The Crypto Crackdown is Upon Us

Contrary to popular belief, the IRS is on to all things digital-asset related, and it has been steadfast with its current initiatives on cracking down on crypto. It’s important to understand the various tax implications surrounding cryptocurrencies, as transactions including such assets are on the rise. Let’s break it down into some digestible components:

What has the IRS already said about the taxation of crypto assets? In the eyes of the IRS, cryptocurrency is viewed the same as any other capital asset. As such, gains or losses derived from buying or selling cryptocurrency are taxable. In 2019, the IRS added a question to the individual tax return inquiring about cryptocurrency, and now for 2023, a similar question will appear on business returns for the first time. The bottom line is that the IRS is ramping up its cryptocurrency enforcement efforts because it knows this is low-hanging fruit.

To the IRS, is buying and selling cryptocurrency the same as buying and selling stock on an exchange? Yes. To the IRS, it is one in the same and is reportable taxable income. Like selling stocks, anything that is bought and subsequently sold in less than a year is deemed to be a short-term transaction; anything that is one year or more, is a long-term transaction. The holding period drives the tax rate. The biggest difference, however, is that for federal tax purposes, digital assets are treated as property – and sales of property are not currently subject to the wash sale rule. The wash sale rule prohibits sales of securities at a loss and reacquiring the same securities within 30 days to prevent taxpayers from accelerating losses to lower their tax liability. The IRS is very much aware of this, and there are rumors that this loophole will be closed sooner rather than later (with possible retroactive application).

What other transactions, outside of buying and selling cryptocurrency, are popular? Without getting too caught up in the details, several common transactions are:

Airdrops: An airdrop occurs when cryptocurrency projects freely distribute tokens to investors’ wallets in an effort to build awareness for a project, reward early investors, improve marketing and foster a community. Airdrops are generally taxed at fair market value as ordinary income upon receipt.

Staking: Staking rewards are an incentive that blockchains provide to participants. Each blockchain has a set number of rewards that it distributes for validating a block of transactions. Like airdrops, staking rewards income is generally taxed at fair market value as ordinary income upon receipt.

Sales and compensation for services: A growing number of businesses are now accepting cryptocurrency as payment for their goods and services. Similarly, businesses are also giving employees the option to receive payment in cryptocurrency as their salary. Generally, there is no difference in the tax treatment of sales income and salaries expense; the biggest challenge is dealing with the volatility of the cryptocurrency market.

About the Author: Nicole DeRosa, CPA, MAcc, is a partner at Wiss and a member of the NJCPA Board of Trustees. She can be reached at [email protected].

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