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Coinbase Switches From 1099-K to 1099-MISC: A Better Mousetrap or Prelude to Litigation?

Posted on Dec. 10, 2020

Welcome back to guest blogger James Creech. Today James looks into a recent announcement by Coinbase that they are changing their method of tax reporting. When I saw this (in a Law360 article by Joshua Rosenberg) I wondered how such a dramatic shift was possible under the tax laws. We are fortunate that James agreed to investigate the matter and illuminate us. Christine

Former Netscape CEO Jim Barksdale once said, “There are only two ways to make money in business: one is to bundle; the other is unbundle.”  Of the two options, virtual currency exchange Coinbase has chosen to go the bundling route. At its beginning in 2012 Coinbase supported only a small number of virtual currencies and has steadily expanding its offerings over the last eight years. Recently Coinbase has dramatically expanded its offerings to include tokens such as the stable coin DAI (don’t worry the technical side does not make a difference to this article) which offers rewards to its holders that functionally resemble interest.

These expanded offerings have caused Coinbase to rethink its third party tax reporting. Prior to 2020 Coinbase reported transactions to the IRS using Form 1099-K. The issuance of a 1099-K was due in large part to litigation between Coinbase and the IRS over the issuance of a John Doe Summons that asked for all information Coinbase had regarding US Taxpayers. (Les wrote about the litigation for PT, most recently here.) While the matter was decided in favor of the Government, Coinbase was able to limit the request to information that mirrored the 1099-K and has stuck with that reporting standard since 2017.

For tax year 2020 that is all changing. Coinbase is no longer going to issue 1099-K’s and will instead only issue 1099-MISC forms.

The switch from a 1099-K to a 1099-MISC could be dramatic for a large number of Coinbase users. Form 1099-K reports gross transactions to the IRS if the taxpayer exceeds 200 transactions or a $20,000 threshold. The standards for Form 1099-MISC reporting are much lower. A 1099-MISC is required to be issued if a taxpayer receives more than $600 in payments during the year. This switch could potentially provide the IRS the names of tens of thousands of taxpayers who thought that they could avoid paying tax on virtual currency gains because they fell under the $20,000 reporting threshold.

Coinbase’s decision to switch from Form 1099-K to Form 1099-MISC could be for a number of reasons. First is that 1099-MISC is a more appropriate form to report payments akin to interest and that Coinbase decided it was more efficient only to issue one type of 1099. The second could be that Coinbase made an internal decision that the shortcomings of the 1099-K were too great to ignore. Since the 1099-K only reports gross transactions and not basis, many taxpayers who actively traded virtual currencies would have a very high dollar amount of transactions reported on the 1099-K but may only have small gains or could potentially have losses. The responsibility of tracking basis and reporting gains and losses still falls on the taxpayer but now that the IRS is issuing CP2000’s based upon virtual currency exchange third party reporting they might have to spend time, effort, and resources rebutting an incorrect 1099.

The bigger unanswered question after this switch is does Coinbase even intend to report sales or other transactions to the IRS in 2020 and beyond?  The webpage announcing the switch to a 1099-MISC reporting standard states: “1099-MISC Eligibility To be eligible for a 1099-MISC, you must: 1. Be a Coinbase customer, 2. Have received $600 or more in cryptocurrency from Coinbase Earn, USDC Rewards, and/or Staking in 2020 and 3. Be subject to US taxes.”  Nowhere in this announcement are transactions such as sales or purchases mentioned.

One reading of this press release is that Coinbase is beginning a taxpayer revolt against virtual currency third party reporting. Recently Coinbase has acquired a reputation of being one of the more conservative technology companies. For example, the company reaction to the Black Lives Matter protest over the summer was to simply ban its employees from speaking out on the matter or using BLM emblems as part of their internal communications. This reaction was starkly different from most companies that put out a politely worded statement offering some sort of recognition of the importance of the events. A further shift into libertarianism vis a vis refusing to provide information to the IRS might play well with the virtual currency community which tends to have an aversion towards any sort of government interaction. Not to mention it would seem to offer a business advantage for any frustrated virtual currency user who had to spend significant time resolving issues based upon 1099-K’s lack of basis reporting.

If Coinbase does stop reporting transactions to the IRS it sets the stage for a reprise of the John Doe Summons litigation from a few years ago. The IRS has made tax compliance in the virtual currency space a priority. It has significantly upgraded its technical understanding of virtual currencies and dedicated significant resources to cracking down on unreported virtual currency income. A resistant firm like Coinbase, and its users, would be the ideal target for the IRS to showcase their significant ability to identify virtual currency tax noncompliance just as it was in the original litigation. Only time will tell what will happen, but the only sure thing at the moment is that there is not an ideal form for virtual currency third party reporting.

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