Imagine a government organization with:

  • Unlimited power to seize your assets;
  • Their own courts, where you are presumed guilty until proven innocent;
  • The power to subpoena bank, broker, exchange, and other records;
  • The power to fine you;
  • The power to file criminal charges, which can land you in prison;
  • The power to chase you and your assets practically anywhere in the world, and to extradite you and seize everything they can find, even in offshore accounts.

That’s the Internal Revenue Service. 

Income taxes and digital assets

Yes, tax codes and regulations are complicated. So let me simplify this – if you buy something and later sell it for a profit, you owe taxes on it. Period.

This is true with Bitcoin (BTC). It’s true with Ethereum (ETH). It’s true with all utility tokens, security tokens, cryptocurrency or other digital asset that any US resident has ever purchased (or ever will). In fact, it’s true with private securities, public securities, real estate, automobiles, rare coins, antique books or anything else.

Here’s a question I get asked rather frequently…

But what if I don’t sell it? What if instead I just exchange my BTC directly into ETH or TUSD or USDK or XLM or some other token, and never convert it to US Dollars? 

 

Ah, okay great…well then that’s easy…yes, you owe taxes on the profits from the time you bought BTC to the time you converted it into ETH (or whatever other token), as that is a “sale”.

Why? Simple. Your taxes are not based upon when you convert something into cash, they are based upon when you give up ownership (“sell”) an asset, regardless of what form of consideration you received for the sale. If you own Apple stock and, after a nice run up you negotiate with someone to trade it for Google stock instead of cash then you still owe taxes on the gains you had on Apple. Same with digital assets and everything else.

How does this affect custodians?

Coinbase received a subpoena from the IRS to disclose information on their customers. The first batch of them, as reported last week, received notices from the IRS. Pointedly, it’s worth noting that for those people it is now too late to avoid penalties and possible prison time even if they quickly reply with an “oops, sorry!

Is Coinbase the only one? What about others who hold custody of people’s digital assets? And those whose businesses are somehow in the chain of control or in processing transactions? What is their potential liability? Brokers report gains and gross proceeds from sales to the IRS for all customers they hold custody of stocks, bonds, mutual funds, ETF’s, commodities and other securities. Title companies report to the IRS the gross proceeds from when you sell your house. Banks report interest you earn on certificates of deposit and money market funds.

So what about the custodians in the crypto industry? The exchanges, wallet providers, brokers, and others? If you are required to report but don’t, that may bring you into an unpleasant situation with the IRS (and state tax authorities) as complicit, enabling and even participatory in people evading or at a minimum failing to report and pay taxes. 

The Prime Trust Solution:

As part of our services, Prime Trust provides 2 options for API integrations with our Prime Exchange Network (PrimeX): 1. “Funds Movement”, and, 2. “Trade”. 

  1. Funds Movement can be used by people who simply need to move/transfer assets between accounts. This can work great for Registered Investment Advisors, clearing brokers, exchanges, correspondent trust companies, correspondent banks or others who use our services while assuming the tax reporting duties on their customers.
  2. Trade Posting enables our exchange, broker, ATS, crowdfunding and other customers to post a buy-price on a purchase (or a value on an asset deposit), and a sell-price on a sale. In this case we display the gains on customer statements and assume the duty to report to the IRS on various required 1099 and other forms.
Conclusion

You may not like this. Of course you don’t like this. Get in line. Nobody likes paying taxes. But as my b-school professor used to say, taxes are one of the two unavoidable facts of life, so just pay them and move on. This is not a bear you want to provoke; you will lose.

And don’t just rely on blogs or internet searches when making these decisions. Go get direction from a qualified CPA who has deep expertise in tax law.

Author Scott Purcell

Scott Purcell is the CEO and Chief Trust Officer of Prime Trust, the blockchain-driven trust company. His firm provides trustee, custody, escrow, AML, KYC, payment processing, accounting, and compliance for numerous stablecoins, exchanges, platforms, broker-dealers, investment advisers, portals and others who are building business that are changing the world.