The IRS Is Cracking Down on Crypto Taxes: What You Need to Know

Overview

Chandan Lodha, Co-founder of CoinTracker, talks about the 10,000 letters the IRS sent to cryptocurrency holders last week, what kinds of letters were sent, what recipients should do depending on what type of letter they received and how the IRS even knew who to write to in the first place. Plus, we discuss which types of transactions are taxable events, where the tax laws still need further clarification, and which types of changes he believes should be made to tax law.

Audio

Link to podcast

Episode Links

• CoinTracker
• Chandan Lodha Twitter
• IRS sending letters to 10,000 crypto holders
• CoinTracker Blog Post on IRS Letter 6174, IRS Letter 6174-A, and IRS Letter 6173
• Forbes article on IRS warning letters
• IRS press release
• CoinTracker guide to filing crypto taxes

Transcript

Laura Shin (00:00) — Hey everyone, just a quick note before we get started. This podcast is informational only and not meant as a replacement for speaking with a tax professional. Now onto the show.

Hi everyone, welcome to Unconfirmed the podcast that reveals how the marquee names and crypto are reacting to the week’s top headlines. It gets the inside scoop on what they see in the horizon. I am your host, Laura Shin. If you’re making vacation plans, consider the crypto weekend retreat I'm teaching with Meltem Demirors of Coinshares and Jalak Jobanputra of Future Perfect Ventures. It'll be at the beautiful Omega Institute in Rhinebeck, New York from September 20th to the 22nd. Be sure to check out the show notes for the link to sign up. Also, if you’re not yet signed up for my weekly email newsletter, go to unchainedpodcast.com to sign up. And don’t forget that Unchained and unconfirmed are now on YouTube. You can go there and subscribe to be alerted to all the latest episodes of both podcasts.

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Today’s guest is Chandan Lodha, Co-Founder and CEO of CoinTracker. Welcome Chandan.

Chandan Lodha (01:33) — Hi Laura. Thanks for having me.

Laura Shin (01:35)— Last week the IRS sent letters to 10,000 cryptocurrency holders. What did the letters say?

Chandan Lodha (01:42) — Yeah, so the IRS is basically ramping up enforcement of virtual currency tax compliance and they sent out these letters in three flavors. IRS letter 6173, IRS letter 6174 and 6174-A. Three letters basically outline different kinds of scenarios with varying levels of severity for folks who may be out of compliance with their virtual currency tax reporting.

Laura Shin (02:06) — And is there any particular reason that they’re sending them now?

Chandan Lodha (02:10) — Eh, it’s hard to say why it’s exactly now, but this is actually part of an ongoing effort that’s been going on for several years, so it’s not something that's out of the blue. For example, the IRS subpoenaed Coinbase back in 2016 for records of all US, bitcoin and cryptocurrency transactors and they ended up actually getting the records of over 14,000 users. So they've actually been doing this compliance for a long time and it's now that we're starting to see these letters come out.

Laura Shin (02:38) — Yeah. And actually that was pretty remarkable at the time for the initial request because they literally wanted every single record of every Coinbase user across three years, and it was even down to things like chat logs that they wanted. So it wasn’t like, you know, they had identified certain people that they thought were sort of sidestepping their taxpayer duties, but just kind of all the data they could get. So then for these letters, is that connected to the Coinbase thing? Like is that how they identified who should receive one of these letters?

Chandan Lodha (03:14) — It’s hard to say for sure. In their press release, they sort of outlined that they have IRS compliance efforts, but they don't detail exactly what they are. But a lot of people are speculating that that is definitely one of the major sources of the data that they have for who the’'re sending these letters to.

Laura Shin (03:30) — And so for those people, did they only send them to cryptocurrency holders who haven’t been paying any taxes on their gains in crypto or just to anybody who holds cryptocurrency in general?

Chandan Lodha (03:44) — So this is where it might be useful to dive into the three different letters and what they mean. The least severe of the three is the IRS letter 6174 and that letter basically says that you may not be aware that cryptocurrency is taxed. So it’s basically a user education letter. There’s no action and you might be perfectly in tax compliance, but they're still telling you because they have reason to believe that you have cryptocurrency. If you received that letter and you’ve been filing your taxes, following all the cryptocurrency guidance, there's nothing you need to worry about.

The next letter is the 6174-A which says that you may not have properly reported your transactions, which means that they have reason to believe that you have virtual currency and maybe you made some reporting but they don't think that you reported it properly. Maybe you submitted the wrong form, maybe you accidentally treated crypto-to-crypto transactions as a nontaxable, when they in fact are, or maybe some other reason. Again, in this case it's a no-action letter. If you believe you've done everything correctly, you don't need to take any action. If you haven't been reporting a cryptocurrency taxes, you should definitely go back and amend your returns.

And then the third and final letter that’s the most aggressive as the 6173. And in that letter, it is an action letter. They're basically saying you haven’t reported your cryptocurrency transactions properly, and if you don't respond with updating your returns and specifically addressing the concerns that they’ve brought up, then they are going to examine your tax returns.

Laura Shin (05:11) — And so let’s, let’s start with the group maybe that has the least to worry about where the 6174 I think you said. Essentially, you know, we don’t know how they targeted these people, but like assuming that it is sort of related to the Coinbase records, then those would be people where maybe they've cross-checked that, okay, indeed they're a Coinbase holder and the Coinbase records sort of match up with their tax returns of recent years. Is that like, like I, I’m just trying to figure out like why some people would get different letters, you know?

Chandan Lodha (05:51) — Right. So one possibility is that they, they basically have this large group of people that they, they have found out have cryptocurrency and some of them have reported nothing about cryptocurrency. Some of them have reported some stuff, but it’s not completely accurate or complete. And then some people have reported a bunch of things. And so based on how much reporting they’ve seen versus the fact that they know whether or not you have cryptocurrency, they might have split out these different letters. So this is a bit speculative, but for example, for the 6174 the one that you’re saying, that you're referring to, which is the least severe of the three, they might say that, okay, we did actually get the right tax form, the 8949 showing all the capital gains transactions, but we’re still gonna send this letter just as an educational notice in case the person wasn’t fully aware and also as a signal to the rest of the market, even for folks who didn’t receive the letter that the IRS is actually paying attention, and this is just phase one of their compliance program.

Laura Shin (06:47) — So I read a Wall Street Journal article about this issue and they reported quote, “the sternness version of the letter asks recipients who believe they have followed the law to sign a statement declaring under penalty of perjury that they are in compliance with tax laws.” And it just got me wondering, are the tax laws around crypto currency totally clear?

Chandan Lodha (07:08) — Definitely not. That’s actually one of the biggest complaints from cryptocurrency users, accountants, CPAs, tax lawyers. Many people have been asking for more clarity since the IRS original guidance on virtual currency transactions back in 2014. And in fact, even the IRS commissioner, Chuck Rettig said that I think in May of this year that the rules are unclear and that they will be issuing further clarity, perhaps as soon as in the next 30 days. But it’s been a couple of months since then we haven't heard. So that’s definitely a source of frustration for a lot of folks.

Laura Shin (07:38) — Okay. So, so for those people who receive that letter, if they’re being asked to sign a statement declaring under penalty of perjury that they're in compliance with tax laws, but the laws aren’t totally clear, then how can they know whether or not they're in compliance with the laws?

Chandan Lodha (07:53) — Yeah, I mean, it’s a bit of a catch 22 and a bit of a ridiculous situation. Which is why the IRS really needs to clarify all these rules. For folks who are in this situation, our recommendation is to get in touch with a tax professional who can help you interpret the tax rules to the best of their abilities given the guidance that’s currently available and using some kind of system, tax software, or tax professional to help you get all your records in order if you haven’t already.

Laura Shin (08:18) — Alright, so we’re going to discuss a little bit more about like the different types of transactions and how they should be taxed in a moment. But first a quick word from the sponsors who make this show possible.

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Laura Shin (09:53) — Back to my conversation with Chandan Lodha of CoinTracker. So let’s just walk through, you know, you mentioned the three categories of letters. So what should people do if they received the different letters?

Chandan Lodha (10:07) — So it depends on what you’ve been doing with regards to filing your cryptocurrency taxes. If you’ve been really diligent, you’ve been filing them to the best of your abilities and you believe that your returns are all accurate, and you received either the 6174 or the 6174-A, then you don’t need to take any action. There are no action letters, they’re reminders and they may not necessarily require any action if you’ve been following the rules already. If you’ve received any of the letters and you haven’t been filing your cryptocurrency taxes, you should definitely either get in touch with a tax professional or on your own or using some tax software, get all of your transaction history reconciled, and amend any previous returns that might apply where you have cryptocurrency transactions. In addition, if you have the 6173, the most severe for three letters, you do need to take an action because the IRS is requiring you to complete this statement and follow up with particular records by a “respond by” date, otherwise your account will be put up for examination.

Laura Shin (11:06) — So let’s just walk through kind of the different types of transactions people can have in crypto and which of these are taxable events and which ones are not. You know, there’s many different examples you, you kind of gave some a bit earlier, but I know there are certain ones where for instance, that’s not a taxable event. So can you just walk us through, you know, like mining or buying, or trading, et cetera.

Chandan Lodha (11:29) — Sure. I’ll try to give a high level overview and we can also link maybe later a more detailed guide in the show notes. So at a high level, when you dispose of a cryptocurrency asset in the United States, you’re triggering a taxable event because the IRS has outlined that cryptocurrency, like bitcoin, is treated as property. So for example, if you buy a cryptocurrency, for example, if you spend $100 to buy a bitcoin, that is not a taxable event because there’s no disposal of the cryptocurrency asset. If you sell a bitcoin, that is a disposal and that is a taxable event. Similarly, if you trade a bitcoin for another cryptocurrency asset, you are disposing the asset you’re selling. So again, a crypto-to-crypto trade is a taxable event. In the case —

Laura Shin (12:15) — Just a question about that one though, has that always been clear? Because I feel like there was some period of time when it was thought that perhaps the law, you know, the like-kind, I can’t remember the exact phrasing of this, but if you trade a crypto for a crypto, there was some thinking that this was like a like-kind trade, which I think at that time, you know, it wasn’t clear if that totally was a taxable event and then later the IRS eventually did come out and say, like it is not. And so from that point forward it was definitely very clear that that was taxable.

Chandan Lodha (12:52) — It’s a good point in you’re hitting on an important issue. So, basically like you said, in 2018 the IRS clarified that like-kind exchanges do not apply to a cryptocurrency or any kind of non-real property, meaning that starting in 2018 it’s very clear: if you had a crypto-to-crypto trade, it is a taxable event. Before that there’s ambiguity because there was no clear guidance. So if you had already been filing form 8824 specifically for every single crypto-to-crypto trade, you may be in the clear, but it’s a grey area. If you didn't previously already file those forms, then you definitely need to amend your returns to include those transactions as either taxable events or as like-kind exchanges, again, knowing that you’re taking on risk in a grey area where the rules have now changed and are clearly taxable events.

Laura Shin (13:45) — Okay. Right. And so obviously we don’t give financial advice, but maybe, better to be safe than sorry. Okay. So keep going with the transactions.

Chandan Lodha (13:53) — Okay. So then you asked about mining, airdrops, forks. Mining is the clearest of these probably where the IRS is basically said that when you receive a mined coin, you’re getting income, you’re realizing ordinary income, and then from that point onwards you have a capital asset. So let’s take a scenario where you mined a bitcoin and it’s worth $100 at the time you receive it. That’s $100 of income. And then, in addition, when you sell that bitcoin or you trade that bitcoin, there’s a capital event happening where you look at the capital gain or loss between the fair market value at the time that you get rid of that coin compared to the basis of the coin, which is the $100, the fair market value of the time you received it in.

In the case of a fork, it’s a bit unclear. There’s not super clear guidance here. The sort of conservative approach here is to say that the forked coin is also income. Again, like mining, you’re basically receiving the amount of income at the fair market value at the time you received the coin and there’s a capital event when you dispose of that coin. And the more aggressive option here would be to treat that as a zero basis income. Meaning that when you receive the forked coin, you didn’t necessarily want to receive it, it was out of your control. It just happened to show up in your wallet or in your exchange account and therefore you have zero income. The basis is zero and when you dispose of the coin you basically realize the full capital gain from the entire fair market value of the coin at the time.

And then the airdrop scenario. Again, a bit unclear. There isn’t clear guidance here, but you can take the more conservative approach and say that the airdropped coin was income and that you realized the gain between the fair market value at the time you receive it and at the fair market value at the time that you sell the coin or trade the coin, or the more aggressive position, which is that I didn’t want to receive this airdrop coin. It just appeared in my wallet. Someone sent it to me outside of my will, and therefore it’s zero income. And then you realize the full capital gain at the time that you sell or dispose of the coin.

Laura Shin (15:56) — And so I’m assuming those last two issues, the airdrops and forks are the ones that the IRS needs to release guidance on?

Chandan Lodha (16:05) — Those are two of the most common scenarios that are pretty unclear and definitely need clarity.

Laura Shin (16:10) — And is there any, I mean, not that the crypto community gets to decide these things, but just among, I guess like tax professionals who work in the crypto space, like is there any consensus around what would make the most sense?

Chandan Lodha (16:24) — Different people have different opinions. The position that I’ve heard that I think seems to be the most reasonable is sort of taking into account the intent of the user. So for example, if you receive an airdrop that you had no intention of receiving, some random person sent you a coin, you don’t know who they are, you don’t know why they sent it to you. Maybe it was spam, maybe it was marketing, maybe it was some random giveaway, then it is pretty strange to have to pay income on income that you didn’t want to receive in the first place. So in scenarios like that where you have no intent to receive a coin, it seems more reasonable to have the zero basis apply, and then only if you choose to realize the gain, meaning you actually trade the coin, then you have taxable event.

Whereas there are other scenarios where users do have intent to receive a coin or get a forked coin or maybe they get a distribution or inflation rewards from Stellar or staking rewards, things like that, where if the user is actually intending to get those rewards, then it would make sense that they’re getting income at the time that they’re receiving those coins.

Laura Shin (17:24) — So, hmm. I’m just trying to figure out how you would determine intent because so obviously there are things like the lockdrop situation, which Edgeware did where you had to like signal or you know, send coins in order to receive coins and obviously lock them up for a certain period of time. But so that’s a pretty obvious case where you know, you’re signaling intent. Right? But then for something like the bitcoin cash hard fork where you know, maybe if I had bought my bitcoins on Coinbase and then I moved them to my own personal wallet in order to receive the bitcoin cash coins, like, okay, sort of maybe that’s intent. But then like what if I had a blockchain.info wallet where you know, it was the, you know, they just showed up, like, so how would you determine that? Is it like literally if you, if you move them from Coinbase in your own wallet, then that’s intent or do you see what I'm getting at? Like, because then, then some of the people who received bitcoin cash would be set to have shown intent and then others would, would be said to not have shown intent.

Chandan Lodha (18:31) — Totally. It’s definitely not a clear cut issue. There’s certainly a lot of messiness here, which is why we need guidance from the IRS. Certainly we can speculate here what would make sense and what would be easy to measure and not, but, that’s exactly why people are pushing IRS to provide clarity here.

Laura Shin (18:48) — Alright. Alright, so I did notice in your blog post on this issue that there were a few other kind of, like, weird edge cases that I was wondering about. One was, you mentioned this thing about foreign exchanges. So for paying taxes on crypto, does it matter where you hold or trade your crypto?

Chandan Lodha (19:07) — Again, it’s a grey area, but yes, it might matter. Specifically for US taxpayers if they’re using US-based exchanges or foreign based exchanges. So for example, Coinbase is US-based. Binance is not US-based, at least not right now. And the reason why it matters is because FinCEN and, other financial regulators in the United States want to make sure that they’re keeping track of US taxpayers foreign assets. So for example, there’s this tax compliance form, FBAR, FinCEN Form 114 which requires us taxpayers who have over $10,000 of assets outside of the United States to report that they have those assets. So people typically do this when they’re using foreign, different kinds of foreign bank accounts or different kinds of foreign exchanges. And now again, there’s sort of regulatory uncertainty and grey area around whether users need to do that if they're holding crypto in non-US based exchanges. Similarly, there is a FATCA form, which is a sort of has a higher bar for reporting. But again, if you’re holding assets and foreign exchanges, you may need to fill that out at as well. But again, it’s a grey area.

Laura Shin (20:16) — And then there was another one where you said, you know, if your crypto was lost or stolen, do this one thing, but only if it occurred before 2018. So can you describe what that case is?

Chandan Lodha (20:27) — Right. So many users have the crypto world will be familiar with the concept of exchange hacks and losing crypto, having crypto stolen, things like that. So a common question comes up, which is how do I actually take advantage of, you know, how do I report this on my taxes? Do I have to pay taxes on crypto that I’ve lost or stolen? So there basically is a tax form lost or stolen property, again, you can link to that. The thing is in the 2018 tax code changes, they changed the rules about what you can do with regards to lost or stolen property and whether you can claim them. So that forms specifically the one that you’re mentioning, which we can link to, applies to the pre-2018 lost or stolen property.

Laura Shin (21:05) — Wait, so what does that mean? That if you lost your, bitcoin in 2018 or later at that now you might still have to pay taxes on something that you don’t even own anymore?

Chandan Lodha (21:18) — It would mean that you wouldn’t be able to claim a property loss on them. You wouldn’t be able to have a tax write-off on the last property.

Laura Shin (21:25) — Okay. Okay. So for people who don’t want to lose their crypto, I recommend, an interview that I did on this phone hijacking situation that’s been going on where people are losing their crypto. You should listen to that. I’ll link to it in the show notes. So let’s now also just talk about the new guidance that the IRS has been promising. We talked about, like, which issues remain to be resolved, but I think like even for some of the areas that are settled, a lot of people want to see changes. So you know, you’re, somebody who works in this world day in and day out. Like what do you, what changes do you think make the most sense? Like what, in your ideal world, what would you like to see in terms of taxation of crypto?

Chandan Lodha (22:08) — The main thing is we want this to be clear for users so that they know how to comply. So I think the most important things like you mentioned, are very clear guidance on how to deal with forks, how to deal with airdrops, and then the other big one that we didn’t talk about that’s still a little unclear is how to deal with, which kind of cost basis accounting methods are allowed.

So for example, with securities like stocks, the IRS details that you can either use first-in-first-out accounting, FIFO or specific-ID in certain situations where you can choose which stock you’re selling at any given time and therefore decide how much capital gains you’re having on a particular trade rather than just the first, you know, the first Google stock I bought is the first Google stock I sold. So similarly we need that same kind of clarity and guidance for cryptocurrency. Can users use FIFO, HIFO, or LIFO, specific-ID? What’s allowed and what’s not?

And similarly from the SEC and/or IRS, we need clarity on, which assets are going to be securities and which ones aren’t, because then things like wash sales would perhaps apply to some coins but not others. Right now the, sort of, default view in the community is that wash sales don’t apply because bitcoin is not a security. But we need clarity on the cost basis, method and clarity on things like wash, sales and securities.

Laura Shin (23:23) — And I’m surprised you didn’t bring up the issue about de minimus exemptions cause I feel like I hear that one a lot. Do you have an opinion on whether there should be some threshold under which transactions would not be taxed?

Chandan Lodha (23:37) — Yeah, that’s a good one too. That makes sense. So for other folks, basically for people who are making small purchases, like for example, let’s say you go to a coffee shop and you buy a coffee with the small amount of bitcoin, like do you really want to be, you know, figuring out the taxes on that and when people are using this as currency rather than property? And I think that one makes a lot of sense. Some other countries, like for example, in Germany they these exemptions and, I think that one makes sense too. Again, we’d love to get clarity from the IRS around letting people actually use cryptocurrency as currency.

Laura Shin (24:07) — And do you have a particular dollar amount that you think makes sense for the threshold?

Chandan Lodha (24:11) — I don’t have a particular amount that I thought ahead of time. For example, in Germany I believe the amount is around 600 Euro. Something like that. Some reasonable limit I think would make sense. I’m not exactly sure what the right amount would be.

Laura Shin (24:23) — All right. Well we'll see if that goes through. I know a lot of people are agitating for it. Okay, well thanks for coming on the show.

Chandan Lodha (24:30) — Thank you so much Laura. I really appreciate it.

Laura Shin (24:33) — Thanks so much for joining us today. To learn more about the topics we discussed, be sure to check out the links in the show notes of your podcast player. If you enjoyed this podcast, be sure to share the episode on Facebook, Twitter, or Linkedin. Unconfirmed is produced by me, Laura Shin, with help from Fractal Recording, Anthony Yoon, Daniel Nuss, and Rich Stroffolino. Thanks for listening.

CoinTracker helps you calculate your crypto taxes by seamlessly connecting to your exchanges and wallets. Questions or comments? Reach out to us @CoinTracker.

Disclaimer: this post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.