Why is Tax Reporting For Cryptocurrencies so Stressful?
The evolution of cryptocurrencies — the virtual “coins,” was supposed to disrupt the very concept of money itself. But it didn’t go as planned.
With no physical manifestation, no central bank, and no government regulation, cryptocurrencies provided a perfect spot for some investors to dodge tax authorities.
Crypto Is No Longer “Bogus”
Bitcoin, the most popular cryptocurrency, and other “privacy coins”, such as Monero and Zcash, used to rule the dark web — the shady part of the Internet where weapons, pornography, and gambling are easily available. But this is slowly changing.
Gone are the days when the government considered cryptocurrency as a “bogus” economy.
Today, government regulations are now playing a vital role in legitimizing cryptocurrencies that are often associated with shady online purchases and money laundering.
Government agencies have now started to tax people that have crypto assets. This may be seen as both good and bad news at the same time.
The Inherent Complex Nature of Cryptocurrencies
The good thing is that some governments are now slowly accepting cryptocurrencies as a legitimate source of income and a real currency.
However, the bad thing is that the number of trades that a high-level crypto trader goes through, is so high that it is nearly impossible for him to calculate the taxable trade income within a few hours, especially when done manually. Traders argue that this time lost in calculations should otherwise have been used to earn more money!
Decentralization Also Provides for Complexity
There is another complexity involved with virtual coins. Cryptocurrencies are difficult to track because of their decentralized nature. And given their unique blockchain structures, cryptocurrencies like Monero and Zcash are even harder to track than others.
Crypto traders often utilize many different exchanges, platforms, and tools to transact and trade cryptocurrencies. It all sounds very simple and easy with two basic forms involved in tax reporting, but it isn’t like that. This is because no other investment has ever worked the way crypto does and nothing about crypto is centralized.
It’s easy to move coins from one exchange to another at any time which makes capital gains exceptionally difficult to track. Most of the people trade on between 5 and 12 exchanges, and there are more than a thousand different coins to trade.
The exchanges don’t communicate with one another, nor do they have any sort of common standard. Some exchanges require investors to identify themselves, while others promise complete anonymity. Some are even more restrictive than others. This makes it impossible for an exchange to accurately report how much an investor originally paid for a crypto coin.
The Difficulties Associated With ‘Crypto Tax’ Calculation
Due to the way the U.S. and IRS classify cryptocurrencies for tax purposes, it becomes more difficult for traders to accurately track the necessary data needed for tax reporting.
Since the IRS treats cryptocurrency as “property”, and not “currency”, for tax purposes, a trader is required to report his capital gains and losses from his crypto trades on the tax filing.
To report these transactions properly, you need to report your original cost basis, the fair market value of the coin at the time of the trade in US Dollars, and the amount of gain or loss you incurred for every cryptocurrency transaction you made.
With the historical USD prices for all coins not readily available, doing all this by hand makes tax calculation close to impossible.
Realizing the tax implications of it all, many individual investors who wish to comply with the IRS, are now demanding that exchanges provide tax information reporting because keeping up with a huge number of transactions and fetching historical prices is nearly impossible for them. Penalties for late or incorrect forms can quickly become more severe.
This makes it all the necessary for software that is designed to address these complexities.
I spoke with CryptoTrader.Tax, who recently partnered with TurboTax to help answer some of my questions surrounding crypto and taxes. The software automates the entire cryptocurrency tax reporting process.
By uploading your cryptocurrency trades onto the platform, the process is condensed down to a matter of minutes. The platform will automatically crunch your capital gains and losses numbers and prepare the necessary tax documents including the IRS Form 8949.
What Does the Future Hold for Crypto?
When it comes to any new, disruptive technology, it takes time for the infrastructure to get built to bring in widespread mainstream adoption.
Due to the inherent nature of cryptocurrency, there will always be tax implications, especially as more security tokens come into the mainstream. Companies that help reduce complexities and save time will enable more and more consumers to enter the world of crypto.
Third-party automated tax calculation and reporting solution providers like CryptoTrader.Tax can help minimize risk by facilitating the centralization and automation of reporting. Both of these factors are key to avoiding penalties and developing efficient tax reporting processes for cryptocurrencies.