Cryptocurrency & Blockchain General Overview & US Taxation JAG CPAs & Co Cryptocurrency & Blockchain General Overview & US Taxation Shehan Chandrasekera, CPA Founder at JAG CPAs & Co Associate Director at Houston Blockchain Alliance www.jagcpa.com/shehan Shehan@jagcpastx.com

Contents Introduction to bitcoin & blockchain technology Tax Overview Investors Miners Payers & Payees Like Kind Exchanges Charitable Contributions Foreign Reporting What is IRS doing? Tax Planning Opportunities Additional Readings Q & A Contents www.jagcpa.com

Bitcoin & History www.jagcpa.com

If you had invested $1,000 in bitcoin in 2011, it would now be worth $ 500,000,000 !! www.jagcpa.com

Background 1990 1998 B-money, Bit Gold 2008 2009 2010 1 BTC = 1 cent Digicash 1998 B-money, Bit Gold 2008 Financial Crisis 2009 1 BTC = $0.0007 2010 Guy buys 2 pizzas and paid 10,000 BTC ($25), $40 million in today’s value 1 BTC = 1 cent 2012 1 BTC = $100 2014 IRS Notice 2014-21 2017 1 BTC = $20,000 www.jagcpa.com

Charts www.jagcpa.com

What is Bitcoin? Invented by Satoshi Nakamoto Digital currency runs on blockchain Limited supply (21 million units) so not prone to inflation and works as a store of value Other cryptocurrencies Ether Ripple There are about 200 other cryptocurrencies www.jagcpa.com

Pole #1 What is the first successful cryptocurrency? Bitcoin bitcoin Ethereum Ripple www.jagcpa.com

What is Blockchain Technology? www.jagcpa.com

What’s a Database A database is a collection of information that is organized so that it can be easily accessed, managed and updated Name Address SSN License Number James 1234 Westheimer Road 234-45-9980 1000982 Mark 3452 Richmond Ave 675-89-99 8999938 www.jagcpa.com

Characteristics and Disadvantages Controlled by a centralized authority Centralized point of failure Prone to hacking Can be overridden by the administrator Independent third party has to verify the info Associated cost with this service Inefficient Relatively slow www.jagcpa.com

Why Blockchain as A Database Structure? Blockchain is a decentralized database. Same copy of the ledger is maintained by thousands of computers known as “nodes” No central point of failure Decentralized ownership of information Immutable Virtually unhackable Third part verification can be avoided by smart contracts www.jagcpa.com

Pole #2 What is not a way to store cryptocurrency? Cryptocurrency Exchange Hardware Wallet Checking Account Mobile Wallet www.jagcpa.com

Taxation - General Only authoritative guidance we have is IRS notice 2014-21 (https://www.irs.gov/pub/irs- drop/n-14- 21.pdf) Q&A Format Per this notice, cryptocurrencies are treated as “property” www.jagcpa.com

Receipt of Crypto as compensation Income Crypto transactions create two major categories of income Capital Gains Spending Exchanging Buy/Sell Ordinary Income Mining Receipt of Crypto as compensation www.jagcpa.com

Investors Investors are individuals who buy and sell crypto assets for speculative purposes Gains and losses are capital (not ordinary) in nature The exchanges will not issue a 1099-Bs 1099-K is issued if: Gross proceeds are more than $20,000 AND More than 200 transactions in the calendar year FIFO is default, LIFO is acceptable as well Use a coin tracking software like BitTaxer. Tracking basis manually is virtually impossible www.jagcpa.com

Investors Example 1: On Jan. 1, 2018, one BTC was purchased for $5,000. On July 25, 2018, it was sold for $8,000. The gain of $3,000 ($8,000 - $5,000) is short-term and will be taxed at the taxpayer's ordinary income tax rate. Example 2: Assume the same facts as Example 1, except that the BTC was sold for $10,000 on Feb. 15, 2019. In this case, the gain of $5,000 ($10,000 - $5,000) is long-term and will be taxed at preferential rates. Example 3: Assume the same facts as Example 1, except that the BTC was exchanged for Cardano (ADA). 1 BTC = 10,000 units of ADA. 1 ADA = $0.60. This will trigger a gain of $1,000 [(10,000 × $0.60) - $5,000]. www.jagcpa.com

Investors Example 4: 10/01/2018 – Bob Purchased 1 BTC for $5,000. This is the original cost basis. 10/20/2018 – Market went up so 1 BTC is now worth $10,000 (200% gain on initial investment) 10/20/2018 – Ethereum (ETH) went down in price so Bob sees a great buying opportunity. He purchased 20 units of ETH using the 1 BTC previously purchased. 1 ETH = $200 Step 1: Calculate the value of new property received Value of 20 ETH Purchased = $4,000 (20 * $200) Step 2: Calculate the number of original token spent to get the new token BTC spent to buy 20 ETH = 0.4 ($4,000 / $10,000) Step 3: Calculate the gain/loss Cost basis of the BTC Sold = $2,000 (0.4 * $5,000) Proceeds of the BTC Sold = $4,000 (0.4 * $10,000) Gain = $2,000 ($4,000 – $2,000) www.jagcpa.com

Investors Poloniex Coinbase www.jagcpa.com

Advantages of using Cointracking Software Automates capital gain/loss calculations Can optimize for FIFO/LIFO/Specific identification API import (similar to bank feed); limited manual input Generates Form 8949 and sometimes, even Fincen Form 114 QB like features for the accountant Direct import to some tax software www.jagcpa.com

Investors Form 8949 presentation -Check Transactions not reported on Form 1099-B www.jagcpa.com

Pole #3 Cryptocurrency gains/losses arising from investing activities are reported on which IRS schedule: Schedule D Schedule C Schedule E Schedule A www.jagcpa.com

Miners Include in Gross income FMV of the tokens mined as of the date of receipt Sale of mined tokens generates ordinary income (not capital gains) Common expenses/deductions Mining Machines Utility Rent Internet Fees Choice of entity: Schedule C, C Corp, S Corp or LLC www.jagcpa.com

Payer | Payee Tokens can be used as a method of payment for goods and services provided or received Payer = deduction is the FMV of the tokens at the date of disbursement Record disbursement on W-2 or 1099-Misc as appropriate subject to those reporting requirements Payee = include in gross income FMV of the tokens received at the date of receipt Challenges Capital gain/loss at the time of transfer Payroll tax/Self-employment tax obligation will be in USD www.jagcpa.com

Method of Payment www.jagcpa.com

Like Kind Exchanges (LKE) LKE exchange under §1031 is a transaction or series of transactions that allows for the disposal of an asset and the acquisition of another replacement asset without generating a current tax liability from the sale of the first asset. Not applicable for cryptocurrencies effective 1-1-18 www.jagcpa.com

Charitable Contributions More and more charities are accepting cryptocurrencies as donations Since the IRS defined VC as property, donations are subject to non-cash capital gain property donation rules Capital gain property is generally subject to 20%, 30% and overall 50% AGI limitation If the deduction is more than $5,000, donor must obtain qualified appraisal report www.jagcpa.com

Pole #4 According to the IRS, bitcoin is treated as: Foreign currency Commodity Property Security www.jagcpa.com

Foreign Reporting Subject to FBAR reporting Subject to FATCA reporting Tokens held in overseas exchanges are considered to be foreign assets $10,000 threshold Subject to FATCA reporting File Form 8938 (Statement of Specified Foreign Financial Asset) as applicable Consider updating foreign reporting paragraph of engagement letters for crypto assets www.jagcpa.com

What is IRS Doing? Currently, there is no matching mechanism Partnership with Chainalysis With the assistance of Chainalysis, the IRS could potentially track bitcoin transactions to identify suspicious wallet addresses from the early days of the digital currency. www.jagcpa.com

Tax Planning Opportunities Wash Sales Rules FIFO(default)/LIFO Optimization Client Status Investor Trader Mark-to-Market Election under 475(f) NO SE Taxes Dealer Status Accelerating deductions for mining operations Sec 179 Vs Bonus Depreciation Expense under De Minimis Safe Harbor for mining equipment R&D Tax Credits 83(b) election www.jagcpa.com

Additional Readings IRS Notice 201421 https://www.irs.gov/pub/irs-drop/n-14-21.pdf Reality Check: Virtual Currency and Its tax Ramifications https://www.thetaxadviser.com/issues/2018/jul/virtual-currency-tax-ramifications.html Practical Issues Related to Bitcoin https://www.mncpa.org/resources/publications/footnote/may-2019/practical-issues-related-to-bitcoin/ www.jagcpa.com

Q&A? www.jagcpa.com

Associate Director at Houston Blockchain Alliance Thank You Shehan Chandrasekera, CPA Founder at JAG CPAs & Co Associate Director at Houston Blockchain Alliance www.jagcpa.com/shehan Shehan@jagcpastx.com www.jagcpa.com