The rise of cryptocurrency has been accompanied by a proliferation of new accounting challenges, not the least of which is how to account for cryptocurrency taxes.
With the IRS recently issuing guidance on how to treat cryptocurrency transactions for tax purposes, the time is ripe for a discussion of how blockchain can be used to streamline the tax accounting process for cryptocurrency.
Benefits of blockchain-based accounting
While the IRS has yet to release specific guidance on how to account for cryptocurrency taxes using blockchain, there are a few potential benefits that could be realized by using blockchain to track cryptocurrency transactions. First, blockchain could provide a more efficient way to track and report cryptocurrency gains and losses.
Currently, tracking gains and losses for tax purposes can be a time-consuming and error-prone process. By tracking transactions on a blockchain, accountants could have a more complete and accurate picture of gains and losses, which would in turn lead to more accurate tax reporting.
Second, blockchain could help reduce the likelihood of fraud and errors in cryptocurrency tax reporting. Because blockchain transactions are public and immutable, accountants would be able to easily verify the accuracy of reported transactions. This could help to reduce the incidence of fraud and error in cryptocurrency tax reporting.
Finally, blockchain-based accounting for cryptocurrency taxes could help to improve compliance with tax authorities. By providing a more transparent and auditable record of cryptocurrency transactions, blockchain could help tax authorities verify that taxpayers are correctly reporting their gains and losses. This could lead to improved compliance with tax laws and reduce the burden on tax authorities to ferret out non-compliant taxpayers.
Challenges of blockchain-based accounting
While the benefits of using blockchain to account for cryptocurrency taxes are clear, there are also some challenges that need to be considered. First, it is important to note that the IRS has not yet released guidance on how to specifically account for cryptocurrency taxes using blockchain. This means that there is still some uncertainty about how exactly blockchain-based accounting for cryptocurrency taxes would work in practice.
Further, even if the IRS were to release guidance on how to account for cryptocurrency taxes using blockchain, it is unclear whether taxpayers would be willing to adopt this new method of tracking and reporting their transactions. Taxpayers are generally conservative when it comes to adopting new accounting methods, and they may be reluctant to change their current methods if they are working well.
Understanding the IRS' virtual currency guidance
To preface, this section is not a comprehensive guide on how to comply with the IRS' guidance, but merely highlights some takeaways for taxpayers. See the IRS' guidance here.
In general, the IRS treats virtual currencies as property for federal tax purposes. This means that taxpayers who own virtual currencies will need to track and report their gains and losses on their tax returns, just as they would for any other type of property.
If a virtual currency is received as payment for goods or services, the taxpayer will need to report the fair market value of the virtual currency as income. For example, if a taxpayer is paid in Bitcoin for consulting services, they will need to report the value of the Bitcoin as income on their tax return.
From mining to investing, there are a variety of ways that taxpayers can acquire virtual currencies. It is important to note, however, that taxpayers will need to track and report their basis in virtual currencies in order to accurately calculate their gains and losses.
The IRS' guidance on virtual currencies provides clarity on how taxpayers should treat virtual currencies for tax purposes. In general, virtual currencies should be treated as property, which means that taxpayers will need to track and report their gains and losses.
Whether a virtual currency is received as payment, through mining, or from an investment, the taxpayer will need to report their basis in order to accurately calculate their gain or loss.