This past summer, the Internal Revenue Service (IRS), the tax-collecting agency of the United States, sent more than 10,000 warning and action letters out to cryptocurrency holders who may or may not have been accurately reporting their crypto gains and losses on their taxes. This series of events had many people questioning how the IRS even had information about their crypto holdings.
As it turns out, cryptocurrency exchanges report tax information to the IRS. This article explains precisely how they do that.
How do exchanges report tax information?
Cryptocurrency exchanges like Coinbase, Gemini, and others that operate within the U.S. market use a specific type of 1099 Form to report tax information to the IRS. 1099’s of all types serve the same purpose within the United States — all 1099’s report non-employment related income.
In other words, 1099’s tell the government how much income you made outside of your job. Income is taxable within the U.S., so it makes sense that the IRS wants to be informed of income sources outside of typical W2 wages.
The problem with the way cryptocurrency exchanges report is that they use a specific type of 1099 known as Form 1099-K.
1099-K reports gross proceeds from a specific platform, and it is typically used by third-party settlement organizations like Uber, Lyft, and others to report gross income incurred on the platform.
When cryptocurrency exchanges use this form, they report gross amounts transacted on the cryptocurrency exchange. This can massively inflate your income, and the document actually becomes useless for cryptocurrency investors for tax reporting—as they need to be reporting capital gains and losses, not merely gross proceeds.
In this sense, it really doesn’t make a lot of sense for cryptocurrency exchanges to be issuing a 1099-K. However, they do so to cover their regulatory bases from a liability standpoint and also to reduce the reporting that they have to do.
If they issued a different type of 1099 that is more common within the world of stocks and investing, they would have to issue forms to many more customers, almost all of them. This would be a significant compliance burden that the exchanges would prefer to avoid if possible. Right now, Forms 1099-K only goes out to a small percentage of customers within the exchanges overall user base.
The government knows
If you meet certain qualifying requirements (based on trading volume and gross proceeds), both you and the IRS will be sent a copy of Form 1099-K by your cryptocurrency exchange. This alerts the government that you have cryptocurrency activity that you should be reporting on your tax return.
Frustratingly, 1099-K does not help the taxpayer actually report his or her capital gains and losses on a tax return. Again, this is because 1099-K does not report any of this, it only reports gross proceeds or the total volume of your transactions on your cryptocurrency exchange.
To properly report, you need to calculate your gains and losses for each trade and report them on Form 8949 and include it with your tax return. You can learn more about the specifics of cryptocurrency tax reporting in this complete guide for investors.
Will crypto exchanges change this practice in the future?
As sending out 1099-K to customers is obviously extremely misleading and frustrating experience for the customers of cryptocurrency exchanges, it is likely that they move away from this practice in the future.
As the IRS continues to pass legislation in the space, cryptocurrency exchanges will likely be forced to send out a Form 1099-B to customers who meet specific requirements. 1099-B is typically used within the world of stock trading and investing, and it does indeed report gains and losses to the taxpayer — this greatly helps when it comes to reporting on your tax return.
There are other challenges that cryptocurrency exchanges face when trying to issue a 1099-B, and they all stem around cost basis reporting. Because cryptocurrency is transferable, cost basis information is not always held by a single cryptocurrency exchange which makes 1099-B reporting extremely difficult.
File your taxes, and you have nothing to worry about
As long as you are reporting your capital gains and losses from your cryptocurrency investing activity, you don’t have anything to worry about.
Coinbase, Gemini, and others may still send out a 1099-K, but you will have your bases covered. When the government receives the 1099-K, they will see that you have indeed claimed cryptocurrency on your tax return and reported the income associated with it properly.