The issue of web3 taxation is quite thorny for the government and taxpayers. With so much innovation occurring simultaneously in the industry, the use of technology to help sort out these gray areas works. We reached out to Ben Borodach, the co-founder of AI tax platform April. Here is what he had to say.
Ben Borodach Co-Founder At April
About Ben Borodach
Ben is co-founder of April, where he is working to make the tax process more approachable and affordable for American taxpayers. Ben has spent his career at the intersection of financial services, cybersecurity, and technology, beginning at Deloitte Consulting, where he advised the largest US banks and insurance companies on growth, M&A, venture, and technology strategies.
More recently, he led corporate strategy for venture group Team8, where he played a critical role in starting and scaling new FinTech and Cyber ventures such as Curv (acq. by PayPal) and Visible Risk (acq. by Bitsight). Ben is a co-creator and designer of the Team8-WisdomTree Cybersecurity Index and the TU-Team8 Cyber Fellows PhD program.
Ben is a graduate of New York University with B.A. in Economics, where he held the distinction of Presidential Honors Scholar.
How does the IRS classify the different types of tax regimes for cryptocurrencies?
The IRS treats crypto as property. The implication of this is that even though some think of it as currency, the IRS does not treat it the same way it treats the US Dollar.
This means that when you transact with crypto there will be taxable events as the asset appreciates or depreciates. The two major categories are either capital gains for disposal of crypto when you sell or exchange it, or ordinary income (if the crypto was earned in exchange for services or via staking or a hard-fork.).
What are the most critical gray areas crypto investors need to watch out for as far as taxes are concerned?
The IRS has made a lot of progress in providing more clarity around the different types of crypto transactions and how to handle their tax treatment.
There are now specific guidelines for sales, staking, forking, gifts and so on. Ultimately complexity and uncertainty can usually get boiled down to two kinds:
The first are edge cases where there is an evolution that the IRS has yet to address. One that is worth paying attention to is the treatment of unclaimed staking rewards.
While these rewards can usually be ascribed a fair market value, some are making the case that if they don’t have control over the assets, such as is currently the case with ETH2, there isn’t taxable income.
The claim is that this income is not yet realized and shouldn’t be taxed until the holder has possession.
It is likely that these circumstances will continue because crypto is a fast-evolving technology that is challenging tax authorities and regulators to keep pace.
The second instance can be in areas where there are gaps between what appears to be clear guidance and the realistic challenges of reporting crypto taxes.
For example, if you are staking, you might be earning a small amount of crypto very frequently.
Because the taxable income needs to be reported in USD – this can create a challenge if you aren’t using a platform that is tracking the fair market value in USD on your behalf. Fortunately, third party tooling with platforms like CoinTracker is making this far easier for those that want to stay ahead of the game.
What are the disparities between Federal and State tax rules?
One potential disparity that market participants should be following are the various legislations in Wyoming and Arizona that would allow taxpayers to settle their obligation with state tax authorities in Bitcoin.
From a tax perspective, this would be a shift from the federal authorities’ treatment of Bitcoin and author crypto from property to more of a currency.
Beyond tax, state recognition of Bitcoin or potentially other crypto as legal tender would mark a significant shift in both the exclusive nature of the US Dollar as the legal tender in the United States and the relationship between states and the federal government.
State’s motivations for adopting crypto as legal tender could be wide ranging, but it’s worth noting that compared to the federal government, who possess the power of the purse, they rely on tax collection to fund their operations.
How are cryptocurrency gains, losses, purchases, and transfers taxed under the Internal Revenue Service (IRS) rules?
According to the IRS, crypto that is disposed of is treated as a capital gain or loss, whereas crypto that is received through staking or forking is treated as ordinary income.
If you earn crypto by providing a wage or service that would also be treated as ordinary income. There are some exceptions, such as crypto that is received as a bonafide gift, that may be exempt.
How does the IRS define taxation for freelancers and independent contractors who receive virtual currencies as payment for services?
This presents an interesting situation because the crypto received in exchange for providing a service is taxed as ordinary income at the fair market value at the time it is received.
However, if that asset appreciates and is then sold at a gain the difference may also qualify for capital gains taxes. Individuals seeking to earn wages in crypto should seek advice and also ensure they are properly withholding taxes or making estimated tax payments commensurate with normative stipulations.
If a cryptocurrency exchange doesn’t send forms to users for tax purposes do taxes still have to be paid by users?
The responsibility is on the taxpayer to report the sale of crypto.
If you are exchanging crypto over the counter (OTC) or through local wallets you are still responsible for your taxes. Furthermore, crypto exchanges do not have all the context when it comes to your tax docs (1099’s).
They may not be aware that you are transferring crypto between accounts you own, which is not taxable according to the IRS, and investors should ensure to go over documentation carefully and ideally keep their own independent records.
Are cryptocurrency tokens received via forking or staking activities taxable?
The IRS states that these are taxable as ordinary income based on the fair market value at the time they are received.
Are cryptocurrency purchased using other cryptocurrency tokens taxable?
If, for example, you bought some ETH with USD to buy an NFT and that ETH had a gain it would meet the IRS’s definition for disposal of virtual currency.
This can be especially tricky because ultimately market participants are responsible for reporting the fair market value of their basis and gain in USD.
When exchanging tokens it’s critical to ensure you have clear documentation of the FMV in USD at the time of the transaction.
How are NFTs taxed?
An NFT like other virtual currencies is going to be treated as property under current IRS guidelines.
When an NFT is sold, the holder is going to pay taxes on the differences between the basis and the gain.
This could be a short or long term gain depending on the duration of the holding period.
What are the best strategies crypto holders can use to minimize taxes legally?
This is a highly individual question and depends on what a holder wants to optimize for.
This includes offsetting other losses or minimizing this year’s tax bill by selling crypto with the highest basis.
The IRS states that you can select specific units to dispose of – also known as a lot sale. If you do not specify, then the default method should be FIFO or first-in-first-out.
Please can you tell us more about April and intelligent taxation?
Crypto is a great example of how existing tax software is ill-equipped to deal with the digital economy.
Crypto is real-time, high velocity and in increments that are well beyond the capabilities of existing tax platforms.
April leverages machine learning and data science to personalize, contextualize, and optimize the tax filing experience for every individual.
This means that if you are holding crypto, April can help provide context around what those transactions were (staking versus lot sales) and handle analysis on a much higher transaction volume.
For many, crypto is but one part of their overall portfolio or tax situation.
April’s solution looks at the entire person or family and provides a robust experience that can help you better prepare for tax season ensuring you have the right amount of cash to meet your obligations and save you time and headache throughout the process.
What roles can artificial intelligence (AI) play in determining exactly how taxes should be paid?
What we have today is a tax process that is one-size-fits-all. This leads to frustrating errors and long manual processes. ML and AI can help provide more personalization and context to the overall experience.
For example, if you are earning crypto for your profession you should have an experience that is tailored to your needs and questions that are specific to your situation.
Also, ML and AI can help provide context by understanding the nature of the transactions – be they income for staking or capital gains.
What are the benefits of your recent partnership with Propel?
Tax is the missing piece in the consumer finance equation.
It impacts virtually every financial and many life decisions, but is noticeably absent from everyday finances.
April and Propel have partnered to break with the siloes traditionally existing between tax and financial planning in order to deliver a more complete tax and financial picture to Propel members.
How are cryptocurrency transactions used as gifts and payments classified under IRS rules?
If you receive crypto as a bona fide gift, you won’t be taxed until you sell, according to the IRS.