COMMENTARY: Regulation is needed for cryptocurrency market

By Alan Shamoun

Bill Gates and Warren Buffet have both publicly claimed Bitcoin is a fraud and is not an investment vehicle. They are correct when they say it is not the same as purchasing stock in a company, but I disagree when they say it is a fraud.

Bitcoin was the first of nearly 1,500 different Virtual Currencies (VCs) currently available around the world. What all of these VCs represent is a new advancement in technology and may one day be the hub that’s running the global economy. The New York Stock Exchange has even decided to get in on the action and open its own exchange (a virtual market to buy and sell VCs), along with NASDAQ and Goldman Sachs. So while Bitcoin itself may one day be worthless as Gates and Buffet predict, the technology behind these VCs is here to stay and is already being utilized in ways never before imagined.

As an example, if an American company is shipping its cargo on a Panamanian cargo ship from Japan, where their product is manufactured, to Mexico, where the item will be sold, which currency will be used along the way? Traditional banking methods could take weeks before the money was in the company’s hand.

What if there was one VC that was accepted in all of these countries, which could be transferred from wallet to wallet nearly instantaneously, where you wouldn’t have to worry about the exchange rate, or nominal transaction fees? There are certain coins out there, such as Ripple (XRP), backed by some of the largest banks in the world and American Express, for the sole purpose to exchange money globally in a quicker, cheaper, and more secure way.

While you may hear about Bitcoin and other VCs in the news more frequently, the truth is there will not be mainstream acceptance of the general public until the IRS comes out with thorough rules on how to handle various crypto transactions. The typical investor in VCs before fall 2017 was someone more tech savvy who understood the technology behind the coins. This changed when the price of a single Bitcoin jumped to over $20,000 this past December and Coinbase, the largest exchange in the U.S., saw more than 100,000 new members enroll in a single day. I would imagine many of these new buyers did not realize the tax implications that lay ahead for them when the price dropped by nearly half a month later.

When Bitcoin first launched in 2009, the price was fractions of a penny for a single coin. The driving factor is simply supply and demand. The volatility of VCs and their lack of transparency in tracking methods have given way to a host of legal issues surrounding major gains and losses of investors, tax evasion, embezzlement, and securities fraud, to name a few.

The IRS describes Virtual Currencies as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value [and] does not have legal tender status in any jurisdiction.” While the Federal Reserve does not recognize VCs as legal tender, more and more outlets are accepting VCs, and you can even pay your Arizona state taxes using Bitcoin and other recognized VCs. The huge swings in the price over the years has made “Bitcoin millionaires” and some have attempted to avoid reporting their virtual gains from the IRS.

Electronic payment systems aren’t new. They have been around the U.S. since 1871 when Western Union introduced the money transfer via telegraph, followed by the launch of consumer charge cards in 1914, but virtual currencies differ from traditional digital payment transfers of value, because VCs do not represent a claim on value; rather the virtual currencies are themselves the value. This new technology is being viewed by many as a threat of entry into the global money and payment system that could force traditional institutions, including central banks, to adapt or die.

Prior to 2017, only hundreds out of a million or more crypto users reported their crypto-gains since Bitcoin’s launch. The IRS has been investigating ways in which taxpayers are (and more often are not) reporting virtual currency transactions. Even though all transactions for cryptocurrencies are on a public ledger, the “blockchain” it is nearly impossible to know who owns a particular coin at any time without the help of the exchanges handling the transactions and providing this information to government agencies.

According to Forbes, the IRS focused on one of the largest exchanges, Coinbase, and sought records related to all of its more than one million customers. Its demand subsequently was limited to those accounts that conducted Bitcoin transactions worth $20,000 or more, which applied to approximately 8.9 million transactions conducted by more than 14,000 Coinbase customers from 2013 to 2015.  Papers filed during the litigation revealed the IRS investigation was prompted by the agency’s discovery that in those years, less than 900 individuals per year declared Bitcoin related losses or gains despite the fact the value of virtual currency soared from $13 to $1,100 during the same period. Since then, digital currencies have continued to explode, with a trading volume of over $10 billion in 2017.

The Securities Exchange Commission (SEC) has also begun its own investigation to determine whether these VCs are securities.

With VCs becoming more popular than ever, the government has finally taken notice, but is still behind in producing thorough regulations. Tax attorneys and CPAs have been working in the “wild, wild west” with very few clear rules and instructions from the IRS on how to handle certain transactions. There are numerous scenarios the IRS has yet to account for such as mining coins, spending coins directly for goods or services, airdrops, hard forks, and many others.

Under the new tax code, the IRS has made only one real change when it comes to VCs – making it so only “Real Property” can be utilized for a 1031 Like-Kind Exchange. Prior to 2018, some people buying and selling VCs tried to make the argument that each transaction from one coin to another was a like-kind exchange, and thus, was not a taxable event. The IRS closed this potential loophole under the new tax law.

Unfortunately, the IRS has provided little guidance in other areas for VC investors, making self-reporting necessary, and there are a number of challenges facing cryptocurrency taxpayers. For example, digital exchanges are not broker-regulated by the IRS. There are no 1099 forms for exchanges, and only some exchanges have begun to roll out tax-reporting functions. Most people dealing with crypto transactions have either had to track the information themselves on spreadsheets or have had to find another service to track the data since most people have utilized more than one single exchange.

One thing is certain; virtual currencies are going to change the whole banking ecosystem, and whereever money is exchanged, virtual or not, the IRS will find a way to track it and get its cut. I hope the IRS publishes guidelines soon.

My advice is:

• Don’t invest more than you can afford to lose. It’s a volatile market.

• Since short-term gains are taxed at normal income rate, and long-term gains are taxed at a reduced rate, consider buying and holding for more than a year to minimize your tax rate.

• Be proactive with reporting. The IRS is more likely to be lenient with those who are proactive with reporting now, rather than reactive once discovered.

• Work with a tax attorney who understands the technology, the market, and the new tax code to report your taxes accurately to avoid penalties, or worse, criminal charges for tax evasion.

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Alan Shamoun is the principal attorney of Frontier Law Firm PLLC, a tax law firm in Southfield.