Bitcoin/CryptocurrencyAn Introduction and the Related Tax Consequences of Buying, Holding, and Selling
Today’sAgenda21. History of cryptocurrency2. What is cryptocurrency3. Initial Coin Offerings (ICOs)4. AICPA comment letters5. Tax issues6. Non-tax issues7. Trends & legal risks8. Q&A9. Resources10. Glossary
1. History of Cryptocurrency“What is needed is an electronic payment system based oncryptographic proof instead of trust, allowing any twowilling parties to transact directly with each other withoutthe need for a trusted third party. Transactions that arecomputationally impractical to reverse would protect sellersfrom fraud . The system is secure as long as honest nodescollectively control more CPU power than any cooperatinggroup of attacker nodes.”Satoshi Nakamoto 2008
Distinguishing Blockchain fromBitcoin Blockchain is the technology platform underlyingbitcoin. A distributed ledger built on a data structure known as“blocks” What problems does it solve?
The Double-Spending Problem Centralized ledgers vs. distributed ledgers The role of intermediaries How a blockchain solves the double-spending problem
Cryptocurrency Enforcement Silk Road Mt. Gox United States v. Coinbase
2. What Is Cryptocurrency?040301 IntangibleNo physical locationUsed either 02Virtual (electronic)For goods or services ANDconvertible to real currency, orOnly in a virtual worldBut not like a currencyDoes not have legal tender status by any governmentLike a currencyMedium of exchange
Types of Cryptocurrency Over 1,600 cryptocurrencies to date(see https://coinmarketcap.com/all/views/all/)Top 5 most popular (based on market cap/price05/23/18):1. Bitcoin (BTC) – 7,565.852. Ethereum (ETH) – 577.183. Ripple (XRP) – 0.594. Bitcoin Cash (BCH) – 995.445. EOS (EOS) – 10.95
Cryptocurrency Wallet A secure digital wallet used to store private and publickeys with various blockchains. Also used tosend/receive various cryptocurrencies. Private key is a secure digitalcode known only to you andyour wallet. Public key is a digital codeconnected to a certainamount of cryptocurrency.
Q-1:How is virtual currency treatedfor federal tax purposes?A-1:For federal tax purposes,virtual currency is treated asproperty. General taxprinciples applicable toproperty transactions apply totransactions using virtualcurrency.Notice 2014-21
Tax Basics When received, fair market value (FMV) at time ofreceipt determines income or amount realized. Basis based generally on value at time of receipt. FMV may be determined by value on establishedexchange. Use of cryptocurrency to purchase/pay is a dispositiongiving rise to gain/(loss).
3. Initial Coin Offerings ICO – “Initial Coin Offering” is an unregulated meansby which funds are raised for a new type ofcryptocurrency. Mining – using of computer hardware/software insolving mathematical problems for the blockchain inexchange for receiving a portion of cryptocurrency. Exchanges:– Fiat exchanges, government-backed currencies forcryptocurrency– Cryptocurrency-to-cryptocurrency exchanges
4. AICPA Comment Letters
AICPA Comment Letters (cont.)102 – Expenses of obtainingvirtual currency2304 – General guidance regardingproperty transaction rules01 – Acceptable valuation anddocumentation03 – Challenges with specificidentification for computinggains and losses4505 – Nature of virtual currencyheld by a merchant
AICPA Comment Letters (cont.)607 – Virtual currency as a“commodity”7809 – Retirement accounts06 – Charitable contributions91008 – Need for a de minimis election10 – Foreign reportingrequirements for virtual currency.As of date, the IRS has notresponded to the June 10, 2016comment letter.
AICPA Comment Letters (cont.) The AICPA is in the process of issuing an updated andrevised comment letter to the IRS in a Q&A format. Additional guidance expected to be requested in the2018 letter, along with the 10 areas from the 2016 letter,including:– Virtual currency events, such as chain splits, airdrops,giveaways or other similar activities– Treatment under Section 1031
5. Tax IssuesGain/losscalculation capital vs. ordinary wash sales, straddles,etc.Like-kind exchanges Not an issue post-TCJA
Tax Issues (cont.) Valuation– “Reasonable manner” per IRS Notice 2014-21 Charitable contributions– Report on Form 8283? Is qualified appraisal required ifFMV 5,000? Accounting methods– Can the FIFO method or specific identification methodbe used? De minimis election– Possible election similar to 200 Section 988(e)(2) forforeign currency exchange gain?
Tax Issues (cont.) Retirement accounts– Are IRAs or retirement savings accounts permittedto hold virtual currency investments? Broker reporting Splits, airdrops and giveaways Derivatives/futures
6. Non-Tax Issues Financial statements SEC Statement on Cryptocurrencies and InitialCoin Offerings (Dec. 11, 2017) FASB – June 8, 2017 letter from Digital Chamberof Commerce for guidance on digital currencyrecognition and how to measure AASB (Australian Accounting Standards Board)“Digital Currency – A case for standard-settingactivity,” December 2016
Foreign Reporting No guidance exists for foreign reporting requirementsfor virtual currency.
7. Trends & Legal RisksFinCEN—Anti-MoneyLaundering and theBank Secrecy ActThe CommodityFutures TradingCommissionSecurities lawsICOsState andinternationalregulation
9. Resources AICPA Tax Section (aicpa.org/tax) AICPA Tax Policy and Advocacy Website AICPA Tax Advocacy Comment Letters Website AICPA Tax Practitioner’s LinkedIn Group
10. Glossary Virtual currency – A medium of exchange thatoperates like a currency in some environments, butdoes not have all the attributes of real currency. Inparticular, virtual currency does not have legal tenderstatus in any jurisdiction. Virtual currency serves as adigital representation of value that is generally trackedthrough a blockchain or software.
Glossary (cont.) Blockchain – A decentralized, distributed ledger that isgoverned by a consensus protocol, maintained by agroup of peers and that operates as a data structure fororganizing information. Consensus protocol – A set of rules and proceduresthat control how and when blockchain transactions areverified, validated, recorded and recognized.
Glossary (cont.) Mining – A process through which blockchaintransactions are verified and accepted by adding suchtransactions to a blockchain ledger. Staking – The act of holding or “mining” acryptocurrency that is based upon a proof-of-stakeconsensus protocol.
Glossary (cont.) Proof of work –A consensus protocol used to validatetransactions recorded on certain blockchains and thatgenerally requires the production of proof of complexcryptographic computations that require large amounts ofcomputing power in order to validate transactions. Proof of stake – A consensus protocol used to validatetransactions recorded on certain blockchains that is basedupon a user’s or miner’s proof of stake in the blockchain.Proof of stake is a common alternative to a proof-ofwork protocol.
Glossary (cont.) Virtual wallet – A software program used to storecryptocurrency private keys. Initial Coin Offering (ICO) – An offer of a coin ortoken for fiat currency or other cryptocurrency,generally performed through a crowdfunding process.
Glossary (cont.) Distributed ledger – A database or ledger that is sharedand administered in a decentralized form across anetwork. Cryptographic hash – A mathematical function oralgorithm that cyphers a given input into a fixed-sizealphanumeric strand known as a hash value.
Glossary (cont.) Token – A subset of cryptocurrency that generallyserves as a representation of value or a particular assetor utility. Airdrop – A procedure for the distribution of virtualcurrency, usually for free and often as a promotionalactivity.
Glossary (cont.) Chain split – A split or divergence in a blockchainleading to distinct blockchains with a shared history upto the point of the chain split event. Soft fork – A change in a blockchain’s protocol that isgenerally intended to result in all users adopting thechanged protocol and maintaining a continuingblockchain.
Glossary (cont.) Hard fork – A change in a blockchain’s protocol thatresults in a permanent divergence from the priorversion and results in two blockchains with a sharedhistory up to the point of the fork. Public key infrastructure – A set of protocols thatgovern digital certificates and an encryption anddecryption process designed to allow for the secureexchange of information.
Glossary (cont.) Node – A computer in a peer-to-peer blockchainnetwork. Peer-to-peer network – A computer network thatallows each computer in the network to share filesdirectly without the need for a centralized,intermediary server.
Glossary (cont.) Utility token – A digital token or cryptocurrency thatrepresents the ability to access a product or service.The concept of a utility token is generally used todescribe a digital token that is not intended to serve asan investment vehicle. Cold storage – The act of generating and storing one’sprivate keys in an offline environment.
Blockchain – A decentralized, distributed ledger that is governed by a consensus protocol, maintained by a group of peers and that operates as a data structure for organizing information. Consensus protocol – A set of rules and procedures that control how and when blockchain transactions are verified, validated, recorded and recognized.