The Switch ‘It’s going to be a nightmare’: Some bitcoin investors are in for a rocky tax season

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Sean McAuliffe doesn’t have much background in investing, aside from a couple of retirement accounts. But over the Thanksgiving holiday, as the price of bitcoinblew past $8,000 in a months-long rally, the 54-year-old construction manager decided to take the plunge. Like many Americans, he’d read enough about bitcoin on the Internet to feel confident buying a stake in the digital currency and several similar ventures.

McAuliffe’s investment paid off almost immediately: Within a month, the price of bitcoin had more than doubled to over $19,000. Encouraged, McAuliffe bought some more. Now, he figures he executes at least one trade a day and, on paper, has made about $7,000.

“I’ve had some dramatic wins and some dramatic losses,” he said in an interview.

But McAuliffe is also looking ahead to what could be a big headache: Doing his taxes when he sells. Although McAuliffe doesn’t intend to exchange his virtual currency back into dollars anytime soon, other investors have. And many tax professionals have noticed an uptick in questions this year.

“It’s going to be a nightmare for people who are worried about doing the right thing,” said Andrew Schaefer, a federally licensed tax expert in Florida who represents taxpayers before the Internal Revenue Service. At stake this year could be tens of billions in profit and perhaps more, Schaefer said, judging by the surge of interest in bitcoin. Some of that could be subject to federal and state taxes based on how many people sold their assets.

“2016 saw some questions come up,” said Lisa Greene-Lewis, a lead certified public accountant at TurboTax. “As people are doing their taxes [this year], we may see more because more people have been trading and selling.”

The most recent IRS guidance on the matter is from 2014, when it said taxpayers should treat their virtual currency like property. Under that rule, taxpayers must declare any profit, also known as capital gains, or losses they take when they sell bitcoin at a different price than when they bought it. The same policy applies to purchases of real-world goods. For example, suppose you tried to buy a cup of coffee with bitcoin. That would technically count as a sale of your bitcoin. You might owe capital gains tax if the bitcoin you paid at the cash register had increased in value from the time you first acquired it. The IRS declined to comment for this story, referring back to that 2014 guidance.

While the IRS ruling cleared up some questions, it raised others, such as who would be responsible for tracking each investor’s purchase and sale prices, and what methodology would be used to calculate gains. Another question is how to treat the creation of new virtual currencies that emerge as offshoots or “forks” of old ones.

“How does one account for taxes when you have a fork — is it [like] a stock split?” asked Jerry Brito, executive director of the Coin Center, a think tank for virtual currency issues.

With stock, brokerage firms such as Vanguard and Charles Schwab typically help investors track their gains and losses with a year-end tax document, Form 1099. But companies such as Gemini that handle virtual currencies, which haven’t been around for very long, face more ambiguous reporting obligations, leaving it mostly up to individual investors to crunch the numbers themselves. That demands a facility for numbers and an exacting level of attention. Things get even thornier for U.S. employees who work for bitcoin-related companies and may receive the digital currency as part of their salary; that money is taxed as regular income, not investment income.

“I definitely have seen people use Excel spreadsheets to show what they spent to buy the coin, any costs to convert dollars to some sort of cryptocurrency or [whether] they use a credit card to buy them,” said Zak Yaffe, a medical student at the University of Washington who bought a mix of bitcoin and the digital currencies litecoin and ethereum in September.

But not everyone makes the effort, or is even aware he or she may owe money to the government, tax experts say. According to the IRS, from 2013 to 2015 only 800 to 900 people a year declared their bitcoin earnings.

The agency has indicated it could go after investors who fail to report those gains. In a recent court battle, the IRS forced Coinbase, one of the largest U.S.-based exchanges where consumers can buy bitcoin for dollars, to provide taxpayer information on more than 14,000 customers. The IRS did not single out any customer for suspicion in the suit but did say it believed gains from virtual currency “are underreported.”

Coinbase said in a blog post at the time that the ruling was a partial victory for its side in that it denied the IRS from accessing an even broader set of data covering 480,000 customers. In an FAQ page on its website, Coinbase said it will distribute Form 1099 to investors on its platform who have made more than $20,000 in gains “related to at least 200 transactions in a calendar year.” The FAQ urges investors to “keep your own records for best results and update the report accordingly.”

That covers high-volume traders and big-time players but offers little guidance to average investors, said McAuliffe, who invested about $3,000 in virtual currencies last year. “Coinbase sent out — I’ll call it a boilerplate on taxes,” he said, which consisted of a link to the FAQ. “Did they send out a tax report like you’d get from TD Ameritrade? No. Only, like, a flag of ‘pay your taxes!’ and guidance on statutes to look up. … It’s all sort of ‘Wild West’ sort of stuff.”

Coinbase declined requests for an interview. Other exchanges, such as Gemini and Bitstamp, did not respond to requests for an interview.

Lacking further specifics, many investors have turned to social media for answers. Several accountants who moonlight as moderators of the popular Reddit forum known as /r/tax say they have noticed a sharp increase in the number of bitcoin-related requests for advice.

“I know I’ve seen an uptick on /r/tax, /r/bitcoin, /r/CryptoCurrency and /r/personalfinance about taxes and bitcoins, as well as my own private practice,” said one moderator, who goes by the handle /u/DasHuhn. “In 2016 I had roughly 5 questions asked about bitcoin, and in 2017 I had probably 30 or so.”

The recent questions on Reddit range in sophistication. Some posters say they are just beginning to think about buying bitcoin and want to weigh the pros and cons. Others have made substantial gains from investing in the currency and are trying to figure out what they owe in taxes. Still others want to know if they can write offwhat they spend on buying bitcoin as a business expense. (The answer: It depends.)

Even more questions are expected as companies such as Coinbase begin sending out 1099s.

Reddit users tend to be at the forefront of technology, the moderators said, so to see such a dramatic increase in bitcoin discussions on the social platform is not that surprising. But many retail investors who do not frequent the site are now coming to grips with the tax consequences of their bets.

There’s “going to be a big wake-up call in the next month or two,” Schaefer said. “There’s mom-and-pop investors asking about it now. I have explained how cryptocurrency works to my grandparents.”