The Holidays Are For Crypto & Taxes

If you’re looking for good Black Friday deals that you can buy this year using cryptocurrency -- keep looking. 2021 may be a great year for giving cryptocurrency and NFTs to an increasingly large number of people who are taking an interest, and it’s certainly a fine season for increasing your own holdings -- though that may not quite be in the spirit of things -- but it’s not a year for spending your crypto as a currency to directly buy something nice for a loved one. 

You can still use BLOOD tokens to buy fancy champagne if you are a Sneaky Vampire Syndicate holder, for example, but it’s not a special offer for the holidays.

Charity-based NFT project, Girlfrens, began minting on the U.S. Thanksgiving holiday -- and they do have a mission to give art supplies to young cancer patients  -- but that seems more like serendipity. 

Top NFT marketplace, Rarible, is ready to help you give something back if your gift recipient is interested in making a green-friendly present. 

Sunil Singhvi, the chief business development officer at Rarible, wrote to explain that between November 30th and December 5th, Rarible will cover enough carbon removal credits to offset any NFT minted in their marketplace.

“In light of our recent partnership with Nori, a high-quality carbon removal marketplace platform, Rarible is covering the cost of carbon removal for any NFT minted on our marketplace… Through this initiative, we are giving back to both our Rarible community and to the environment by limiting our carbon footprint with each NFT minted,”  Sunil Singhvi, chief business development officer at Rarible said. 

Singhvi believes that supply issues in 2021 and an increasing interest in digital ownership make this a great year to give NFTs.

“With ongoing supply chain issues, we foresee digital assets as a popular gifting category this holiday season. As consumers turn to NFTs and other forms of digital assets as gifts, overall sales across the industry will increase,” Singhvi said.

Exchanges and trading platforms are happy to offer little seasonal incentives for buying crypto, but there is not much publicity around what special offers you can access using just crypto -- without cashing it in and creating a taxable event. 

And if you intend to use your lovingly collected portfolio of coins and NFTs to buy some RL gifts, you are going to have at least two levels of taxable events -- at the sale of your digital assets and at the time of your purchase.

Holidays and Taxes

Of course, we are used to paying taxes for nearly every sale or purchase, but few taxes are as unpopular as the capital gains taxes which can take more than one-third of the holiday spirit out of selling your prized pocket watch NFT to purchase a set of comb NFTs for your beloved’s beautiful hair NFT, which they have inevitably sold to buy you a gold chain NFT for your pocket watch NFT that you just sold. Worse, the exchange has made everyone poorer because every time you cash out digital holdings in the U.S. you have made a sale and created a taxable event. 

Taxes are a reliable subject to bring up if you want to make a room full of crypto enthusiasts unhappy, and with the passing of the Biden infrastructure bill the level of concern was higher than usual. 

Specifically, there was some consternation on Twitter regarding changes to the Internal Revenue Code (IRC) based on Section 6050i of the $1.2 billion bill. The new rules treat digital currency like other currency, requiring reporting of over $10,000, triggering the need to report, and generally making investors nervous. 

Many articles at the time suggested that this was a major misstep in terms of tax reporting burden for the buyer and for lack of privacy for the crypto and NFT investor. 

Will the new tax regulations have a withering effect on NFT and crypto investing?

We interviewed Wendy Walker, solutions principal at Sovos, Chair of the Information Reporting Subgroup of the IRS, a member of the Advisory Council (IRSAC) and advisor to the IRS on a variety of withholding and information reporting issues impacting the industry regarding the changes and she broke out the changes to the IRC sections and meanings as follows:

• IRC 6045 is being amended to require 1099 reporting (of some kind) for brokers transacting in digital assets.
• IRC 6045A is being amended to require companies transferring digital assets for their customers to include basic details needed for tax reporting to the IRS (should the asset be disposed of on the receiving exchange platform).
• IRC 6050I is being amended to require all businesses receiving $10,000 or more of crypto to report that transaction. Currently, all cash transactions of  $10,000 or more by all businesses are required to be reported following this section of the code. 

Walker believes that the changes will be a net positive for retail investors that they will help streamline reporting to the IRS.

“The 1099 reporting requirements will have a positive effect for retail investors and the industry. For the last few years, the IRS has been actively pursuing crypto investors due to the John Doe Summonses leveraged on Coinbase, Kraken, Circle, and Bitstamp. In many cases, investors had accurately reported their information but had to go through a lot of work to prove that information to the IRS -- and likely incurred costs from their CPA or lawyer along the way. 

According to the IRS, the reason they levied the John Doe Summonses is because they are not receiving third-party 1099 reporting from the exchanges. By requiring 1099 reporting for crypto transactions, retail investors can look forward to less interaction with the IRS in future years.

Also, third-party reporting of tax information is extremely valuable for taxpayers because it provides them with the details that they need to properly prepare their income tax returns.... Retail investors can look forward to a more efficient annual income tax process where they can rely on Form 1099 reporting rather than trying to piece together thousands of transactions across different exchanges that occurred all throughout the year,” Walker said.

Walker did note that the changes coming from the Biden Infrastructure bill will need to better define and limit the scope of reporting transactions.

“As it relates to IRC 6050I changes, this is already required for every business transaction that is transacting in USD or any foreign currency valued at $10,000 or more. This section of the code complements 31 U.S. Code 5331 Reports relating to coins and currency received in a nonfinancial trade or business which are the regulations associated with the Bank Secrecy Act. Here, I think the government will need to be careful to limit the scope of reporting to transactions where crypto is being used as a medium of exchange -- rather than an asset of stored value. So, for example -- if I transfer $10k worth of BTC from Kraken to Binance, that should not be a reportable transaction for purposes of IRC 6050I. However, if I use $10,000 of ETH to purchase an NFT, I expect that the transaction would need to be reported as I am using the ETH as a medium of payment rather than as an asset of stored value,” Walker said.

We also interviewed Jessica Lanning, CERTIFIED FINANCIAL PLANNER™, who echoed Walker’s sentiments -- this is not something for most investors to worry about.

“These are standard forms for investors.  The only reason to fear these forms is to fear taxes or fear being caught receiving money for an illegal purpose.  An investor who is thinking about getting into digital assets to avoid taxes or arrest might rethink their strategy,” Lanning said.

According to Lanning, these “new” complications are only new to retail investors who are unfamiliar with the process.

“Governments have taxed capital gains for a long time.  That might be a new experience to an investor who has never had a taxable gain.  If the government decides to start taxing unrealized capital gains – that is, gain in an asset that has not been sold yet – that would be a new taxable event. For now, it’s about paperwork,” Lanning said.

But, will this take some of the shine off the idea of buying an NFT that appreciates tremendously?

“Well, this is the rub right now.  Crypto/NFT investors want things “decentralized” because it feels more democratic and more like it’s leveling the playing field.  And governments and big financial institutions are starting to bend those assets to their will -- big surprise... Does it take away the appeal of buying an asset that potentially appreciates in a huge way?  I wouldn’t let it do that.  Making money is fun. I can argue that paying taxes is part of participating in your community.  Paying taxes means you made money. Go make money,” Lanning said.

Conclusion 

Perhaps the concern over reporting gains from the sale of NFTs and crypto has more to do with the profile of the retail buyers involved. As the cryptosphere continues to expand, we have buyers, particularly in the NFT space, who may not have had digital holdings -- or traditional holdings -- before the past couple of months to years.

After all, if you aren’t making money you aren’t subject to most taxes.

Otherwise, the responses from users and even the press over the changes in tax code showed some lack of sophistication. Not much has changed -- you are required to report anything over $10,000, as you were before. You will be taxed on gains, as you would before and to do that, they will have to know your identity.

It’s a tough idea to welcome the paperwork as helpful preparation, as Wendy Walker suggested, but perhaps the kickoff to the 2021 holiday season should have the same sense of world-weary realism that the rest of the year has had.

That said, enjoy the time and keep HODLing -- it would take a real seer to say where cryptocurrency as a whole will land 50 years from now, but it’s a safe bet that the mainstream world has decided it has a place. At least when there is a sane tax structure around the asset, it shows the asset is becoming understood and accepted, which is all part of the great mainstreaming we have been seeing all year. 

Update: Sovos emailed me again in the intervening time since the interview to highlight that with the e-filing threshold changes are still not final, and since the deadline to apply for the necessary filing code already passed, most will need to seek advice from their financial advisors, apply for an exception, or seek out a third-party solution.