Cryptocurrency Taxation Just Got Nuttier with This Million-Dollar Loophole and the IRS’ “J5” Formation

IRS? What IRS? Meet the "J5."

The IRS wants your money — and that means crypto gains, too.

In July, the IRS announced it would be launching initiatives to “address noncompliance related to the use of virtual currency.” Those holding crypto assets are now in the tax man’s crosshairs. That same day the IRS also revealed the agency is teaming up with peer revenue services in Australia, Canada, the Netherlands, and the UK “to pursue cyber criminals” and “fight against international and transnational tax crime and money laundering.”

The member countries, self styling themselves “The J5”, are directed — at least in part — toward enforcing tax laws on cryptocurrency traders.

“The formation of the J5 demonstrates the serious commitment of governments around the globe in enhancing international cooperation in fighting serious international tax and financial crimes, money laundering, and cybercrime through the use of cryptocurrencies,” said Johanne Charbonneau, Director General of the Canada Revenue Agency.

Hans van der Vlist, General Director of the Netherlands’ FIOD, cited “the threat of cryptocurrencies to tax administrations” as a primary concern of the J5, while Simon York, Director of HMRC Fraud Investigation Service, ominously added “no one is beyond our reach.”

The IRS has also been muscling crypto exchanges like Coinbase for user information. In February, Coinbase turned over the names, birthdates, taxpayer IDs, home addresses and transaction histories of 13,000 high-volume users. What they will do with it remains to be seen, but the handover disrobes the anonymity cloak quickly.

Nevertheless, there are still some ways to keep your crypto money and stay on the right side of the law. Especially since the Trump Administration’s latest tax law changes might have incidentally changed the rules.

A loophole allowing for tax deductible investments

The investment-research platform Pareto stumbled upon a loophole for investors and businesses looking to build their net operating losses by end of year. By way of background, Pareto’s research subscription is accessed by making purchases of the Pareto token to build up a score, with a higher score determining preferential access to the content.

Any purchases made to this end qualify as expenses, for businesses and sole proprietorships. But on your balance sheet, there remain assets, in the form of the Pareto token. With its vibrant market, and limited supply of Pareto tokens, you can still recoup the costs, at least partially, or sell as profit.

That means any of your end-of-year Pareto token purchases can become something once thought impossible: tax-deductible investments.

Usually there are no assets used to access a service like this that also have a secondary market. It’s a unique situation, and it opens the door to potentially unlimited tax deductions and net operating losses, if one were inclined to take it so far.

The IRS in response

So how will the IRS — or the newly formed “J5” — respond to such a strategy?

That depends on how they decide to classify cryptos, or the many kinds of transactions related to them. “There is still a lot of uncertainty about how the IRS will come down on virtual currency,” tax attorney Clay Littlefield recently told Bloomberg. “There are some good arguments for why this analogy or that analogy should apply, but there’s not a lot there.”

The American Institute of Certified Public Accountants (AICPA), whose 400,000 members practice as Certified Public Accountants (CPAs) in 143 countries, has been looking for more specific answers.

“The rapid emergence of virtual currency has generated several new questions on how the tax rules apply to various transactions involving virtual currency and activities and assets related to it,” wrote chair of the AICPA Tax Executive Committee Annette Nellen in a letter to the IRS, adding that “the development in the number of types of virtual currencies and the value of these currencies make these questions both timely and relevant to a growing number of taxpayers and tax practitioners.”

In the interest of CPAs and their clients remaining in good standing, Nellen recommended that the IRS release “immediate guidance” on the taxation of cryptocurrencies.

“Virtual currency transactions, in which taxpayers increasingly engage, add a new layer of complexity to the analysis of a client’s reporting requirements. The issuance of clear guidance in this area will provide confidence and clarity to preparers and taxpayers on application of the tax law to virtual currency transactions.“

But until we have such guidance, the jury — so to speak — is still out and a lot of questions still remain about how the IRS will handle all the tricky little details that make crypto so interesting.

2018 has been a different crypto experience than 2017, with new complexities—and new loopholes—helping to stir the pot.


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