Joe held the paperwork in his hand. The IRS audit hadn’t gone like he thought it should and a million “If only I had” regrets ran through his brain.
The IRS wanted tax, penalties and interest of over $250,000 and if he was reading the paperwork right, they were getting ready to file criminal charges. Criminal charges! He’d never done anything really bad in his whole life.
Joe knew he had sometimes fudged on a few deductions, mainly on the value of charity items that he gave to the local Goodwill, but nothing too bad. He always filed his tax returns on time. He paid his taxes that were due. He was a good person!
It was all because of Bitcoin. “Why on earth did I buy it?”, he asked himself.
It started innocently enough.
His long time friend, Sharon, had sent him a message about crypto currency. It was a brand new way to invest outside the normal Federal Reserve controlled US dollar. He knew that the Feds had been manipulating the money supply and currency for years and this was a way to beat the system, by getting out of the system. Or so he thought. Sharon said the time to buy was now! It seemed like a bit of a stretch. Heck, he couldn’t even explain exactly what it was or how to use it, but Sharon assured him that she’d help him.
So, at $600 per Bitcoin in 2016, he gambled and bought 20 coins. He cleaned out his savings account to do it, but she told him it was a sure thing. He didn’t actually get a coin or anything tangible, just a code. Sharon advised him to work with a coin exchange. In this case, it was Coinbase, headquartered in San Francisco, California.
“Now,” Sharon said. “We wait.”
His other friends thought he was nuts for investing in Bitcoin. Some of them just didn’t care and obliviously went about their regular life, working during the week, partying on the weekend and running out of money before the next paycheck. Others were more like Joe and worried what the future would bring. They were buying gold or silver, stockpiling against the inevitable crash. There was nothing tangible about Bitcoin, so they didn’t agree either.
“Just wait,” Sharon said.
Then, it was 2017. In January, Bitcoin’s value was up to $900 for a bit. But as soon as it went up, it fell again.
“Don’t worry,” Sharon said. “It’s just the profit takers. The value has gone up and they’re taking some of their money out of the market. “
Joe waited. He decided to stop telling his other friends what he was doing. They didn’t understand and either lectured him or tried to turn it into a joke. He looked online for other Bitcoin investors and meanwhile watched the value closely, his heart pounding with every increase or decline of his only nest egg.
In March 2017, the value broke above the all-time high for Bitcoin and started shooting up. $2,000, 5,000 and then hitting $10,000 and above. He had started with just 20 coins, but he kept buying more whenever the price dipped a little. Suddenly he felt a lot richer than he ever had in his life.
“Do I sell it now?” he asked Sharon when Bitcoin crossed the mystical $10,000 line. He’d also discovered an online crypto currency community and he asked them the same question.
“No, don’t sell! USE the coins instead,” the community responded.
It was a way to stay under the radar, he was told. And businesses were beginning to take Bitcoin in payment. He could trade part of a Bitcoin, since at over $10,000 per coin that was more than most products or services he wanted. USE the coins. Don’t sell them. Never pay tax. At least, that’s what the community told him.
Another person recommended that he diversify.
“You’ve got too much in Bitcoin. Trade a few coins for some of these other cryptos, they are just about take off.”
Joe did just that.
In the summer of 2017, Bitcoin offered a crypto version of a dividend, called a fork, and he suddenly was the proud owner of a new currency called Bitcoin Cash.
But, selling? No, he decided to ride crypto all the way out. He was well on to his way to being a crypto millionaire.
It came time to file his 2017 tax return and he reported income and deductions like he always had. He had his job income and a home mortgage, property tax and some charitable donations. He filed on time, paid the tax that was due and just continued on. A few of the other people in the online crypto currency community said they were taking investment expense deductions, like it was a business. Joe didn’t think that sounded right. He wanted to always be conservative with his tax return. The worst thing that could happen, he reasoned, was to stand out and end up an IRS target.
Joe wanted to stay under the radar.
“The loophole,” he proudly told others. “The loophole is to just not ever sell your crypto! Then you don’t pay taxes. Trade them to diversify into other currencies. Use them to buy things you want. Collect the dividends. But just don’t sell. Then you don’t have to pay taxes!”
A few people in the community, newcomers, were desperate to learn more about trading and all that goes into making money with crypto. Joe began coaching people, and, of course, payment was in crypto for the services he provided.
“That way we don’t have to report anything!” Joe explained. “Unless it gets turned into fiat currency, you know, like US dollars, there is nothing to report.”
Others followed Joe’s lead. Others were even more aggressive, selling their crypto and figuring they were invisible. They said you didn’t have to report that either.
“Not so,” said Joe. “Don’t break the law. You could go to jail.”
Joe continued to buy and he had a good sense of timing most of the time. He bought when the market corrected (dropped). Others started to follow him and he became known as a guru in the crypto world. So, people listened when he said to buy, when to trade (diversify) and he compiled a list of places that would take Bitcoin or other crypto in payment for goods and services.
The first glimmer of trouble ahead happened when someone posted a question in the online community.
“What does this IRS subpoena of Coinbase mean for us?” he was asked.
Joe wasn’t exactly sure, but he reassured his readers.
“Don’t worry. As long as you’re not selling, you’ll be fine,” he said.
Coinbase fought back against the IRS’s subpoena and the whole matter ended up in court. The IRS won and got their subpoena, but their far-reaching scope was reduced. The subpoena was limited to just people who had more than $20,000 in crypto currency transactions in the year.
There were over 15,000 people on that first list, complete with names, addresses and social security numbers. There were 15,000 people, Coinbase said. But the IRS said that only about 800 people had reported crypto transactions on their tax return.
The IRS began their audits.
Joe was on that first list. He was fine, he thought, because he’d never sold any asset. He’d traded some, sure, but never sold. Or at least that’s what he thought.
Members of the online crypto currency community started getting notices themselves.
“Don’t worry,” Joe said. “You’re fine. You don’t need a high-priced CPA or tax attorney. You can do this yourself. They don’t even understand how crypto works anyway. I’ll help you.”
He knew he would call the number and extension on the IRS notice he received right away, per their instructions. Even though he kept up a brave front to the community, he was a little nervous before he called the IRS office. And wouldn’t you know it! The audit notice had arrived Friday afternoon so he had all weekend to stew about it.
First thing, Monday morning he called the number on the IRS audit notice. He got right through. That was a good sign!
He knew he was innocent. So there was no problem which explaining what had happened to the IRS auditor he got the on phone. He figured the more he told her, the better it would be for him. He explained about the trades, the dividends (forks) and how he had used the currency to trade for goods and services. “Just like bartering”, he said. “You don’t have to report that either.”
The auditor was quiet during this time. Taking notes, probably, Joe though. Joe became bolder. Maybe he could teach her about what crypto is and what law applies and doesn’t apply so she’d leave his community alone. He could be a hero to the crypto group!
Joe went on to explain that he didn’t take any deductions for the investments or expenses. He reported all of the income he made from his job.
He just didn’t make any income from the crypto. He said he was an expert on all this and people even paid him money to figure out how crypto worked and the legal and tax responsibilities.
“No CPA or attorney I’ve met knows this!” he said. “That’s why I need to do this myself and why I help other people learn so they can do it themselves too.”
Later, he thought maybe it would have been better not to brag that much, but it was true. He was sure from the questions that the auditor asked that she didn’t have a clue what crypto even was.
A couple of weeks later, he got a letter with the full list of everything he needed to show. It included information on his trades and when and how he used the Bitcoins for goods and services. They also wanted to know how much he’d been paid, in what currency and by whom.
He was starting to panic now. There was a lot of things on the list. But, he reassured himself.
“Honesty is the best policy,” he told himself. “All I need to do is tell the truth.”
He spent a few weeks, working every night and on weekends, to put together the lists of information requested.
He met with the auditor and turned over his lists.
“I worked hard on this,” he said. “You can see, I never sold any of the Bitcoins. Every single purchase is accounted for!”
There were a few follow-up questions via telephone. The IRS doesn’t even use email or have private faxes, he thought scornfully. They really need to get with the times!
That’s why he was so shocked to receive the IRS letter in the mail. Again, on a Friday. Does the IRS always mail things so you get them on Friday and you have to spend the whole weekend obsessing about them?
The IRS said he owed $250,000 in taxes, interest and penalties. Plus, what was that? There is some kind of threat of a criminal action?
He spent the weekend, looking for the name of a lawyer. He realized now that he was going to need some help.
Cryptocurrency is a brand-new animal when it comes to taxes. With prices going to brand new high levels and falling as people take profit, there are plenty of gains and losses. But it doesn’t work like you think it does
Dividends are taxable. Using crypto to buy something creates a taxable event for both YOU (as buyer) and the seller. Trading crypto creates a taxable event. The only thing he did with crypto that wasn’t taxable was buying it.
That doesn’t mean there aren’t strategies you can use to pay less tax with your crypto.
I’m working on my next tax book now, “Tax Tales from the Cryptocurrency”. There are some sections that are basic so you can get up to speed on terms like blockchain, proof of work, proof of stake, hard drops and a whole bunch more. If you know that already, skip it and move on to the tax strategies and reporting requirements.
PLUS we’re watching a brand-new big change in reporting that the IRS is hinting at. We’ll see what happens with that.