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Coinbase and the Evolving Crypto Taxation Landscape

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Further reflecting the ongoing uncertainty around today’s cryptocurrency tax environment, newly released court documents appear to reveal the intention of the U.S. Internal Revenue Service (IRS) to more narrowly focus its investigation in its ongoing saga on obtaining user information from Coinbase.

According to the July 6 notice, the IRS is only going to be seeking records on users who have conducted "at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in any one year during the 2013-2015 period." This news seems to align with an article in Fortune, where the IRS noted that it wouldn’t be seeking information that could compromise customer account security.

This news aside, the IRS left the window open to seeking more information on the users in question indicating that it may still elect to "issue summonses in individual examinations of Coinbase users for the information that it no longer seeks in this proceeding.”

In an exclusive interview with BTCManager, tax attorney Tyson Cross, founder of the Cross Law Group talks about his journey into the world of crypto taxation along with some thoughts on how he believes this broader landscape will take shape over time.

Tell us a little about your path into tax law

I was practicing as a tax attorney in San Diego, CA when I first got into the cryptocurrency space back in 2013. At the time, there was a lot of uncertainty regarding the tax treatment of bitcoin and other cryptos. I decided to do a write-up answering the most common questions I was seeing and generally explaining how bitcoin was treated for tax purposes. I posted it to r/bitcoin and was immediately inundated with requests for help. Realizing that I had tapped into an underserved market, I launched Bitcoin Tax Solutions and started offering tax services to early adopters, day traders, and miners.

What are some of the more common cases you have dealt with involving cryptocurrencies?

I'd say the majority of my clients would be considered "day traders," who engage in moderate to high-frequency trading on various exchanges and with a large number of different cryptos. This makes their tax situation very complex, even aside from the unique issues of crypto taxes in general. I also have a large number of early adopters who need long-term planning strategies, as opposed to just annual tax preparation. The latter group used to be predominantly early bitcoin adopters, but now includes early adopters holding various altcoins as well (Ethereum in particular).

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Are there any emerging trends that you’re keeping tabs on?

I'm most interested in the regulatory trends facing cryptocurrencies, which in the current regulatory environment and how it's going to apply to cryptocurrencies. We're still in the infancy of this space, and regulators have a long way to go developing an acceptable framework. We are currently seeing shortcomings in almost every facet of the cryptocurrency space.

What are some of the common legal minefields you see with respect to cryptocurrencies?

I'm still seeing a great deal of mistakes being made with regards to tax filings. The most common being issues center around things like poor record keeping and inaccurate capital gains computations. A less common mistake, but one that I'm seeing more and more frequently, is the mistaken assumption that "like kind exchanges" do not have to be reported on a tax return. Although such exchanges are indeed tax-free (assuming that altcoins are indeed "like kind property"), each one must still be reported using Form 8824.

Are there any others?

Another mistake a see, and which is probably the most serious, is the inadvertent violation of anti-money laundering laws by individuals buying and selling bitcoins on LocalBitcoins as a business. This activity, which takes advantage of the arbitrage opportunity between bitcoin prices online vs. local trades, is considered a "money service business" by FinCEN. As a result, these "individuals" need to comply with federal anti-money laundering laws. They also might be subject to state level regulation as well depending on where they live. The feds have been making arrests of individuals they find operating an unlicensed money service business, as well as for money laundering violations.

Regarding the current regulatory landscape around cryptocurrencies, how you see that evolving over say the next couple of years?

The next big move I think we're going to see in the regulatory space is action by the SEC against Initial Coin Offerings. Although some ICOs that are carefully structured might be able to slip by characterization as a "security," many in this space have completely flaunted securities regulations in the US and are at serious risk of getting into trouble with US authorities. It's possible that the SEC will wait for one of the ICOs to go bad and scam investors before stepping in, but that's certainly not a requirement before they take action.

Anything else you would like to offer as we conclude?

Another development in the crypto space will be at the state level as more and more states pass regulations on crypto related businesses. Unfortunately, most of these regulations are not going to be friendly. On a long-term horizon, there needs to be some clarification on the taxation of cryptocurrencies, which hopefully will come voluntarily from the IRS instead of having to be developed via litigation in US tax court.

It would be great if Congress could enact some tax rules specific to crypto, such as a de minimus exception for small transactions like we have for foreign currency transactions, but that is likely not high on their priority list at the moment.