The Tax Man Cometh (to an exchange near you, soon)

The approaching end of 2017 gives us a lot to reflect back on.

Bitcoin climbed from under $1K to well over $14K (as of the writing of this column).  In conjunction, Bitcoin’s corresponding market capitalization climbed from $15.5 billion to over $244 billion.  And to hear many tell it, this phenomenal growth is just the start.

In less than 24 hours, the Cboe Global Markets, Inc. will begin offering futures trading in Bitcoin followed a week later by the Chicago Mercantile Exchange and a promise of the same by NASDAQ further down the road in 2018.  Despite the tendency of the cryptocurrency community to shirk the “establishment,” this big step toward legitimization of the currency will almost certainly lead to even more rapid adoption by more traditional investors looking to get in on the profits of trading in the crypto environment.

On a side note, if you are concerned about institutional traders trying to drive down the price of Bitcoin through futures trading, here is my limited understanding:  No one trading in futures is actually buying or selling an actual bitcoin.  They are trading on price projections.  Think of it like Fantasy Football.  Lots of real players are actually playing professional football and making millions out there.  You and I play fantasy football and bet that the players we pick will have the game of their life.  We hope the players we don’t pick will come down with a season-ending injury so we can finally shut up that loudmouth, Todd, who has won the last three years and flaunts it like he is on the cover of GQ or something.  Jerk.

Suffice it so say that these futures traders are simply betting on the future price of Bitcoin one direction or another.  The actual buyers and sellers of Bitcoin (me & you) will still set the price based on our demand of the scarce product.  I think the two most important words there are “demand” and “scarce.”  High demand coupled with scarcity will continue to drive the price up.  Since by its very design, Bitcoin’s scarcity cannot be alleviated, the only variable in this equation is the demand.

Anyway, a concern I have seen mentioned repeatedly is that institutional money will flood into the market and short bitcoin to drive the price down in an attempt to de-legitimize or even crash the market (or maybe just find a better entry point for a long position).  I personally do not think this is very likely for this simple fact:  Futures trading will have to maintain some level of equilibrium simply because for every trader betting that Bitcoin’s price will crash by way of a short sale, another trader must be betting that Bitcoin’s price will rise by taking a long position.  A short sell cannot exist unless a long position exists to borrow from.

Again, I’m no expert on that topic but I have used that logic to reassure myself that I should continue to HODL.

So what else have we seen in 2017?  Oh yeah, the IRS, as I predicted in my column What are the tax implications of investing in Bitcoin and other cryptocurrencies? (United States Tax Code), won its first battle to force Coinbase to disclose investors with more than $20,000 in transactions or transfers to or from Coinbase during the period from 2013 to 2015.  The IRS has even vaguely promised to work even harder to make life difficult for anyone avoiding reporting and paying their capital gains taxes , and frankly, I am comfortable predicting they will continue to win.

The ruling was not entirely a loss, however.  The modification of the original IRS subpoena setting the floor at $20,000 could indicate that the idea of exempting a certain dollar volume of transactions from capital gains tax is taking hold even with the IRS.  See my column, What is The Cryptocurrency Tax Fairness Act of 2017 and how could it affect my Bitcoin transactions? for more details regarding pending legislation on that topic.

As for me, without any advice from my friends or colleagues, I have taken a long, HODLing position in Bitcoin and numerous other cryptocurrencies this year.  Needless to say, I am feeling pretty big for my britches as I continue to watch the charts along with the rest of you.

The reason I had no advice from friends or colleagues is because, as a CPA, none of my friends or colleagues have a clue what Bitcoin is.

Seriously.

In my profession, we are required to maintain what is referred to as Continuing Professional Education.  The amount varies from state to state, but my state requires 80 hours every two years.  Earlier this summer, I attended a week of continuing education focused on taxation, and the only Bitcoin reference was during a seminar highlighting how criminals might perpetrate a fraud or crime online. Not one CPA in the room had ever filed a tax return for a client reporting earnings from Bitcoin, and everyone seemed to share the perception that anyone using Bitcoin must be a criminal.  I was afraid to even admit owning Bitcoin lest I fall under suspicion.  Perhaps after a few clients come to them and say, “I need to report my Bitcoin earnings and/or trades this year,” their eyes would be opened to the vast possibilities beyond buying illegal drugs and fake identities.

Based on past and present actions of the IRS, taxation will occur one way or another, so prudent investors who value their freedom will report now rather than letting penalties and interest compound for failing to report over the years.  In fact, those with over $20,000 in Coinbase transactions between 2013 and 2015 should probably get in touch with their accountant and start working on filing amended returns.  The sooner the better since penalties and interest start accruing from when the return should have been filed not from the moment of discovery.

Mass adoption will equate to higher demand and increased gains for you and me and all others currently in the crypto markets, but I truly believe it will only come once people start actually reporting their earnings on this stuff and the IRS gets their feathers unruffled.  While I completely agree that taxes stink profusely, I also believe that any action taken by the IRS to secure unreported taxes, in its own unique way, continues to push cryptocurrencies towards further legitimization.  Unfortunately, their current, very aggressive and adversarial approach to tracking down who has not reported and paid taxes on their crypto is literally going to ruin the lives of some people who are unluckily chosen as examples.

Right now, over 14,000 customers on Coinbase are probably feeling pretty nervous while the rest of us sit by and watch with consternation and sympathy.  They should be nervous.  We all should, for the tax man cometh, pale horse or not.

© Michael L. Collins

Be sure to check my blog The Crypto Tax Center for my previous columns on the tax effects of mining, how to shelter your crypto gains from taxes using IRAs and more.  Sign up for email notices and of course, if you feel like supporting The Crypto Tax Center, you can donate here.