5 things every US accountant should know about cryptocurrency

Because TokenTax specializes in crypto tax, we’re sometimes contacted by other accountants who are struggling to track and make sense of a client’s crypto transactions.

Based on these experiences, we’ve identified five things we wish every accountant knew about cryptocurrency.

5 crucial crypto tax facts

1. Not every crypto exchange issues a 1099

If you have clients who are very active in the crypto space, it’s likely that they will have traded on an exchange that doesn’t issue 1099s (or doesn’t issue 1099s that cover all types of transactions).

Although Biden’s Infrastructure Bill requires US based exchanges and brokers to send 1099s starting in the 2023 tax year, they are currently not required to do so—and some have opted not to. 

For example, Binance.US, the American offshoot of the world’s largest crypto exchange, stopped issuing 1099-Ks after the 2020 tax year. Instead they will send 1099-MISCs, which only report income from rewards or staking.

This means that if you’re only considering data from a client’s 1099, you could be missing a large portion of their transactions.

It’s important that your clients keep track of the platforms on which they’ve been trading. If they’ve made transactions on an exchange or protocol that does not issue 1099s, they will need to obtain their trade history from the company as a .csv download.

2. You can use HIFO accounting to lower a client’s tax liability

The IRS allows specific ID accounting for crypto assets. This means you can use the highest-in-first-out (HIFO) method to apply cost bases to sold assets, potentially significantly reducing your clients’ tax liabilities for the given tax year.

Using HIFO or other specific ID methods requires investors to keep detailed records of their tax lots. Too often this is not what has happened, leading to headaches for accountants because of a preponderance of missing or incorrect cost basis.

3. Many popular exchanges are not US-based

Some of the world’s most popular exchanges are not based in the US, including Binance, FTX, and KuCoin. While US trading is officially disallowed on these platforms, US investors often get around the restriction by investing in virtual private networks (VPNs), which encrypt a user’s IP address so exchanges cannot determine where they are located.

Clients who have traded on international exchanges will not only not receive a 1099, but they may also want to send an FBAR to FINCEN out of an abundance of caution, provided the sum of their international holdings was $10,000 or more at any point in the tax year

4. Losses from theft, fraud, or technical breakdown cannot be written off by individuals

Unfortunately, losses due to scams, theft, or technical breakdown are not unheard of in the crypto space. Many clients hope that they can write off these losses as casualties.

However, the Tax Cuts and Jobs Act of 2017 reduced eligibility for individual casualty loss deductions to assets lost due to a federally-declared disaster, which is unlikely to apply to crypto.

5. Gray areas abound, especially for newer technologies

Despite the Biden administration’s push to regulate digital assets, very little explicit guidance about crypto tax reporting has been issued by the IRS. This means that ‘gray areas’ are one of the biggest challenges of crypto tax preparation.

For example, wash sale rules don’t technically apply to crypto transactions because crypto hasn’t been classified as a security. However, there is a concerted legislative effort to close this loophole. 

In 2021, the House of Representatives considered two proposals to apply wash sale rules to crypto, suggesting that legislative changes may be coming in the near future. This may lead some accountants to recommend their clients do not make wash sales.

Regulatory uncertainty is compounded by the speed at which the DeFi (decentralized finance) space is evolving. There is considerable debate about the tax treatment of newer technologies such as wrapped coins, rebasing tokens, and multichain bridging.

The time is now to get smart about crypto tax 

Increasing public adoption and regulatory scrutiny make it clear that tax accountants can’t ignore digital asset classes. 

Crypto tax software goes a long way in simplifying the crypto tax preparation process, as it aggregates data from multiple exchanges, protocols, and wallets. 

However, it’s important that accountants also get up-to-speed on not only relevant tax law and IRS guidance, but also on blockchain technology itself, as understanding a protocol’s mechanics is often the clearest way to determine the most appropriate tax treatment for the profits it generates for users.