In current year, IRS the tax collecting agency of the United States, send out more than 15,000 warnings to suspected cryptocurrency traders and holders who may have misreported their assets mainly digital assets on their tax return. The problem here is that the IRS doesn’t have all of the necessary information. This information, which was supplied to the IRS by cryptocurrency exchanges like Coinbase, is causing the agency to blindly and oftentimes inaccurately come after cryptocurrency traders.
How is cryptocurrency taxed in U.S.?
In many countries like U.S., cryptocurrencies like Bitcoin treated as property, rather than as a currency. Like other forms of properties like stocks and real-estate, you incur capital gains and capital losses that need to be reported on your tax return whenever you sell, trade or otherwise dispose of your cryptocurrency.
For instance, if you make money investing in Bitcoin, you have a tax liability that you should be reported. If you lose money, then it is a loss, which will actually save you money on your taxes. Both of them need to be reported.
So many enthusiasts have not been paying taxes on their cryptocurrency activity. Because of this, it actually makes a lot of sense why the IRS has started carrying out these enforcement campaigns. However, the agency is using information that is extremely misleading.
How does it exactly lead to misleading?
Cryptocurrency exchanges like coinbase and Gemini issue form 1099-k to users who achieve certain thresholds of transaction volume. The IRS on its website that the 1099-K is an information return used to report third-party network transactions to improve voluntary tax compliance.
In England, the 1099-K is used to report your gross transactions on a third-party network like cryptocurrency exchange. This means that all of your transactions, buys, sells, transfers, etc. are summed up and reported on a 1099-K. If you meet certain thresholds you and the IRS are both sent a copy of this 1099-K from the cryptocurrency exchange. The IRS is using these documents to monitor who is and isn’t paying taxes correctly.
These “gross transaction” reports can get extremely large for high volume cryptocurrency traders. Remember, every transaction you made is being summed together on this form. I purchased $1,000 worth of Bitcoin, and then traded that Bitcoin in and out for Ether (ETH) five times, and my gross proceeds are now over $6,000 — even though I only ever “put in” $1,000 cash! This is because all “buy” transactions are added together to report gross proceeds, and in this case, I technically had six different buy transactions and six different “sell” transactions — a Bitcoin trade into ETH is considered both a buy of ETH and a sell of BTC. You can imagine how this number can become extremely large for a high volume trader.
Why it makes problem?
1099-K forms are reporting gross transaction amounts and are being sent to IRS. But the numbers reported are actually irrelevant because you are only taxed on your capital gains. For example, if you buy $100,000 worth of Bitcoin and two months later you sell it for $95,000.
You have a $5,000 capital loss. But what is reported in 1099-K is you have $195,000 transactions. So this is problematic because you get tax on you capital gains and losses not you transaction amounts.