2014-21. In this new guidance, IRS is trying to address some issues taxpayers and tax practitioners have had over the years. They're focusing specifically on airdrops and forks, the taxation around it, and, in addition, they're also going into some other areas like gift taxation and evaluation, things like that. They're trying to explain more on those issues through this new guidance.

What do you think inspired the IRS to add a question about cryptocurrency, the Schedule 1 of the Form 1040?

[Chandrasekera] According to Michael Desmond, IRS's counsel, the service should be receiving roughly 12 million tax returns with some type of cryptocurrencies now in section, but right now they're not receiving that many, they're receiving far fewer than that. What the IRS is trying to do is to increase compliance by adding in a question like that because when you see a question like that, the taxpayers know that IRS is looking into this issues, so the taxpayers are trying to be more proactive when it comes to cryptocurrency reporting. By adding that question, IRS is trying to increase compliance and hopefully get more revenue into their service.

On the flip side of this, why will the insertion of such a question be a big issue for tax practitioners when filing 2019 returns?

[Chandrasekera] It's an interesting space. A couple of years ago when I did CPE and speaking engagements all over the country, Bitcoin and cryptocurrency taxation, that was like a niche topic area. But after the addition of this question which you had to answer, if you're a taxpayer most likely you had to answer this question. Because of that question, this is now becoming a more mainstream issue.

And especially if you're a practitioner and you asked this question and declined, said yes to this question. By the way, the question reads like, "Have you sold, traded, exchanged, or have any financial interest in any cryptocurrency?" Pretty much I was just asking, "Have you even touched cryptocurrency even remotely?" It's such a broad question.

Again, going back to my point, if your client says yes to this question as a practitioner, now it's your responsibility to calculate the gains and losses and how do you pull them correctly and advise your clients. This is a great time meant for you to learn more about this subject and going through the next tax season with the right set of skills.

That's interesting. You mentioned that several years ago this was more of a niche issue, but you're finding, and I guess people are finding on the whole, that people are using cryptocurrency a lot more.

[Chandrasekera] People are using cryptocurrencies much more. Adaption has slowly increased and, again, I'm not saying every taxpayer will have an obligation to file the Schedule 1 on the Form 1040, but most, likely a majority, of the taxpayers that you're serving will most likely file the Schedule 1. When you file the Schedule 1, you have to ask that question and, again, tax practitioners have to be careful when answering that question and taxpayers have to be careful there, because you signed a return saying that all the information is right. Something to keep in mind in the next tax season.

Is this revision to the Schedule 1 finalized, or is it possible the IRS will make further adjustments at the conclusion of the comment period?

[Chandrasekera] From the sources that I know of, even though it is in draft form, the form has already been sent out to major tax software providers. What that means is most likely this will be the final form, because in reality the tax software providers, they need these forms a few months beforehand in order for their software to be ready by January/February time. In my opinion, this is the final form and IRS will finalize this form in the coming weeks.

I should mention to our audience that we are recording this episode on November 19, 2019, and the comment period has just ended. Do you expect the IRS will get more aggressive in regulating cryptocurrency overall?

[Chandrasekera] I think they're slowly easing into it. Again, right now the main problem that IRS is having is taxpayers not reporting anything whatsoever. IRS is not expecting perfect calculations or perfect returns, calculating every complicated transaction related to crypto. Right now, they're in the beginning phase. What they're trying to do is, how can we get these people who don't report anything to report something on their tax return?

That's the phase they're in right now. Once that voluntary compliance increases, then the service will look into the more complicated issues, how to aggressively go after taxpayers who are trying to evade taxes related to Bitcoin and cryptocurrencies. But we are not there yet.

Are there any issues not yet publicized related to this new requirement that CPAs should be aware of as they prepare 2019 returns?

[Chandrasekera] One of the main questions that I get when I do CPE and when I go to events is “Is this new guidance applicable retroactively?” It's a good question and last week I was at AICPA Tax Conference, which was held in D.C., and I had an opportunity to talk to several IRS agents, including the agent who put together 2019-24 Revenue Ruling. They realized that, even though we call this new guidance, this is how IRS has already been thinking about this space since the issuance of 2014-21.

What that means is, in simple terms, this new guidance has already been effective since 2014. If you're a practitioner who didn't apply new guidance in between 2014 and 2019 returns, I asked a question from the IRS, "Hey, should we go back and amend it?" And their response was that it depends, like specs and circumstances of each cases and so many other things.

The point that I'm trying to make here is that, if you think that you made a mistake, meaning you didn't apply new guidance for the past-year returns, I wouldn't panic. I would just keep that in mind and going forward I would try to rectify the issues and apply the new guidance going forward.

I really appreciate you bringing that to the attention of our listeners. I know that was certainly something that's probably on the minds of many right now.

[Chandrasekera] Absolutely. Because when they issued the new guidance, IRS wasn't clear about when it will be activated, applicable retroactively or not. A lot of people had issues because some of the provisions like recognition of ordinary income pursuant to airdrop. Those things have significant impact on prior-year returns, especially if you deferred airdrop income because you didn't know about this new guidance when you filed your 2016 or 2017 returns.

Or maybe you applied like-kind exchanges before when you filed the tax of your returns. I personally, my clients and I, do have those things. That's why I asked the IRS representatives and their response wasn't that clear. Their response was, "We cannot, it's case-by-case determination." Yes, we just had to go with that one now.

What tools would you recommend CPAs use to help calculate cryptocurrency taxes this tax season?

[Chandrasekera] As a practitioner, I think your biggest challenge is going to be to calculate the gains and losses arising from these various cryptocurrency-related transactions. Problem is that the crypto exchanges, they're not issuing the Form 1099-B, which you emulated. You see, it doesn't issue any transaction reports, it's very complicated.

What I'm trying to say is that calculating the gains and losses in the Excel spreadsheet or doing it manually, it's virtually impossible because you have to crack bases, you have to convert every unit and deal with deeds at a specific second. That's where your struggle is going to be. However, the good news is that just know that there are tools, for example That's a tool that's going to help you calculate gains and losses automatically.

All you have to do is have your client connect the exchanges and wallet to the platform, and then the platform provides you with the Form 8949 and gains and loss report. That's my advice for next tax season, especially for those who are going to see these type of clients for the first time. Don't spend so many hours and try to calculate cost basis and proceeds and everything manually; just know that there are tools that you can leverage.

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Podcast transcripts are provided as a summary of the conversation and have been lightly edited for the written medium. The transcript is not a verbatim representation of the interview.
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