Tesla, the IRS and the Future of Cryptocurrency

SMITH BRAIN TRUST – Maryland Smith’s Samuel Handwerger says he knows one thing about Elon Musk’s 2020 personal tax return. The billionaire Tesla CEO and founder will be checking “Yes” next to this question: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

The question first appeared in 2019 on the IRS tax return form, but was on Page 3. Now the question is on Page 1, the first question right after your name and address. “Is this a subliminal message from the IRS?” asks Handwerger, a CPA and an accounting lecturer at the University of Maryland’s Robert H. Smith School of Business.

It’s interesting, he says, that the question doesn’t ask merely if you made money on cryptocurrencies. Just buying Bitcoin or another crypto-based currency necessitates a “Yes” to that question.

“And if you answer wrongly, willfully, well, that’s perjury, my friend,” Handwerger says. “Crypto may be virtual, but it is real in the eyes of the IRS and has tax implications when traded or used for transactions.”

Musk lately has been a frequent topic of conversation within cryptocurrency circles. This month, Tesla announced in an SEC filing that it bought $1.5 billion in Bitcoin at the end of last year and that the electric automaker would start accepting the cryptocurrency as a form of payment. Musk himself, meanwhile, has been credited with driving up the prices of Bitcoin and dogecoin, after a series of unsubtle pro-crypto messages.

It’s helpful, Handwerger and other experts say, to think about crypto-based digital currencies not as currencies at all, but as property, like a stock or a bond.

“If you buy, for example, Bitcoin at $200 and sell it for $400, then you have a $200 gain subject to tax using the capital gain rules,” Handwerger says. “Regular income tax rates apply if it’s sold short-term and preferential rates if held long-term, defined as greater than 12 months.”

Seems straightforward, right?

“But if you use that same Bitcoin that you paid $200 to acquire and now use it to buy a pair of Bluetooth headphones valued at $400, you also have a $200 gain on the Bitcoin, same as if you had merely sold it”, Handwerger says.

“This is the type of transaction that is giving the IRS nightmares, as they believe that perhaps millions of such transactions have occurred in recent years and have not been reported.”

And it’s what led last year to the IRS crackdown on the San Francisco-based digital currency exchange Coinbase, with 10,000 letters to Coinbase customers. The IRS says the letter was an “educational” communication about the need to report taxable crypto transactions on a tax return. But some Coinbase customers say the letter was threatening; they say the IRS improperly received their personal information via a subpoena. The case is pending.

In 2021, the IRS will be seeking third-party requirement reporting by brokers for transactions in virtual currency. “The IRS is tracking down markets that are going unregulated – and virtual currency is squarely in its sight line,” says Handwerger.

Individuals or firms who receive Bitcoin as payment for services or products should have the value of Bitcoin at the time of the transfer translated to U.S dollars and report that equivalent value as income for the transaction.

For employees who are paid in Bitcoin, the same conditions would apply, he says, with the fair value being reported as wages and added to their W-2. After that, if the Bitcoin is ever sold or used as currency, any gain on the value from the time of receipt is taxable. Now you see the need for brokerage tracking.

And it’s not only the IRS that has crypto on the radar screen. The Financial Crimes Enforcement Network (FinCEN) is watching too. FinCEN oversees the reporting of foreign assets with the Form 114 filings required of all “U.S. persons,” listing their foreign accounts when greater than $10,000 on any one day in the calendar year, in the aggregate. Starting in 2021, cryptocurrency will be added to this reporting, labeling it as a type of reportable account.

The IRS provided some guidance on the taxation of cryptocurrency last year, Handwerger recalls. Among the guidance are rules for donating or gifting cryptocurrency, the holding periods in virtual currency as transactions were made, tax consequences for software changes that lead to the currency splitting into two (otherwise known as a hard fork), and tax return reporting. More detailed information is available in the FAQ section of the IRS website.

“Tesla is onto something with their stake in virtual currency,” Handwerger says. “Cryptocurrency is possibly on its way to redefining the future of finance – and the IRS.”