Inevitable Tax Trap of Cryptocurrency Capital Gains

Explanation of what happened, why it happened, and guide to interest and penalties from a CPA.

Written by Andrew Perlin, a CPA, co-founder of The Crypto CPAs

Assuming you didn’t get scammed or hacked along the way, 2017 was one awesome ride. There were 5x-ers, 10x-ers, 100xers and even more x-ers to be had everywhere. The altcoin market was booming. Getting big gains was as simple as scooping up whatever the new ICO or newly listed coin was. The best part was, you didn’t have to be good. Heck, I don’t know much at all compared to most developers and computer engineers.

This didn’t exclude me from the nice increases in portfolio value in virtually every Blockfolio refresh (there were dozens of these a day). I long for those bull runs. This drastic plummet of most coins and tokens in 2018 thus far sucks, but it was not totally unpredictable. New FUD comes up daily, but one thing that is tough to argue is that US taxpayers (and likely worldwide) are getting left with the tax liability bags.

Tax Code, or Lack Thereof, is Partial to Blame

As a CPA myself, I’m a bit more cognizant of my taxes than most. Most importantly, I was aware of these three things:

1. My tax liability for 2017 would be locked in when 2017 ends, no matter what happens in 2018.
2. Typically, every coin to coin trade would be a taxable event.
3. Like-kind elections would not apply or be feasible to the thousands of trades I made.

For those of you with large, realized gains that knew this and proceeded to keep all your funds in crypto, it is on you and you should learn from the mistake.

It is unfortunate for those who were misled. Those who were told by their friend with a Minor in Accounting, a Reddit post, a Slack group, or a Bitcoin forum that as long as you keep your funds in crypto, you had no taxable event.

And there’s a misconception in the crypto space that like-kind election was as easy as not reporting anything because crypto is all like-kind. It is human nature to run with the best news that you hear. However, the consensus among most CPAs and Tax Attorneys, especially those specializing in the Crypto space, is that the blanket like-kind exchange does not work at all.

IRS take on this

The IRS has been silent. Since the March 2014 virtual currency guidance provided by the IRS claiming cryptocurrency is to be treated as “property”, there has not been much else. There was a warning that came out, but no guidance. We all know the IRS is busy, but this is important. Of course, misinformation will spread until CLEAR guidance is provided. Anyway, the situation is what it is.

Is this the Reason for the Sell-off?

I’m sure it has something to do with it. We get several inbound calls asking for tax help. Many people are caught completely off-guard by their tax liability. After seeing their portfolio go down 70–80% recently, they decide they need to sell their holdings to pay their taxes. If enough people are doing this, the price gets driven lower and lower. This may continue to happen for a while.

“There is No Way in Hell I’m Liquidating all of my Crypto to Pay my Tax Bill”

We get this in multiple variations from many of our clients. I understand, especially for those who went from having a large gain in 2017 to possibly being far in the red after paying their tax liability. If you are a believer in crypto, maybe the interest and penalties are worth it to you. Just remember, as of 12/31/2017, you basically have a loan from the IRS until you pay your tax bill. You owe this money and if you keep it in Crypto, it is not different from taking cash advance on a credit card to invest in the market. I do not recommend this. So, let us touch on some of the penalties and fees this involves.

Are the Penalties and Fees Worth Waiting for a Bounce?

I will just say, there is no guarantee of a bounce. But you can decide for yourself with some info below.

The Failure to File penalty is the first penalty to worry about. It is easily avoided, simply file your tax return or your extension by the due date and you’re in the clear. Even if you owe taxes, file an extension. The extension does not give you more time to pay your taxes, but it gives you more time to file your return and avoid this penalty. This penalty can be huge, a whopping 5% of your tax liability per month or part-thereof you do not file your return. This can last up to 5 months or 25% of your tax liability. Once again, the extension will not reduce the Failure to Pay penalty.

The Failure to Pay (reported on return) penalty is basically the interest on your unpaid balance. Without a payment plan, the Failure to Pay penalty is ½ of a percent (.5%) per month or part thereof. Even with the extension, this interest will start accruing as of 04/17/2018. If you file your return and enroll in a payment plan with the IRS, you will be charged a lower .25% per month fee. If you do not report the tax you owe, you may be required to pay 1% interest per month. This could be the case if the IRS rejects a like-kind election one makes, for example.

*Note, in some situations these two penalties may be abated. I have seen some discussion about using this abatement as a “strategy”. Though the penalties can likely be abated, especially for first-time offenders, I would not count on it. See penalty relief due to first-time penalty abatement.

Interest

Interest on balances is 4% at the time of this writing. Interest is charged by law and cannot be abated. Of course, in the crypto world, I don’t think many people care about this 4% interest.

Payment Plans

I suggest to most who do not want to pay their balance yet to get on a payment plan with the IRS. More information on payment plans can be found here.

Conclusion

Overall, I find it incredibly risky to use your tax bill as leverage in the crypto market. However, it is the taxpayer’s decision and not mine. The market may go back and exceed all time highs again, giving everyone enough money to pay their tax bills. It can also go the other way, leaving everyone with the same tax liability and even less crypto. One thing is for sure, I am still HODLing.

So coming to the last act, better be safe than sorry. To skip all the manual work on calculating cost basis for your crypto trades, use BearTax

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If you want professional consultation and clarify more questions around cryptocurrency taxes have more questions contact CryptoCPAs.

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