Paying Crypto Taxes: Nuisance or Cost of Doing Business?

A seemingly internal matter of US policy - Biden’s Infrastructure bill - is turning heads in the global crypto community for a reason. A $1 trillion package of supposed goodies for the American people almost came to a halt because lawmakers couldn’t agree on how to tax crypto.

Staunch opposition to the bill from the crème de la crème of crypto- and near-crypto super executives (Brian Brooks, Brain Armstrong, the Jack, and others) poured more gas on the fire. The rubbing point was and remains tax evasion in the Cryptoverse, and we all know that when it comes to their money, the members of the Uncles club (Sam, Karl, Ivan, and whatever the Chinese uncle’s name is) are as cranky as a hung-over CPA.

Here are the points made universally in every musing about crypto taxation: crypto has an excellent potential for [insert country] economy, but it needs to be regulated for individual capital gains to translate into the entire nation's wealth. Risks associated with crypto can and must be addressed through technology. A soothing tax climate needs to be instituted and sufficient checks and balances introduced to ensure the traceability of assets, encourage disclosures, and slow down evil-doers.

All fine ideas. Unfortunately, most of the time, the next thought that comes to a lawmaker’s mind is “tax now, ask questions later.” Biden’s bill isn’t an exception: to pay for it; a new tax reporting provision would have to be imposed on virtually everyone involved with crypto. Lowly Python coders and stock price-dependent VPs - the entire tribe would have to chip in for the extra $28 billion to materialize out of thin air over the next ten years to help Main street. Me? I’m confident that with government and former government officials, current and former representatives, and legislators vigorously penetrating the space (and not as humble students of blockchain tech but as advisers and board members), we are headed in the ‘meh’ direction.

The IRS Needs New Skills, Not New Regs

The IRS is always polite and precise. It has been training its eye on crypto users for a while now, adding a question to the front page of the tax form asking taxpayers, “at any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” While tech like crypto or NFTs is designed to be invisible, tax collectors know that money laundering is a daytime job for some crypto users. But rather than imposing a new tax, the IRS and others need a new skill set in asset tracing, along with crypto expertise and digital asset auditing.

Data analytics technology and artificial intelligence are in the spotlight today. Sifting through billions of transactions in the digital world and making the process more efficient for investigators is impossible without new intelligence, especially in the rapidly developing and constantly changing crypto world. It’s challenging, but if the old “follow the money” mantra appended with “trace the data,” the breakthroughs could be significant. But despite all technological innovation, the IRS’ tactic appears to be attrition: the token itself is of no interest to the state (after all, it’s just a piece of code), but when it goes on exchanges, it becomes traceable and taxable. Neither does anonymity work any longer: however many coins you have in your cold storage, at some point, you are going to want to spend it on something, and that’s when the taxman pounces.

Operation “Hidden Treasures”

The new reporting requirements sawed-in to the Biden plan are basically mechanisms for creating a data trail. It’s crucial because, through an inter-government group known as J5, the US, Canada, the United Kingdom, Australia, and the Netherlands will gain unique (read: secret) insight into tax cases involving cryptocurrency. Essentially, J5 is about typologies and methodologies for helping governments worldwide address various emerging threats, and illicit activities involving cryptocurrency are a top priority. J5 takes the issue even further, addressing non-compliance in cryptocurrency and facing down professional enablers. The organization intends to work closely with leading experts in cryptocurrency, pulling together recourses for finding and shutting down the tech that allows various tax signatures to operate on the dark web freely.

There’s actually a J5 operation called “Hidden Treasures,” It is almost a detective story. The op involves “identifying various signatures within blockchain transactions to detect patterns of tax evasion from a structuring standpoint.” And since tax evasion is a borderless crime, the J5 countries are looking at crypto as both a problem in and of itself and the underlying technology for a whole different set of problems. It’s perfectly natural: to a hammer, everything looks like a nail, especially when there is no unified global understanding or definition of cryptocurrency and legal basis for its taxation methodology. In the United States, it wasn’t until 2014 that crypto was classified as property, and in some countries, it still either isn’t or is under a different legal purview.

This means that issuing “John Doe summonses” to Coinbase and Kraken to disclose information about their anonymous users is a destructive practice that’s bound to create pushback - legal and otherwise. The aggressiveness with which the IRS wants exchanges to disclose and report is a stark testimony that, essentially, the current taxation system is a one-trick pony. Still, that trick doesn’t bode well with the new economic and technological realities.

Can The Pony Learn New Tricks?

The Treasury Department’s Green Book is a well of proposals from the Biden administration for the IRS to increase its tax enforcement budget to pull in more tax revenue from cranked-up tax enforcement, including requiring banks and other financial institutions to report more information about their customers’ accounts. Again, the same pony, same trick. The somber motif of the new financial account reporting regime is certainly a valid effort to capture more tax revenue. Unfortunately, the requirement for U.S.-based crypto assets exchanges to report data about their foreign users to the U.S. government is, as a build-up on FATCA, a move that many in the space consider excessive and even dangerous. In one way or another, some variety of the measure will enter the EEA, and for brokers to disclose beneficial ownership information on their clients, including foreign ones, would mean unseen inconveniences and avoidable expenses, which will most definitely stifle innovation.

There’s also skepticism that increased funding for tax enforcement will yield more money to pay for the administration’s priorities. Ironically, the $80 billion for the IRS retooling is supposed to result in a $700 billion increase in tax revenue. This is an unsubstantiated claim, to say the least; if anything, we’ve learned long ago (last time in 2008) that simply throwing money at a government rarely constitutes a well-rounded solution. For instance, the topic of retraining tax revenue agents for the ongoing digital transformation of the global economy is seldom raised, and performing complex audits, investigations, and compliance checks on cryptocurrency using data analytics and other advanced technologies is essentially a brand new accounting-cum-law enforcement discipline. Working smarter is becoming a top priority for government services, and the need for a modernization plan is at hand. Tax revenue collecting services are in desperate need of new infrastructure and updated system architecture that will make the highly sophisticated job of an agent or auditor in the 21st century doable, let alone easier.

In Short…

Essentially, cryptocurrencies embody an idea of the ultimate financial independence without the need for government oversight. The theory purports control over assets coming from the community (in the best possible sense of the term). Understandably, inspired by this philosophy, crypto has successfully risen to the point of mainstream acceptance. Therein lies a curious controversy for us all. On the one hand, the legitimization of crypto as an asset in full rite creates enormous earning potential. However, once that potential is realized, the taxman comes knocking demanding his cut for the privilege of earning openly and legally. Whatever you, the reader, conceive to be a resolution to this problem, I guess we’ll have to learn to reconcile the paradox and accept clear taxation rules as benefits for the entire space. And the most militant of us will have to find it in them to bend the knee and accept paying taxes on crypto as a necessary cost of doing business.