Here are different types of tax reporting challenges that crypto exchanges come across when using Form 1099-B.
Crypto investors have been advised by the IRS to contact brokerages through which they have bought the virtual currencies for tax purposes.
Form 1099-B requires brokerages to report every transaction that the brokerage has enabled between the crypto buyer and the seller. And this tax regime requires crypto exchanges to send a copy of 1099-B to all their crypto investors.
The investors have to further recognize the transactions itemized in the form and report their crypto investments and capital gains made in a year after a thorough validation of transactions.
While this practice may seem quite simple from a layman’s perspective, there is some friction within the process.
Not every brokerage through which the crypto investors bought their virtual assets maintains a comprehensive report of all transactions. The same logic applies to crypto exchanges.
Note: Some crypto exchanges also provide in-house brokerage services, which makes them the broker in the transaction [1].
Further, some crypto investors are not even aware of the capital gains structure of their sellers, which could have a significant impact on the tax burden.
Many such challenges create friction and hinder regulatory reporting and tax compliance in cryptocurrency transactions.
The following will discuss in detail how these challenges act as roadblocks for crypto tax compliance.
Investors may not have the full record of transactions
Not all crypto investors are active investors. While many crypto investors believe in buying the digital currencies and selling them for profits in the short-term, many investors buy their digital currencies and then forget about them, intending to come back to them after a few years, when the capital gains have added up (while also forgetting to report them).
Even the short-term investors are too busy in the trade and may not have to sit down and maintain proper reports of every transaction that occurs in a day.
This brings us to the fact that not all investors have a complete record of all the transactions [1]. When it comes to recognizing capital gains reported in 1099-B, investors may even find it hard to recollect when they might have paid a brokerage for certain transactions and how the capital gains structure works. Lack of transactional records could be one of the main reasons for this.
So, when the crypto investor does receive a copy of the 1099-B, they find it challenging to recognize the transactions, reporting capital gains, validating the reported transactions, and furnishing the information in Form 8949 with the IRS.
No access to tax details of customers
Some crypto exchanges can often be in a hurry to sell their virtual currencies to crypto enthusiasts and do not find the need to obtain the tax details of their customers.
When crypto exchanges do not have validated records of taxpayer information, they are implying that they’re not worried about reporting the transactions. This could be due to the ultimate ownership of the virtual asset, which defines that the asset owner has to deal with the tax burden.
However, brokerages that do not report their transactions through Form 1099-B are at the risk of jeopardizing the tax compliance ecosystem. Further, investors could risk being issued an IRS B-Notice for TIN discrepancies.
The virtual world can be very confusing. When crypto exchanges do not obtain the tax details of their customers, they are most likely not providing any tax details in return either. This could complicate the entire process of crypto tax reporting.
Crypto investors are unaware of the tax obligations
Not a lot of crypto investors are educated about the risks and obligations involved in crypto transactions.
Further, virtual assets are treated as property which means that the virtual asset acquisitions are subject to the same tax regimes as physical property. This also means that the investor is solely responsible for reporting their capital asset purchases, capital gains or losses, and profits in Form 8949.
Crypto investments mean that your investments might bring in larger bucks. Nowhere do the tax rules say that capital gains are not subject to taxes.
If you don’t report your crypto gains, the IRS treats it as tax evasion, which would force you to pay more in penalties for failure to filing and evading taxes.
Inconsistencies in cost basis reporting
The IRS released a comprehensive guide on cryptocurrency tax reporting, which explicitly specifies that crypto investors have to report their investments on a cost basis. This means investors have to report their capital investments at the cost at which they bought their virtual assets, including any brokerage fee.
Crypto exchanges must report payments received through a brokerage in 1099-B and itemize each transaction for which they have received such a payment.
This allows the IRS to tax the brokerage (crypto exchanges), recognize, and tax the investor appropriately after validation.
However, when the cost basis assignment structure is not consistent for all investments, the crypto exchange has to individually maintain the cost basis records, capital gains, and other related variables.
Currently, the IRS recommends crypto exchanges to follow only two cost basis assignment methods: 1) First in First Out (FIFO) and 2) Specific Identification.
When the crypto exchange follows a cost basis assignment structure other than the ones recommended by the IRS, inconsistencies are inevitable.
Inertia towards automated solutions
Newer crypto exchanges are embracing the advantageous automated crypto tax solutions to enable automated reporting and tax compliance. However, crypto exchanges that are not embracing these solutions are missing out on a lot.
Manual efforts to maintain records of every transaction are not sustainable in the long run, especially when thousands of transactions take place every day.
Further, dedicated teams to manage each transactional record and following it up with any mandatory updates will end up being too expensive.
Advanced Crypto Tax Management solutions from Tax1099 allow you to sync your accounting books and transactional data through any of the available integrations. This enables you to make real-time changes to your customer data and tax data at the same time, making it easy for you to report and file your forms to the IRS. Imagine all the time and effort you can save!
Further, Crypto Tax Management solutions from Tax1099 are highly scalable, which means your tax needs are always met, no matter how huge the volume of your transactions.
What’s more? No more TIN discrepancies, thanks to the TIN Matching API from Tax1099, and no more worrying about missed data because you will have it all in one place.
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