The digital assets world continues to change every year, as the industry begins to go through the maturation phase. The remainder of 2020 and next year will bring new challenges, as well as new opportunities, for the ecosystem. Tracking digital assets and blockchain tax laws continues to be challenging for startups and well-established companies. Staying well informed of the developing industry trends and compliance/regulatory developments worldwide are just some ways BPM’s Blockchain and Digital Assets group prepares for what lies ahead.
With tax year 2019 now concluded, the following are the top six digital assets tax topics BPM’s blockchain professionals are keeping in mind while helping organizations involved with virtual currency maintain compliance and save money along the way.
Form 1099 Compliance and Reporting
Form 1099 compliance and reporting remains and will continue to remain a hot topic for exchanges, wallets, market place makers, facilitators, broker-dealers, payment/third-party networks and other ecosystem players.
Currently, the IRS does not receive information return on potentially-taxable transactions involving virtual currencies. This makes it difficult for the IRS to detect compliance. Many taxpayers continue to struggle with compliance, because those who receive, sell or exchange virtual currency must properly report the transactions and comply with federal, state and local income tax requirements.
It appears, based on the recent United States Government Accountability Office report, only a small number of digital asset companies subject to 1099 virtual currency reporting requirements are currently complying. As a result, taxpayers with digital asset transactions are required to self-track, summarize, analyze and report virtual currency transactions to the taxing authorities.
1099 tax planning requires robust analysis of facts and circumstances and clear understanding of business operations of each entity that is subject to 1099 reporting. As exchanges, wallets and other marketplace makers expand their digital asset services into custody, rewards, intermediary and other DeFi services, the 1099 compliance challenges will require significant tax planning and implementation.
Companies working with an outside legal counsel should consider concurrent 1099 implementation (or immediately after) with Know Your Customer (KYC) and anti-money laundering best practices implementation. The 1099 implementation process may take up to six months (or longer) and may require significant involvement and investment from internal and external IT blockchain professionals; and 1099 services providers.
Important: Companies that have not yet initiated the 1099 compliance process for the 2020 tax year should consider starting on the implementation process no later than September 15, 2020 in time for 2021 reporting deadline.
W-2 and Other Compensation Compliance
Digital asset companies are uniquely positioned to creatively structure executive and employee compensation using virtual currency, in addition to fiat compensation.
Some companies created sophisticated compensation plans that may include, but are not limited to, restricted tokens awards, restricted token units, token options, stablecoins and other digital asset based awards.
Such compensation arrangements create unique tax, valuation, tracking, compliance and reporting challenges; and require implementation of best practices and collaboration with experienced employee benefits advisors, plan administrators, employment attorneys, tax advisors and valuation professionals.
Majority of the state and local jurisdictions have yet to address digital asset transactions taxation, while only a few have addressed (or in the process of addressing) some but not all virtual currency transactions.
Navigating the current multi-state tax environment requires extensive state and local tax (“SALT”) knowledge. Experienced SALT professionals help navigate the uncertainties around state and local income tax compliance and reporting, which is essential.
This is an especially challenging tax environment, considering recent federal legislation and state conformity (or non-conformity) to The Tax Cuts and Jobs Act of 2017 and The Coronavirus Aid, Relief, and Economic Security Act of 2020.
Important: State and local jurisdictions do not follow U.S. income tax treaties. As a result, tax treaty benefits (treaty protection) generally do not extend to the imposition of state and local business taxes for business with U.S. operations.
Indirect and Gross Receipts Taxes
Indirect taxes (sales and use, value added taxes, etc.) and gross receipts taxes remain the most controversial topics. Even though the European Union (2015) and some European tax jurisdictions (Switzerland) recently provided some tax guidance for indirect taxes, non-European and United States jurisdictions continue to present unique challenges and require significant digital asset transaction facts and circumstances analysis to determine if virtual currency transactions are subject to tax compliance and reporting.
The U.S. Supreme Court recently decided South Dakota v. Wayfair, Inc, which overrules an earlier precedent that limited states power to impose sales and use tax collection obligations on out-of-state sellers where the seller lacked physical presence in the state. The Court determined physical presence is not necessary to create a substantial nexus (and filing obligation). As a result, the Court significantly expanded state ability to impose sales and use tax requirements on businesses; and, expanded states reach into the realm of income taxes.
As with state income taxes, navigating the indirect tax environment requires assistance from tax professionals with extensive global indirect tax experience.
International Tax Issues
With significant differences in the characterization of digital assets among various countries for tax purposes, multinational digital asset and blockchain businesses have significant considerations to address in properly assessing tax liability and reporting obligations.
For example, with respect to intercompany transactions and the appropriate treatment and recognition of gain or loss on any transaction involving a sale, exchange or other disposition of digital assets. Likewise, mobile individuals holding and trading virtual currency assets while working in different jurisdictions may find significant challenges accounting for receipt or acquisition of digital assets and the subsequent disposition, given the interplay between taxable nexus in a particular country or countries and the inconsistent characterization or treatment for tax purposes of digital assets.
International tax planning and compliance is a subject of considerable complexity. Multinational companies engaged in transactions involving digital assets in their international operations (inbound and outbound) should consider involving tax professionals with subject-matter expertise and significant experience in the digital asset and blockchain space. These tax professionals who understand this highly-specialized industry can assist both businesses and individuals with all relevant tax matters, such as international and domestic tax structuring and planning, intellectual property migration, valuation, supply chain optimization, transfer pricing of intercompany transactions, financial instruments, debt vs. equity transactions, shareholder implications (foreign and domestic), withholding requirements, FBAR/FATCA, and other tax compliance and reporting considerations.
Self-Insurance vs. Insurance and Re-Insurance
Digital asset transactions are a target for hackers and other risks (legislative changes, government civil and monetary penalties, etc.), which is one reason why digital assets and blockchain companies continue to struggle to find banking and insurance services.
A few large digital asset companies have considered or are considering self-insurance, captive insurance and reinsurance of its digital assets to help mitigate risk associated with holding of digital assets, which may include, but is not limited to, loss of digital assets.
This is an emerging issue for the industry and requires significant planning and assistance from multiple professionals of diverse subject-matter expertise.
BPM is one of the largest West Coast-based CPA firms that specializes in serving the digital assets and blockchain industry. BPM provides individual and business tax compliance, consulting and tax structuring services. Our professionals have extensive knowledge and experience in dealing with accounting and auditing matters, as well as regulatory and compliance issues, including revenue recognition, IT compliance, enterprise risk management and classification of digital assets. Contact us today to learn more.