Bitcoin Tax Reporting Nightmare 2023

You spend weeks going through your transaction history, trying to make sure your tax return is accurate. Despite your best efforts, you end up receiving a warning letter from the IRS saying you owe thousands of dollars in unpaid taxes.

It may seem like a bad dream, but just a few years ago this nightmare scenario happened to thousands of cryptocurrency investors. And, because of short-sighted regulations hastily drafted by American politicians, it’s likely to happen again in the near future on a much larger scale.

Form 1099-K: A Brief History

In the past, there were no clear guidelines dictating the tax forms that bitcoin exchanges had to send to their customers. As a result, different exchanges have chosen different approaches to tax reporting.

Coinbase and other exchanges chose to send Form 1099-K to customers (and the government) if customers reached a certain threshold of trade value and number of transactions. Of course, there was a problem. These forms were designed for use by credit card companies, not cryptocurrency exchanges. Therefore, all of the merchant’s transactions (even those that were not taxable) were reported on the form.

This ended up causing a nightmare for taxpayers, as the IRS was made aware that some taxpayers had transacted with hundreds of thousands of dollars worth of cryptocurrency. The IRS ended up sending thousands of warning letters to investors, many of whom had gone to painstaking efforts to accurately file their taxes.

To their credit, the major exchanges seem to have learned from their mistakes. Due to the confusion caused by these forms, Coinbase and Gemini have since stopped issuing them to customers. Unfortunately, it does not appear that the federal government has learned the same lesson.

How the infrastructure bill will lead to a tax reporting nightmare

In the near future, taxpayers will face an even bigger tax reporting problem. This time, it won’t just be a few thousand people who will receive a 1099-K. Due to the Infrastructure Bill of 2021, these issues will now impact all investors who trade and transact with bitcoin.

While the infrastructure bill didn’t change how bitcoin is taxed, it did change what bitcoin brokers like Coinbase or Binance are required to report. Like stock brokers, they will be required to issue 1099-B forms to clients and the IRS.

At first glance, this may seem like a positive development for the ecosystem. Since exchanges will have clear requirements regarding tax forms to be sent to clients, we could avoid problems resulting from a lack of regulatory clarity. Unfortunately, a closer examination of the situation shows that this bill probably presents more problems than solutions.

Although exchanges are required to report the total amount of fiat you earned (proceeded) from bitcoin transactions, they won’t know how customers originally got their coins or how much money they invested. (on a cost basis). Since transferring bitcoins between wallets and exchanges is so common, we are likely to run into tax reporting issues.

For example, imagine transferring your money from your personal wallet to Coinbase, or from Binance to Coinbase. Then you sell your bitcoin for $50,000.

In both of these situations, Coinbase will not know your original cost base. However, Coinbase will still need to file Form 1099-B with the IRS.

On Form 1099-B, it is likely that Coinbase will report the proceeds of your transactions, but leave the base blank or say “unknown”. So if you sell your bitcoin for $50,000, the IRS could hold you liable for $50,000 in earnings (even if you originally bought your coins for $40,000).

These are the same problems that accompanied Form 1099-K in previous years. Again, this will likely lead to bitcoin investors receiving warning letters about their unpaid tax, even when they have accurately filed their tax returns.

Due to the infrastructure bill, taxpayers will be required to keep detailed records of all their cryptocurrency purchases and transfers. If these records are not kept, the IRS will likely require all proceeds from cryptocurrency disposals to be recaptured as revenue in the event of an audit.

Form 1099-B works for stocks, not bitcoins

Some investors struggle to understand why Form 1099-B would cause such significant problems. After all, stockbrokers like Robinhood and E*Trade are already required to hand out these forms to clients. Yet the vast majority of stock traders are able to easily report their gains and losses during tax season.

It is important to remember that bitcoin is fundamentally different from stocks and securities. Bitcoin is designed to be easily transferable, whether you send it to a friend or family member, hold it in a cold wallet, or trade it on a decentralized exchange.

While brokers can easily share information about transfers and assignments, it’s hard to see how cold wallets and decentralized entities can do the same. Unfortunately, the infrastructure bill seems to ignore the differences between cryptocurrencies and stocks.

Misguided Tax Regulations Hurt Bitcoiners

It is disappointing that the United States has attempted to regulate the new financial system with the same rules that governed the old one. In doing so, regulators completely ignored the benefits that decentralization could bring to Americans across the country.

The infrastructure bill will not negatively impact companies like Coinbase and Kraken. Instead, it will harm bitcoin investors who store their holdings on cold wallets and wish to withdraw from the predatory financial system. Now, their tax reporting is likely to become more difficult and complex than ever.

This is a guest post by Miles Brooks. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.