Crypto at ESA

Since we’re the cool, diamond-handed, trendy-loving, FUD(fear, uncertainty, and doubt)-crushing, FOMO(fear of missing out)-haters and at the same time professionals, now seems just as good of time as ever to discuss what we are doing at our firm to familiarize ourselves and become more competent in the ever-growing and evolving world of magic internet money, cryptocurrencies.

ESA Activities Related to Cryptocurrency

Mining

Earlier this year, in an effort to seek passive income opportunities, learn more about mining, and possibly have some fun in the process, our firm decided to mine cryptocurrency. Now, just because we have elected to do so does not mean we are experts in the field of mining.

We have seen two major ways to mine. First, one can build graphics card rigs from computer graphics cards (“GPU Miners”). Second, there are application-specific integrated circuit miners (“ASICs”). We are trying both. The GPU Miners are set to mine Ethereum. The ASICs are set to mine Litecoin, albeit on a more productive basis by merge-mining Litecoin and Dogecoin, getting paid in Litecoin.

In our experience so far, the ASICs are much more efficient when factoring in opportunity cost, maintenance, and just having to spend time tinkering with the machines. While the GPU Miners were a great learning experience, it would seem the days of those machines may be numbered. Primarily, Ethereum, by far the most profitable coin to mine with GPU Miners, is set to change its model for mining from what is called “proof of work” where miners undertake complex computations to validate transactions to “proof of stake” where mining will be done by validating transactions based on staking Ethereum (i.e. putting money on the line saying the transactions are valid).

HODL-ing (Holding)

With the coins we have mined with our miners, we have primarily held them for investment (commonly referred to as “HODL-ing”). For better or for worse, HODL-ing limits one’s risk to volatility. Given the less volatile nature of coins like Bitcoin, Ethereum, and Litecoin, and their seemingly constant appreciation, this tactic is low-maintenance and is perhaps one of the least risky approaches.

Trading

While we have not traded much, I have ventured into the fray personally. I have won. I have lost, excruciatingly so at times as well. After much time spent watching markets, learning trends, and generally becoming more knowledgeable of trading, I have found myself yet again paying more tuition for my extended education in the legal field. I am probably best set to stick with law. That is not to say that I cannot trade to some extent. This is due to an incredible discovery I have made recently, algorithmic intelligence (“AI”). With AI, combined with automated trading, via a bot, one is able to utilize automated market trends, predetermined strategies, machine learning, and programmed risk-reward limitations. In effect, one can throw in a bunch of strategies into a computerized blender, have the system run a lengthy historical analysis, training the trading bot how to trade efficiently, and based on whatever algorithm seems best for the chosen coins, set the machine into autopilot and let it run, learning along the way. This seems to be the way. As I learn more, I may update as things move along and we become more competent in this arena. Traders utilizing this technology can, instead of their own intuition and, scarier yet, emotion, can utilize non-emotional pre-determined trading algorithms of other experts with actual wins under their belts.

Why Write about Cryptocurrency?

First, it is fun and relevant for the times. Second, we are seeing more clients with substantial cryptocurrency holdings. When we undertake certain types of estate planning, the manner in which assets are held, controlled, transferred, and handled becomes extremely important. Fiduciary risk and management is an important part of those considerations. Additionally, given the nature of the investment and its potential for huge income or losses, income tax planning can become quite important as well.

The benefits to our clients based on our own cryptocurrency ventures will allow us to serve the needs of our clients, by being familiar with cryptocurrency in general, how to mine, hold, and protect cryptocurrency more competently. Further, by knowing these dynamics, we can integrate these new digital assets, some of which have extreme value, into complex plans for our clients.

Knowing what we know now, if cryptocurrency was intended to be sold or gifted to a trust with a direction to continue to hold the cryptocurrency, a trustee saying “what’s a seed phrase” would be most troubling. That’s if a trustee would even be willing to entertain the idea of holding cryptocurrency. Win or lose in our own ventures, a major goal is to be able to create wins for our clients in their planning. As for trading or income-generation related to cryptocurrency, that is not us. We have no Lambos. Instead, we have an expensive education, fun stories, and as Liam Neison would say, “a very particular set of skills.” For better or worse, continuing education through our professional organizations alone seems insufficient. We prefer to get our hands dirty.

Recent Tax Issues Pertaining to Cryptocurrency

Our articles would not be complete without discussing some tax news or implications surrounding the subject matter. There have been some changes recently based on the Infrastructure Investment and Jobs Act (IIJA, PL 117-58), which also was previously referred to as the Bipartisan Infrastructure Framework (BIF). The IIJA was enacted on November 15 of this year. With it comes some changes to the reporting requirements in the cryptocurrency world.

New Reporting Requirements for Digital Assets

To start, see the addition to Form 1040 where taxpayers are required to answer “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” This question is modeled much like previous questions regarding foreign accounts. The consequences could be immense.

Currently, taxpayers receive Form 1099-Bs at the end of the year showing all stock trades during the year. This allows brokers to report details of transactions, including proceeds, relevant dates, basis for sale, and gain or loss character. Further, if shifting assets from one broker to another, the old broker is required to furnish a statement with relevant information, such as tax basis, to the new broker. The IIJA expands the definition of brokers who must furnish Form 1099-B to include businesses that are responsible for regularly providing any service accomplishing transfers of digital assets on behalf of another person. This would encompass cryptocurrency exchanges. Accordingly, any platform utilized to buy or sell cryptocurrency assets will be required to report digital asset transactions to taxpayers and the IRS at the end of each year.

There will be transfer reporting of digital assets as well, even if not a sale or exchange. It would seem at this time that this applies to exchanges or trading platforms only (i.e. centralized exchanges). There are decentralized exchanges, and I would be curious how this would work. Guessing, I would venture to say that such would be self-reported as there would not be a broker involved as those exchanges are peer-to-peer.

These rules do not just apply to cryptocurrency, but digital assets as a whole. A “digital asset” is any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology. Furthermore, the IRS can modify this definition. This definition is expected to capture cryptocurrencies as well as some non-fungible tokes (NFTs) that are using blockchain technology for one-of-a-kind assets like digital artwork.

Historically, when businesses receive $10,000 or more in cash in a transaction, that business is required to report the transaction, including the identify of the person from whom the cash was received, to the IRS on Form 8300. The IIJA extends this reporting to treat digital assets like cash. So, if you pay for something with cryptocurrency, cash-like reporting requirements may apply. Also, one must not forget if using cryptocurrency as currency, then gain or loss may be recognized as well.

A Brave New World Begins When?

These new reporting requirements apply to information returns due after December 31, 2023. Expect soon for exchanges to collect Form W-9’s. Also, expect exchanges to report not only cryptocurrency to cash transactions, but also cryptocurrency to cryptocurrency transactions. There are some technologies out there to help ease the pains of these requirements, but it would not be unreasonable to assume the solutions to be imperfect, at least for a while.

If you have questions involving cryptocurrency and how to ensure tax compliance or integration into your estate planning, please feel free to contact our firm.