January 2018

How Traders Can Get The 20% QBI Deduction Under New Law

January 12, 2018 | By: Robert A. Green, CPA | Read it on

Like many small business owners, traders eligible for trader tax status (TTS) are considering to restructure their business for 2018 to take maximum advantage of the “Tax Cuts and Jobs Act” (Act). Two tax benefits catch their eye: The 20% deduction on pass-through qualified business income (QBI), and the C-Corp 21% flat tax rate.

The 20% QBI deduction
There are two components for obtaining a 20% deduction on QBI in a pass-through business.

1. QBI: I’ve made some excellent arguments over the past few months in my blog posts for including Section 475 ordinary income for TTS traders in QBI, but the Act did not expressly confirm that position. I am confident that Section 475 is part of QBI, so consider that election for 2018. The law only counts QBI from domestic sources, which may mean trading activity in U.S. markets, but not foreign markets and exchanges.

I’ve also suggested that TTS “business-related” capital gains should be includible in QBI since the Act excludes “investment-related” short-term and long-term capital gains. For now, I assume the IRS may reject all capital gains.

2. SSA vs. non-SSA: Assuming a TTS trader has QBI on Section 475 MTM ordinary income, the calculation depends on whether the business is a specified service activity (SSA) or not. I’ve made some arguments on why a trading business could be a non-SSA but based on the new tax law, TTS traders should assume their business is an SSA.

For example, if a TTS trader has 2018 taxable income under the SSA threshold of $157,500 single and $315,000 married, and assuming the trader has Section 475 ordinary income, then the trader would get a 20% deduction on either QBI or taxable income less net capital gains (whichever is lower). The 20% deduction is phased out above the SSA threshold by $50,000 single and $100,000 married. If taxable income is $416,000, above the phase-out range, the married couple gets no QBI deduction at all.

A QBI deduction is on page two of the Form 1040; it’s not an adjusted gross income (AGI) deduction or a business expense from gross income.

An owner of a non-SSA business, like a manufacturer, is entitled to the 20% deduction without a taxable income limitation, although there is a 50% wage limitation, or alternative 25% wage limitation with 2.5% qualified property factor, above the SSA income threshold. (See Traders Should Be Entitled To The Pass-Through Tax Deduction.)

TTS trading with Section 475 ordinary income
TTS is a hybrid concept: It gives “ordinary and necessary” business expenses (Section 162). A trader in securities and or commodities (Section 1256 contracts) eligible for TTS may elect Section 475(f) mark-to-market (MTM)) accounting, which converts capital gains and losses into ordinary gains and losses.

Steven Rosenthal, Senior Fellow, Urban-Brookings Tax Policy Center, weighed in for my prior blog post and again recently: “Section 475 treats the gain as ordinary income,” he says. “Section 64 provides that gain that is ordinary income shall not be treated as gain from the sale of a capital asset.” Mr. Rosenthal thinks Section 475 ordinary income is QBI under the new tax law for this reason and “because it’s not on the QBI exclusion list.” Rosenthal pointed out there is no statutory definition of “business income.”

In the new law, QBI excludes a list of investment items including short- and long-term capital gains and losses. I don’t see how an IRS agent could construe Section 475 ordinary income as capital gains.

I look forward to the Congressional analysis in the”Blue Book” for the General Explanation of the Act — hopefully, this will shed further light on my questions. Some traders may prefer to wait for IRS regulations on these Act provisions and other types of IRS guidance. Hopefully, big law firms will form a consensus opinion on this issue for their hedge fund clients, soon.

Congress may not have envisioned the pass-through deduction for hedge funds and TTS trading companies, and they may fix things through interpretation or technical correction to prevent that outcome.

Trading in a C-Corp could be costly
Don’t only focus on the federal 21% flat tax rate on the C-Corp level; there are plenty of other taxes, including capital gains taxes on qualified dividends, potential accumulated earnings tax, a possible personal holding company tax penalty, and state corporate taxes in 44 states.

If you pay qualified dividends, there will be double taxation with capital gains taxes on the individual level — capital gains rates are 0%, 15% or 20%. If you avoid paying dividends, the IRS might assess a 20% accumulated earnings tax (AET). If you have trading losses, significant passive income, interest, and dividends, it could trigger personal holding company status with a 20% tax penalty. (See my blog post How To Decide If A C-Corp Is Right For Your Trading Business.)

How to proceed
For 2018, TTS traders should consider a partnership or S-Corp for business expenses, and a Section 475 election on securities for exemption from wash sale losses and ordinary loss treatment (tax loss insurance). Consider a TTS S-Corp for employee benefit plan deductions including health insurance and a high-deductible retirement plan, since a TTS spousal partnership or TTS sole proprietor cannot achieve these deductions. Consider this the cake.It puts you in position to potentially qualify for a 20% QBI deduction on Section 475 or Section 988 ordinary income in a TTS trading pass-through entity – icing on the cake. If a TTS trader’s taxable income is under the specified service activity (SSA) threshold of $315,000 (married), and $157,500 (other taxpayers), he or she should get the 20% QBI deduction in partnerships or S-Corps. Within the phase-out range above the threshold, $100,000 (married) and $50,000 (other taxpayers), a partial deduction. QBI likely includes Section 475 and Section 988 ordinary income and excludes capital gains (Section 1256 contracts and cryptocurrencies). It might be a challenge for a TTS sole proprietor to claim the pass-through deduction because Schedule C has trading expenses only; trading gains are on other tax forms.

I suggest you consult with me about these issues soon.

Darren Neuschwander, CPA, and Roger Lorence, Esq., contributed to this post. 


How To Decide If A C-Corp Is Right For Your Trading Business

January 9, 2018 | By: Robert A. Green, CPA | Read it on

When taking into account the Tax Cuts and Jobs Act for 2018, don’t focus solely on the federal 21% flat tax rate on the C-Corp level. There are plenty of other taxes, including capital gains taxes on qualified dividends, state corporate taxes in 44 states, and accumulated earnings tax assessed on excess retained earnings.

When a C-Corp pays qualified dividends to the owner, double taxation occurs with capital gains taxes on the individual level (capital gains rates are 0%, 15% or 20%). If an owner avoids paying sufficient qualified dividends, the IRS is entitled to assess a 20% accumulated earnings tax (AET). It’s a fallacy that owners can retain all earnings inside the C-Corp.

C-Corp vs. individual tax rates
Starting in 2018 under the new tax law, C-Corps may benefit from a 21% flat tax rate vs. individual graduated rates of 10% to 37%. Don’t confuse your tax bracket with your tax rate, which is less. For example, the average individual tax rate is 27% for a married couple entering the top 37% tax bracket of $600,000 and 30% for a single filer approaching the top bracket of $500,000; so the actual rate difference is 6% and 9% in these two examples.

Upper-income traders may also have individual 3.8% net investment tax (NIT) on net investment income (NII). NIT applies on NII over the modified AGI threshold of $250,000 (married) and $200,000 (single). Adding this in, the difference between the flat rate could be 9.8% and 12.8% in our example.

Traders don’t owe self-employment (SE) tax, so I don’t factor that into the equation. Other small business owners have SE or payroll tax in pass-throughs but can avoid it with a C-Corp. Let say the C-Corp has a 10% rate advantage for high-income traders and a lower or no benefit for middle- to lower-income traders.

Now come all the haircuts that can lead to adverse taxes and make the C-Corp a costlier choice for a trader. Double taxation on the federal level can wipe out that savings with a 15% or 20% capital gains tax on “qualified dividends.” Double taxation on the state level can lead to a C-Corp owner paying higher taxes than with a pass-through entity. There are potential 20% accumulated earnings taxes and personal holding company tax penalties. Look before you leap into a C-Corp and consult a trader tax expert.

C-Corp double taxation with qualified dividends
A C-Corp pays taxes first on the entity level, and the owners owe taxes a second time on the individual level on dividends and capital gains.

When C-Corps make a cash or property distribution to owners, it’s a taxable dividend if there are “earnings and profits” (E&P). If the individual holds the C-Corp stock for 60 days, it’s a “qualified dividend,” subject to lower long-term capital gains rates of 0%, 15%, and 20%. The 0% capital gains bracket applies to taxable income up to $77,200 (married) and $38,600 (single). A 15% dividends tax offsets the difference in individual vs. corporate tax rates.

State double taxation can ruin the C-Corp strategy
According to Tax Foundation, “Forty-four states levy a corporate income tax. Rates range from 3 percent in North Carolina to 12 percent in Iowa.” (See your state on the Tax Foundation map, State Corporate Income Tax Rates and Brackets for 2017.) States don’t use lower capital gains rates for taxing individuals; they treat qualified dividends as ordinary income.

A C-Corp is a wrong choice for a trader entity in California with an 8.84% corporate tax rate, but it could be the right choice for a high-income trader in Texas without corporate taxes if he or she retains earnings and can successfully avoid IRS 20% accumulated earnings tax (more on this to come). The Texas 0.75% franchise tax applies to all types of companies with limited liability, including LLCs, and C-Corps, and the “No Tax Due Threshold” is $1.11 million. Most traders won’t trigger the Texas franchise tax.

Don’t try to avoid filing a C-Corp tax return in your resident state. You are entitled to form your entity in a tax-free state, like Delaware, but your home state probably requires registration of a “foreign entity,” if it operates in your state. Setting up a mail forwarding service in a tax-free state does not achieve nexus, whereas, conducting a trading business from your resident state does.

The new tax law capped state and local income, sales, and property taxes (SALT) itemized deductions at $10,000 per year. It does not suspend SALT deductions paid by C-Corps, but that expense is only the double-taxed portion; the individual SALT on qualified dividends is still limited.

Accumulated earnings tax
If the C-Corp does not pay dividends from E&P, the IRS can assess a 20% “accumulated earnings tax” (AET) if the C-Corp E&P exceeds a threshold and company management cannot justify a business need for retaining E&P. The IRS is trying to incentivize C-Corps to pay dividends to owners. The IRS AET threshold is $250,000, or $150,000 for a personal service corporation. (See Section 533.)

If the IRS treats a trader tax status (TTS) trading company as an “investment company,” then it may assess 20% AET on all E&P and therefore undermine the C-Corp strategy for traders. But I don’t think a TTS trading company with Section 475 ordinary income is an investment company. A TTS trading C-Corp needs to demonstrate a business need for E&P above the $250,000 threshold.

“AET requires the corporation to have adopted a plan for business expansion that will require substantial additional capital,” says Roger Lorence, a tax attorney in the New York City area who specializes in hedge fund tax. “The plan must be in writing and adopted by the Board; it must refer to the analysis of the business, the need for expansion, the need for more capital, and include a timeline for implementation.”

Arguing the C-Corp needs more trading capital for growing profits is likely not an acceptable reason for avoiding dividends. Sufficient reasons might include buying exchange seats, hiring traders and back office staff, and purchasing more equipment and automated trading systems. Over a period, the C-Corp must implement its formal plan. Otherwise, the IRS won’t respect the policy. Many one-person TTS trading companies don’t have these types of expansion plans, and they likely won’t succeed in defending against an AET assessment. Previously, I pointed out a C-Corp might be suitable for a high-income trader, but they would probably exceed the AET threshold in the first year.

Personal holding company tax penalty
“Personal holding company” (PHC) status is triggered when a closely held C-Corp has at least 60% of gross income coming from certain passive income (including interest, dividends, rents, and royalties), and has not made sufficient distributions to shareholders. The IRS is entitled to assess a 20% PHC tax penalty. The new tax law did not revise the PHC rules, and some tax experts think Congress should have tightened them.

Capital gains and Section 475 ordinary income are not passive income, so a successful TTS trader C-Corp will likely not meet the definition. However, if a trader incurs a net trading loss for a given year, then passive income might exceed 60% of gross income and trigger a PHC penalty. If a trader has substantial passive income, don’t hold those positions in a C-Corp.

Officer compensation avoids double taxation
Historically, C-Corps paid higher officer compensation to avoid the 35% C-Corp tax rate. But now, C-Corps may want the 21% C-Corp tax rate over the individual tax rates up to 37% on wage income instead.

C-Corp Cons
1. No lower 60/40 capital gains tax rates on Section 1256 contracts.
2. Ordinary losses do not pass-through to the owner’s tax return, missing an opportunity for immediate tax savings against other income. The new law has an excess business loss limitation of $500,000 (married) and $250,000 (single), and it repealed the NOL carryback, only allowing carryforwards.
3. A C-Corp investment company without TTS may not deduct investment expenses. The Act suspends miscellaneous itemized deductions for individuals, which includes investment expenses. Don’t try to house investments in a C-Corp; it might be deemed a PHC.
4. If you liquidate a C-Corp to realize the capital loss and ordinary loss trapped inside it, you might qualify for Section 1244 ordinary loss treatment up to $100,000 (married) or $50,000 (single), with the remainder of the loss treated as a capital loss. Therefore, you could be stuck with a capital loss carryover. Per Section 1244, “a corporation shall be treated as a small business corporation if the aggregate amount of money and other property received by the corporation for stock, as a contribution to capital, and as paid-in surplus, does not exceed $1,000,000.” Conversely, with a pass-through entity and Section 475 ordinary loss treatment, the trader would have all ordinary loss treatment.

There are a few good things about C-Corps: A more extensive assortment of fringe benefit plans for owners, and charitable contributions, which some individuals may limit due to the higher standard deduction.

Example: Profitable trader in a tax-free state
Nancy Green, a resident of Texas, consistently makes well over $500,000 net income per year trading securities with Section 475 ordinary income. She has officer compensation of $146,000 to maximize her company Solo 401(k) retirement plan contribution of $55,000 (under age 50).

With an S-Corp, her 2018 gross income is $646,000 ($500,000 K-1 income and $146,000 wages), she takes a $25,000 itemized deduction, which makes her taxable income $621,000. Nancy is over the $207,500 taxable income threshold for a specified service activity, so she does not qualify for the Act’s 20% deduction on qualified business income (QBI) in a pass-through. Her 2018 federal income tax is $195,460. Her marginal tax bracket is the top 37% rate, and her average tax rate is 31% — 10% above the C-Corp flat rate of 21%. She also owes 3.8% NIT on $300,000 ($500,000 K-1 income less the modified AGI threshold of $200,000), which equals $11,400. Nancy’s total federal tax liability using an S-Corp is $206,860.

With a C-Corp, Nancy’s individual tax return gross income is $146,000 from wages, and she takes a $25,000 itemized deduction, which lowers her taxable income to $121,000. Her individual federal income tax is $23,330, which is 19.3% of taxable income. Nancy does not owe NIT in this case. (This assumes she has no qualified dividends from the C-Corp.) The federal corporate tax is $105,000 ($500,000 times 21%). With her individual tax paid using the C-Corp, her total federal tax is $128,330.

The C-Corp structure delivers 2018 federal tax savings of $78,530 vs. the S-Corp. There is no corporate or individual income tax in Texas, and she did not exceed the franchise tax threshold, so the savings with the C-Corp can be significant. It also depends on whether or not she pays qualified dividends or has an IRS 20% AET assessment.

If Nancy needs distributions for living expenses, she has two choices:
1. Pay additional wages, which only are subject to Medicare tax of 2.9%, reducing C-Corp net income at a 21% rate, and subjecting her to more individual tax at 24% and 32% marginal rates. (This might be the more attractive option.)
2. Pay qualified dividends taxed at 15%, plus some 3.8% NIT, which does not reduce C-Corp taxes. Her overall savings will decline, but it’s still substantially positive vs. the S-Corp. For example, a qualified dividend of $300,000 would cause $45,000 of capital gains taxes and $9,348 of NIT. Net federal tax savings from using the C-Corp vs. the S-Corp would be $24,182.

If Nancy moves to California, the C-Corp is not a good idea because California has an 8.84% corporate tax rate and with double taxation, the C-Corp savings disappears. Like many other states, California treats all income as ordinary income; it does not distinguish qualified dividends or long-term capital gains. In Nancy’s case, California’s corporate tax would be $44,200 ($500,000 x 8.84% rate), plus individual taxes on $300,000 qualified dividends would be approximately $28,000. A C-Corp in California would lead to much higher federal and state taxes vs. using a dual entity solution, where a trading partnership and S-Corp management company are used to avoid the state’s 1.5% franchise tax on S-Corps.

The 800-pound gorilla in the room is the 20% accumulated earnings tax (AET), and under what conditions the IRS may assess it on a trading business C-Corp. Nancy can tell the IRS she is a TTS trader entitled to retain earnings up to $250,000. Her C-Corp made $500,000 and paid qualified dividends of $300,000, so she kept $200,000 of profits inside the C-Corp. The IRS allows up to $250,000, so she should be fine for 2018, but what about 2019? Does Nancy have a written plan that is feasible for keeping a war chest of earnings over the $250,000 threshold? Probably not, and that could render the C-Corp tax advantage a mirage for her and others in a similar boat.

I suggest traders consult with me to discuss their 2018 projections and see which shoe fits best: a partnership, S-Corp or C-Corp, or some combination, thereof.

 

 


Cryptocurrency Traders Owe Massive Taxes For 2017

January 1, 2018 | By: Robert A. Green, CPA | Read it on

I consulted dozens of cryptocurrency (coin) traders on taxes in December and confirmed what the media has been reporting: Coin traders made fortunes in 2017. Now that the 2017 tax-filing season is underway, these traders should gather online tax reports if available, use a coin trade accounting program, and review the latest guidance on tax treatment.

Coinbase has a new online tax report
On July 6, 2017, the IRS narrowed its summons against Coinbase, the most substantial U.S.-based coin exchange, to retrieve larger customers’ trades and other transactions to find unreported income. In late-December 2017, Coinbase added tax reporting of capital gains and losses using first in first out (FIFO). This move should undoubtedly please the IRS since there is no 1099-B issuance on coin trades.

Update Feb. 2, 2018: Coinbase issued 2017 Form 1099-Ks to “qualifying customers,” including businesses, and traders, over specific volume thresholds. (See 1099-K Tax Forms). The IRS intended 1099-K for businesses (merchants) to report Payment Card and Third Party Network Transactions. (See Understanding Your Form 1099-K.)

Capital gains and losses
If you invested in cryptocurrencies and sold, exchanged, or spent it in 2017, you have to report a capital gain or loss on each transaction, including coin-to-currency sales, coin-to-coin trades, and purchases of goods or services using a coin. Deduct coin fees and other expenses appropriately.

Some coin deals naturally generate taxable income, including coin-to-currency trades and mining income. For example, Bitcoin sold for U.S. dollars is a noticeable capital gain or loss reportable on Form 8949. Or, when a coin miner receives a coin for his work, he or she naturally recognizes business revenue based on the value of the coin.

Imputed income
The big problem for the IRS is that most other coin transactions are not evident for tax reporting, including coin-to-coin trades, hard forks (chain splits), and using a coin to purchase goods and services. The coin investor should “impute” a sales or exchange transaction to report a capital gain or loss on coin-to-coin trades and using a coin to purchase items. Many coin investors and their accountants overlook or mishandle this reporting and underpay the IRS.

The IRS labels coin “intangible property.” Coin users may call it “digital money,” but it’s not sovereign government-issued money. That’s the critical difference: Each use of money is not a taxable event. Imagine having to report a capital gain or loss every time you purchased an item or asset with cash or a credit card. That would be ridiculous.

Coin-to-currency trades
Most taxpayers comprehend that if they purchased Bitcoin in 2016 for $10,000 and sold in 2017 for $30,000, they should report a capital gain of $20,000 on their 2017 tax return form 8949. A coin position held for one year or less is considered a short-term capital gain, taxed at ordinary tax rates (up to 39.6% for 2017 and 37% for 2018). A coin position held for more than one year is considered a long-term capital gain, taxed at capital gains rates (up to 20% for 2017 and 2018).

Capital losses offset capital gains in full, and a net capital loss is limited to $3,000 against other types of income on an individual tax return. An excess capital loss is carried forward to the subsequent tax year(s), and it may not be carried back to a prior year. Some coin traders will pay massive taxes on capital gains in 2017 and get stuck with a capital loss limitation and carryover in 2018.

Coin-to-coin trades
Many coin traders actively make coin-to-coin trades like Bitcoin to Ethereum and then Ethereum to Litecoin. Currently, coin investors purchase alt coins using Bitcoin or Ethereum.

Many taxpayers and preparers delay capital gains income on coin-to-coin trades by inappropriately classifying them as Section 1031 “like-kind exchanges,” where they may defer income to the replacement position’s cost basis. While the IRS hasn’t provided guidance on this matter, I do not believe the majority of coin-to-coin trades made on coin exchanges qualify for Section 1031 transactions as they fail one or both of the two primary requirements (and both are required). First, Bitcoin may not be a like-kind property with Ethereum. Second, coin-to-coin trades executed on coin exchanges do not constitute a direct two-party exchange, and coin exchanges are likely not qualified intermediaries in a multi-party exchange.

Coin-to-coin trading reminds me of forex trading between different currency pairs. Various currencies are not like-kind property (i.e., U.S. dollars are not a like-kind property with euros). Each coin has its version of a blockchain, and the network of users has a different purpose for each coin.

I asked coin tax expert Jim Calvin, Partner of Deloitte and author of When (and If) Income is Realized from Bitcoin Chain-Splits, if he thought these trades could qualify for Section 1031 like-kind exchange treatment in 2017 and prior years.

“It is neither a simple nor single factual issue,” he said. “It is not just whether the swapped coins are like-kind property, but also whether all the other requirements of Section 1031 can be met including the use of intermediaries.”

Atomic swaps or atomic cross-chain trading started in August 2017. The new technology allows a direct two-party exchange, bypassing coin exchanges. That may meet one requirement, but the coins must also be a like-kind property for Section 1031 deferral.

Tax Cuts and Jobs Act and coin traders
Starting in 2018, the Tax Cuts and Jobs Act limits Section 1031 like-kind exchanges to real property, not for sale. Investors may not use it on artwork, collectibles, and other tangible and intangible property, including cryptocurrencies.

The Act introduced Section 199A, a 20% deduction on qualified business income (QBI) in pass-through entities, subject to thresholds, limitations, and haircuts. A trader tax status (TTS) coin trader likely does not qualify for the deduction because he or she has capital gains income, excluded from QBI. This is different from a TTS securities trader who can elect Section 475 MTM ordinary income, which is included in QBI.

Coin hard forks (chain-splits)
The IRS has not provided guidance on hard fork transactions, and tax experts and coin traders debate its tax treatment. Bitcoin had a hard fork in its blockchain on Aug. 1, 2017, dividing into two separate coins: Bitcoin and Bitcoin Cash. Each holder of a Bitcoin unit was entitled to arrange receipt of a unit of Bitcoin Cash. Some Bitcoin holders did not gain immediate access to be able to sell Bitcoin Cash, so they may feel it’s okay to defer income on the fork transaction until they obtain such access, or later sell it. Coinbase did not support Bitcoin Cash when it forked, but it did add it to accounts for rightful holders in late-2017.

It’s reasonable that coin traders should not have to report taxable income on a hard fork until the new coin is time-stamped as a ledger entry, sending the coins to new outputs in the blockchain. Facts and circumstances on hard forks vary widely. An “old fork” could die out if miners collectively switch over to the new blockchain and abandon the old coin. Bitcoin Cash successfully forked from Bitcoin; both trade at higher values today than on the fork date. Hard forks frequently happen, and their initial fair market value varies significantly across coin exchanges.

“Taxable income is realized if the owner of pre-split bitcoin exercises dominion and control over the corresponding chain-split coins, and the income realized will be equal to the value of the chain-split coins at that time,” Calvin said. “Most owners holding Bitcoin on exchanges were unable to control if and when chain-split coins were claimed, the time income was realized, and may still be unaware of the date or value to use.”

I think many Bitcoin Cash holders had dominion and control over the new coin sometime in 2017, and they should recognize ordinary income on receiving it.

Coin trade accounting programs
Coin tax reporting is complex and voluminous. Consider two coin accounting solutions: Bitcoin.Tax and CoinTracking.Info.

I suggest using the FIFO accounting method for cost-basis on coin capital gain and loss transactions. The IRS has not yet stated if it will permit other accounting methods for coin, like the specific identification allowed for securities. Even if the IRS approves specific identification for coin, compliance with the requirement for contemporaneously written instructions to the coin exchange doesn’t seem possible. I doubt a coin exchange would confirm and execute a specific identification.

Because the IRS labels coin intangible property, wash-sale loss rules likely don’t apply. TTS traders using Section 475 ordinary gain or loss on securities and/or commodities (Section 1256 contracts) may not use Section 475 on a coin since it’s not a security or a commodity in the eyes of the IRS.

How to deduct coin-trading costs
Coin traders pay various transaction costs, fees, and interest expenses in coin and currency. Be sure to convert coin expenses to U.S. dollars at the time spent. It’s critical to distinguish between tax categories — transaction costs, investment expenses, investment interest expenses, and trading business expenses — as they are all handled differently on tax returns.

Transaction fees can be deducted from sales proceeds and then added to cost basis for purchases, so reflect them on net capital gains and losses. These charges include trading costs (approximately 0.25%) paid to a coin exchange and fees paid to miners when transferring coin between addresses to get transactions into the next block.

The new tax law suspends investment expenses for 2018, but you can still deduct them as a miscellaneous itemized deduction for 2017 (if they are more than 2% of AGI). These costs include bank wire transfer fees for transferring currency to a coin exchange; loan or borrow fees paid to a coin exchange; and withdrawal fees paid to a coin exchange for removing money or coin. (It’s essential to separate loan fees vs. margin interest, as they have different tax treatment.)

Investment interest expense can be an itemized deduction, limited to investment income, with the excess carried over to the subsequent tax year. This includes interest on borrowed funds paid in coin to lender/exchange. The new tax law did not change the rules for investment interest expenses.

Trading business expenses are deducted from gross income. If the coin trader qualifies for TTS, investment expenses and investment interest expenses are deducted as business expenses on Schedule C or through an entity.

Miners deduct business expenses against revenues.

Example: Purchasing goods and services with coin
On Jan. 1, 2017, Joe bought 100 Bitcoins at a price of $998 each, for a total cost basis of $99,800. On June 1, 2017, when the price of a Bitcoin unit was $2,452, Joe used a Bitcoin to purchase a computer for $2,452. Without realizing it, Joe triggered a reportable short-term capital gain on his 2017 Form 8949. The sales proceeds are $2,452, representing the fair market value of the Bitcoin he used to purchase the computer. His cost basis for that one Bitcoin unit used is $998, so his net short-term capital gain is $1,454. If Joe uses the computer in his business, he will deduct $2,452 as an expense.

Bottom line
I suggest coin traders calculate capital gains and losses on coin transactions, including coin-to-coin trades made on exchanges, and use the FIFO accounting method. File an extension by the due date of your tax return (April 17, 2018, for individuals), and pay taxes owed for 2017 with the extension. During the additional time (file by Oct. 15, 2018), perhaps the IRS will answer our questions, including which if any coin-to-coin trades may use Section 1031 deferral in 2017. If the IRS allows it, maybe coin traders can still file that way on an original tax return filing. Consult a coin tax expert.

For more information, see Green’s 2018 Cryptocurrency Tax Guide.

If you have any questions, contact us.

 


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