Collaboration is essential to creating accurate crypto tax reports

According to the White House, approximately 16% of American adults have purchased cryptocurrencies. If we consider that there are approximately 258 million adults in the United States, approximately 41 million adults have invested in cryptocurrency. While no one knows the exact number of taxpayers who have checked “yes” to the virtual currency question on Form 1040 and reported crypto taxes, the additional $45 billion in IRS funding for crypto enforcement from Congress suggests that there is a wide gap between those who owe crypto tax and those who actually report.

We’ve all known since 2014 that virtual currencies are treated as property and that US taxpayers have a tax liability when trading them. The principles are simple, right? Report gains and losses as well as any income. So why do taxpayers continue to underreport crypto taxes? I would argue that most people want to be compliant and do the right thing. If so, what can the IRS and industry do to help?

As a CPA with years of experience preparing tax returns and calculating crypto taxes, including my role at Accointing.com, I have to admit that crypto taxes are complicated. Crypto tax software should make it easy, but I’ve run my data through eight different tools and the results can vary widely. The number of transactions, income, gains, losses and income are different depending on which tool you use, and the differences can change the entire outcome of a tax return. Each individual tax tool you use will struggle with different parts of the data which, unless manually corrected by the taxpayer, can cause significant differences in the calculations.

The only way to fix this is to identify any errors in a tax report, trace the problem through the data and find out what was broken in the chain that leads to the wrong outcome. But this requires the user to be very skilled in using the tax tool, to be able to identify errors in a tax report and to be able to fix the error with sometimes little or no data from the exchanges or wallets. When you consider the volume of transactions and platforms that most crypto users interact with, you can see how this can be a difficult puzzle to piece together.

Lack of standard

I would argue that the biggest problem today is the lack of a reporting standard and requirements. While the Infrastructure Investment and Jobs Act will help close this gap by requiring exchanges to issue tax forms, the earliest we’ll see those forms will be in 2024 for the 2023 tax year — if we’re lucky. Still, we know that the IRS is not going to wait to enforce taxation until tax year 2023. This means that taxpayers are left on their own to get their data, and they calculate and report crypto taxes for any year before that. What happens when you use an exchange that is not supported by the crypto tax calculator of your choice? What if the exchange is supported but the particular product (eg futures trading) is not? What if you traded on an exchange that no longer allows the user to access their data due to regulatory or financial issues?

The lack of a reporting requirement with a standard for the data is a major obstacle that both taxpayers and tax authorities must overcome. The transfers and activity on other exchanges can be tracked and data can be linked, but the gains and losses will not be accurate.

Even when crypto exchanges issue tax forms (1099-DA), the problem may not be fully resolved and we can see a lot of missing data on these forms. One of the biggest reasons we’re here today is because we’re trying to apply tax principles that rely on information collected by third parties to a decentralized system that was built to operate peer-to-peer. Of course, exchanges are still centralized and can track and report information, much like any other broker. But crypto is interconnected, and the moment funds flow from an exchange to DeFi, getting the right data points is dependent on the data points of the blockchain in question.

According to CoinMarketCap, there are 565 protocols on ethereum, and the way each interacts with a smart contract and with the funds can be completely different. And that’s just ethereum – there are many other chains used in crypto, each with potentially different code, data and decentralized apps (dapps). Many of these blockchains were innovated to work in a decentralized way, with smart contracts automating the decisions and the data being tracked only by each node (wallet), without a central party tracking all of this for anyone. Still, what happens in each of these chains can have a fiscal impact in a centralized exchange, assuming those funds are eventually converted back to fiat. That means integrating the data from each different blockchain and dapp can be daunting, especially as the speed of innovation in crypto generally increases.

Considering the decentralization and interoperability of these platforms, it is easy to see why we struggle to use tax principles that rely on collecting data for each transaction.

Possible solutions

I would suggest a different tax system as the best solution. Instead of taxing every transaction, it would be easiest and fastest to adopt a property tax system. Other countries like Switzerland and the Netherlands tax crypto based on year-end value – this makes sense when you consider that it’s much easier to track and audit a balance at one point and apply a valuation to it than to create the entire transaction history. This is not the only system, and perhaps we need to think more outside the box of conventional property or securities tax principles – after all, crypto is a unique and different asset.

However, the ideal solution will take time, and while we may get there eventually, taxpayers need help today. So what can be done?

Exchanges should be more proactive in helping taxpayers obtain data, figure out what to report, and do everything in their power to simplify their customers’ tax filing journey. After all, if your customers get into tax trouble, they won’t be customers for long. Protocols must consider the information provided via their blockchain explorers and dapps to facilitate taxpayers’ access to this data. Tax tools have to keep working day and night to keep up with each new chain and exchange. The regulators can provide clear guidance on many uncertain aspects of the crypto tax law and be more accessible to questions from the public. And taxpayers need to be proactive in keeping track of their data, learning their tax tools and making sure to report their crypto income to the best of their ability.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author information

David Canedo, CPA, specializes in the taxation of digital assets. He is the head of tax and compliance strategy at Accointing.com, a company that provides tracking, consolidation, tax and compliance solutions for crypto investors.

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