Crypto taxes: You still owe the IRS even if your lender collapsed

The problem is a product of the tax code. Much of the income is considered taxable as soon as it is earned – and the bankruptcy process can take years to play out before creditors know exactly what they will get back.

For investors trying to earn interest on their crypto, it was almost impossible to avoid being hit by a bankruptcy in the last year. Celsius Network, Voyager Digital and BlockFi all took deposits of Bitcoin and other tokens from retail investors on the promise of returns that could exceed 10%. They were able to pay such high returns by re-lending the money to institutional investors who could pay even more, or investing the money in riskier trades or in so-called decentralized finance protocols.

The platforms collected tens of billions of dollars in deposits, even though securities regulators said the products broke the law and failed to disclose their risks. And as crypto companies and investors began to implode, one by one the firms halted customer withdrawals and filed for bankruptcy protection in 2022.

Each of the companies’ bankruptcy proceedings are still ongoing, and it remains unclear how much crypto customers may recover.

Customers of crypto exchange FTX US, which filed for bankruptcy protection in November, are also likely to have to wait to see how much of their funds they are able to recover before trying to claim a loss on taxes.

Some bankruptcy experts say it can take years for the cases to be finalized.

But customers who were paid interest by some of the firms — even if the money is still trapped in a bankruptcy estate — will likely still have to pay income tax on the earnings this year, said Shehan Chandrasekera, head of tax strategy for CoinTracker, a firm that helps investors calculate taxes on crypto investments.

That’s because the IRS considers income earned when it’s paid, regardless of whether those funds ever made it off the platform. For the filers to start realizing losses, the bankruptcy cases must be closed and investors must know exactly what they will get back from the proceeding.

“Unfortunately, it’s difficult for tax purposes to do anything right now because all these bankruptcy filings are pending. Nothing is finalized,” says Chandrasekera.

Gemini, the crypto exchange founded by the Winklevoss twins, recently told clients in an email that it had requested a 30-day extension from the IRS to send its clients the 1099-MISC forms used to report income from the income-paying product , called Tvillingen Tjen.

While not itself under bankruptcy protection, Gemini Earn had provided its clients with loans to Genesis Global, whose lending unit filed for bankruptcy last month. Gemini’s customers have not been able to withdraw money since November. In the letter, Gemini said the delay was related to the Genesis bankruptcy case and investors’ inability to access their assets on the platform.

Separately, the firm warns on its website that it will report earnings of $600 or more that were available for withdrawal at any time in 2022 “whether or not it was actually withdrawn by the customer.”

Similarly, Voyager late last year urged customers to get tax advice, but added that “because your crypto claim has not yet been settled, it is our understanding that you are unlikely to be able to use the company’s bankruptcy to claim a loss in respect of any cryptocurrency you has invested in. The Voyager platform.”

Once the bankruptcies of the various lending firms are closed, depending on how much of their assets customers get back, they may be able to claim losses on future tax returns, Chandrasekera said. If they end up not getting any of the income they earned last year, some filers may be able to amend their 2022 return to get the tax back, he said.

In any case, if investors claim these losses on future tax returns, they should be prepared for an audit.

“Even if you get [the tax filing] properly and truly lost the money, it could still trigger the IRS to look at your returns again, says Chandrasekera, who said investors should hire a tax professional to help them. “These are strange, rare deductions.”

Write to Joe Light at [email protected]