Today’s post provides an update on some important US tax issues relevant to digital assets.
While the Internal Revenue Service (IRS) continues its crackdown on digital asset tax reporting, the controversial broker tax reporting rules for digital assets have been postponed. It looks like we will be in for a wait! Today’s post provides the details.
The year 2022 was not very kind to crypto investors and many are looking at deducting losses on their failed investments. The IRS has provided some recent guidance on that issue, also examined today. Spoiler alert – it’s not taxpayer friendly.
Digital Asset Broker Reporting
The 2021 Infrastructure Investment and Jobs Act (the “Act”) amended Internal Revenue Code Sections 6045 and 6045A imposing mandatory tax reporting requirements for “brokers” of certain digital asset transactions entered into after December 31, 2022. This amendment made the prior “broker” reporting rules (which generally applied to stock trades) apply to digital asset transactions. Such 3d party reporting has proven to be a tried and true method of getting taxpayers to report income accurately.
Generally, Section 6045 requires brokers to report on IRS Form 1099-B certain information about taxpayers, including names and addresses, as well as certain information about the property underlying the transaction, (e.g., date of sale and its gross proceeds and more detailed information for transactions involving so-called “covered securities”). It also mandates that the broker provide payee statements to its customers.
The Act expanded Section 6045’s definition of “broker” to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Furthermore, under the Act digital assets are defined as “any digital representation of value which is recorded cryptographically,” and can be treated as “covered securities”. Section 6045A involving transactions between brokers, requires transferors of covered securities to furnish transfer statements to transferees.
The IRS recently released guidance on the digital asset tax reporting rules. The guidance is in the form of Announcement 2023-2, and effectively postponed the January 1, 2023 effective date of the digital asset broker rules and reporting obligations imposed under the Act. The IRS intends to publish regulations specifically addressing the application of sections 6045 and 6045A to digital assets and providing forms and instructions for broker reporting. A notice of proposed rulemaking will be published that sets forth proposed regulatory text, explains the proposed rules, solicits public comments, and announces a public hearing – so, we are in for a wait.
While this announced postponement might be good news for those in the digital asset and cryptocurrency industry, what it means for investors is that they may not receive an IRS Form 1099-B covering their digital asset investments. As a result, tax reporting may remain difficult and cumbersome this tax season.
Foreign Crypto Exchanges
According to a Government Accountability Office Report (GAO-20-188 Feb. 2020) on virtual currencies, unless owned by a US payor (including a so-called “controlled foreign corporation“), digital asset exchanges operating outside the United States are currently not required to file 3d party information returns such as Forms 1099-K or 1099-B unless the customer or transaction has certain connections to the United States (GAO report at p. 24). Bitfinex, for example, is a cryptocurrency exchange owned and operated by iFinex Inc., which is headquartered in Hong Kong and registered in the British Virgin Islands. By contrast, Coinbase, Binance and Kraken are US-based cryptocurrency exchanges. Readers may wish to review my earlier tax blog on the issue of foreign crypto exchanges and 3d party reporting.
Deducting Crypto Losses
Unfortunately, many investors experienced drastic declines in the value of their cryptocurrencies during 2022. Many crypto companies have gone bankrupt. These scenarios leave US taxpayers wondering if they can claim losses for tax purposes. On January 13, 2023, the IRS issued Chief Counsel Advice Memorandum CCA 202302011 (CCA) which impacts crypto investors who have lost on their investments. While a Chief Counsel Memorandum cannot be used or cited as precedent and is not binding authority, it does give valuable insight into the current IRS’ view of the tax positions discussed. A Chief Counsel Memorandum is also subject to change without notice.
The CCA concluded that taxpayers who have not sold or otherwise disposed of their crypto asset cannot claim a deduction for cryptocurrency losses that have substantially declined in value if such cryptocurrency continues to trade on at least one cryptocurrency exchange and has a value that is greater than zero. Thus, standing alone, a substantial devaluation of cryptocurrency is not enough to claim a tax loss. The CCA focused on a hypothetical individual taxpayer who continued to hold his crypto but wished to claim an ordinary loss deduction under IRC Section 165 when the taxpayer’s crypto had significantly dropped in value but was still trading at 1 cent. The IRS concluded a loss was not permitted since the cryptocurrency was neither “abandoned” nor “worthless”. IRS focused on two main points: the taxpayer had not disposed of the cryptocurrency, and it was still trading for some, albeit miniscule, value on the market.
The CCA further points out that even in the case of an individual taxpayer who could otherwise successfully make a claim for an ordinary loss deduction under Section 165, the loss would nonetheless be disallowed due to the limitations on miscellaneous itemized deductions for tax years 2018 through 2025.
If you have not been properly reporting crypto transactions or are unsure what to do with your tax returns positions, email me for assistance vljeker@us-taxes.org
Watch this space – A later blog post will discuss the latest with FBAR and digital assets as well as the new digital asset questions on Form 1040.
Posted February 9, 2023
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