By Michael Scott
A 2017 report by the global investment banking, securities and investment management firm Goldman Sachs highlighted the explosive growth of digital money with visions of a cashless society. As this emerging trend continues to take shape, media stories abound alleging that these forms of financial transactions are a boon for those seeking to hide money from tax authorities.
These allegations have been especially loud when it comes to cryptocurrencies, the rapidly growing alternative to fiat currencies like the U.S. dollar. The IRS, in fact, considers “cryptos” as similar to stock investments — requiring that capital gains or losses be reported.
According to a finding in March, however, compliance with this requirement is virtually nonexistent; only a small percentage of cryptocurrency owners record bitcoin profits and losses in their annual tax returns.
The Tax “Bullseye”
Further complicating this issue are a group of cryptocurrencies — Zcash, Monero and Dash, among others — that reportedly have stealth anonymity and privacy features that make the desire to hide money more tempting.
Perry Woodin, an expert on the intersection between cryptocurrencies and taxes, and the founder of Node40, one of the leading server providers for the Dash network, said that this gap between cryptocurrency users and the demands of the IRS has created an interesting dynamic.
“There is still a lack of guidance,” he said. “The only thing we have for reference is the IRS’s Notice 2014-21 from March of 2014. What’s clear is that digital currency is treated as property. What remains unclear is how the authorities are going to ‘encourage’ people to report their tax liability.”
Woodin went on to say that at this stage, it seems the most likely scenario is for the IRS to request user information from exchanges. He noted that as digital currency transactions become more popular to mainstream audiences, the amount of data that will be available to the IRS for tracking people who underreport will increase.
When asked to comment about some media reports implying that cryptocurrencies like Dash, Zcash and bitcoin, among many others, are being used to hide money, Woodin pointed out a noteworthy differentiation.
“There is a significant difference between privacy and obfuscation with the intent of hiding your assets,” he said. “For example, the privacy model in Dash allows users to control their public transaction profile. Every Dash transaction is still visible on the public blockchain, but Dash’s PrivateSend allows users to silo transactions, making it impossible to build a user profile based on transaction history. This siloing of transactions not only provides user privacy, but also insures fungibility by removing the risk of tainted coins.”
Woodin added that, because Dash retains a transparent blockchain (as opposed to an opaque blockchain), users can still determine their tax liabilities by evaluating the blockchain.
“Most of us still live in a world where we interact with government-issued currency for most of our day-to-day transactions,” he said. “If you are going to live in a world where you are expected to pay your tax liability, then it makes sense to use a digital currency that supports compliance.”
Node40 released a new tool in time for the 2016 tax filing season that makes tax accountability simpler for Dash users. Woodin said that because Node40 hosts Dash masternodes, all users are receiving ordinary income in the form of Dash rewards from the network. While some customers manually keep spreadsheets to track the U.S.-dollar value of every reward, most do not.
“We started receiving a large number of requests to provide the data necessary for our customers to report their tax liability,” Woodin said. “And to make things as simple as possible, we generate IRS Form 8949 for users who have realized a gain or loss.”
With respect to emerging trends he sees on the horizon over the next 12 to 18 months in the cryptocurrency tax space, Woodin concluded:
“Once we’re into late 2017 and early 2018, we’ll see more and more people looking for ways to comply. It’s a particularly massive hurdle for merchants who want to begin accepting digital currency as a form of payment, but don’t want to put their business at risk over non-compliance.”