Anyone who bought into the idea that cryptocurrencies – aka digital assets – such as bitcoin cannot be traced and are a perfect shelter from tax are in for a rude shock. The author of this article, David Lesperance, examines what holders of these entities must bear in mind.
The following article is from David Lesperance, of Lesperance
Associates. Based in Canada, he advises people on matters such as
cross-border wealth planning and solutions. We carried
earlier comments from him on the issue of Americans
renunciating their citizenship here.
Here, Lesperance talks about the tax implications arising
from cryptocurrencies such as bitcoin. Still a new area –
although it sometimes feels older – there are traps for the
unwary. A number of jurisdictions take very different views on
how to treat cryptos such as bitcoin.
The editors are pleased to share these views and hope readers
respond. The usual editorial disclaimers apply. Email tom.burroughes@wealthbriefing.com
and jackie.bennion@clearviewpublishing.com
One of the major claimed features of cryptocurrency was that it
was “untraceable’’ and the “perfect tax haven”. Unfortunately,
those who bought into this nonsense are now finding themselves
forced to make a decision about their futures…do they get onside
and act smarter or do they continue to stick their heads in the
sand and try not to get caught by tax authorities?
Death of secrecy
During the past year, any concept of secrecy in crypto evaporated
like morning dew on a summer day. The most public example of the
traceability of bitcoin occurred when authorities disclosed that
they had recovered the ransom paid in bitcoin in the Colonial
Pipeline ransomware case. When this occurred, the horrified
cryptocurrency enthusiast community immediately started talking
about ways of hiding their crypto activity through the use of
techniques such as “mixers” and more secure cryptocurrencies such
as Monero, Zcash, DASH, Horizen, Verge and Beam.
The fantasy that mixers are a magic bullet imploded when Larry
Dean Harmon of leading mixer, Helix, pleaded guilty to money
laundering charges in August 2021. Of course, Helix is not the
only or last mixer that authorities are targeting.
Most of the other supposedly secure cryptocurrencies suffer from
the fundamental flaw that mixers had. Namely “someone has a
record of the transaction.” Monero tries to get around this
problem by “ring signatures” and “stealth addresses.” The problem
is that Monero is not really that secure and those who believed
the hype and used it need to understand that their prior
transactions will be uncovered.
Won’t I avoid any problems if I put it into a cold wallet?
Then there are those who think they can “go dark” by placing
their cryptocurrency in cold wallets and hiding them.
First, please remember that you bought your crypto from somewhere
or were awarded it from mining activities. This means that each
crypto coin is registered on the blockchain. What may not be
known is “Who owns that specific crypto coin?” That question can
be triangulated and then answered by tax authorities in a number
of ways:
— If you purchased a Tesla or other product or service with
crypto;
— If you purchased crypto from an exchange. That exchange
is now giving tax authorities whatever information (such as an IP
address) they have about that purchase under either a John Doe
summons or new regulations;
— If you traded one crypto coin for another on an exchange,
they will also turn over information on that trade;
— If you ever bragged online, to a former partner or friend
about your crypto activities, all of these people are now
motivated to collect a large whistleblower award to turn you in;
or
— If you used your cryptocurrency as collateral for a loan.
While the loan may not potentially be a taxable event, the
identities of the borrower and the owner of the crypto collateral
are recorded by the lender; and
— If you posted a TikTok showing off your ride or crib and
cannot explain how you paid for these extravagances in a
lifestyle audit!
What do I do now?
With the myth of anonymity emphatically exploded, those with
undisclosed cryptocurrency are now facing a serious crossroad
with two paths that can be taken.
Path A: Condemn yourself to playing hide and seek with a tax
authority who has unlimited time and resources and is joined
globally by other tax authorities who can also out you; or
Path B: Retain expert professional advice to:
1, Prepare a tax-efficient disclosure to tax authorities to
bring yourself in compliance; and
2, Organise so as to minimise/eliminate future tax
liability.
There are both domestic and international tax strategies worth
exploring fully. Which strategy or combination of strategies is
most appropriate will be determined by the crypto owners
individual circumstances and approach.
How do I execute a Path B strategy?
The key to minimising the tax paid necessary to come into
compliance is helped by the fact that the taxation of
cryptocurrency is still a relatively new concept both for
taxpayers and tax authorities. This provides some opportunity to
claim lower potential liability than may be available in the
future when the tax rules become more mature. Therefore, it is
critical that the individual seek and follow the advice of expert
tax counsel.
After becoming tax compliant, the correct domestic solution to
becoming more tax efficient depends upon the jurisdiction to
which you are subject. Domestic solutions depend upon taking
advantage of applicable rules. This includes qualifying for the
reduced rates applied to long-term capital gains, and avoiding
being defined as a “trader” subject to ordinary rates. Other
strategies such as “wash sales” may be possible, but it is worth
noting that both the US and the UK want to ban this strategy. The
changing rules on wash sales illustrate a fundamental problem
with any domestic solution…the government often moves the goal
posts without much notice.
As a result of this domestic legal volatility, having an
international strategy for either immediate implementation or
future insurance is increasingly attractive. This is especially
true for those involved in the crypto space as their operations
are completely location independent. As with domestic solutions,
the requirements of an international strategy involves first
putting together a backup plan of alternative citizenship(s)
and/or residence(s).
Success or failure will depend upon retaining a team of advisors
who are well-versed in:
a) How best to leave your current tax jurisdiction;
b) how best to enter your new country of residence in a
tax-efficient manner; and
c) how to select the appropriate residence and/or citizenship
statuses that are necessary to implement your departure and
relocation.
Still on the fence? Remember not deciding whether to act is
making a decision.
No matter which tax jurisdiction you are currently in, it is
worth recognising that the tax authorities are coming after you
with guns blazing. The sooner you move beyond the denial stage,
the more actions you can take to make your future bright. Those
of you who have large undisclosed holdings need to get your house
in order BEFORE the tax authorities are aware of you. Once the
authorities have your name, your options narrow considerably.
However, with proper planning you can not only come onside, you
can also legally organise yourself to reduce or even eliminate
future tax liability on your crypto activity.
If you have read this far but are still unconvinced that tax
authorities are capable or motivated, then as a final step I
suggest that you take some time to review tax authority efforts.
If you are still hesitant, then I wish you luck…because you are
going to need it.