Cryptocurrency has become a worldwide phenomenon since the first Bitcoin transaction in 2009. Today’s market is valued at more than $2 trillion, with recent advancements in crypto expanding how digital assets can be created, used, and transferred.
However, the ever-changing scope of digital assets and introductions of new applications—such as the recent wave of NFTs—has created complexity. How should accountants approach digital assets, and are there tax risks that must be considered? This blog will explore how cryptocurrency and accounting interact.
What is cryptocurrency?
Cryptocurrency is a digital currency that uses encryption to verify transactions and regulate printing. These transactions are then maintained through a ledger called the blockchain, a decentralized, distributed, and public digital ledger.
Blockchains have a low chance of their records being tampered with because they are challenging to hack. Malicious actors would have to break into every block in the chain to change the transaction data, meaning the decentralized network can’t be physically broken into at one location.
For most people, cryptocurrency is another form of making and spending money. However, regarding cryptocurrency accounting, the Internal Revenue Service (IRS) and Certified Public Accountants (CPAs) consider cryptocurrency property.
What are the implications of crypto being considered property?
Buying, selling, or trading cryptocurrency are taxable events—even when trading one cryptocurrency for another). Additionally, because its purchase will be treated like the sale of property, it could result in capital gains taxes.
For businesses using cryptocurrency to make purchases, the company could owe hefty capital gains taxes if the crypto’s value has appreciated since it was purchased. This is because they owe capital gains taxes based on the value of bitcoin at the time of sale.
On the flip side, being paid in crypto in exchange for goods or services or as a salary is treated as ordinary income based on the cryptocurrency’s fair market value at the time.
Also read: 3 Ways to Mitigate Risk When Outsourcing Accounting Services
Cryptocurrency and accounting: A new asset class
As cryptocurrency is a new asset class, laws and regulations are still developing and vary between countries or even states.
This creates complexity, leading to potential cryptocurrency and accounting reporting issues for those who do not understand local tax regulations. A few examples include rapid swings in the currencies’ value, the challenges of reporting them as an intangible asset, and the fact that only unrealized losses—not gains—are recorded in the United States.
The last point is due to the GAAP (Generally Accepted Accounting Principles)’s intangible asset accounting rules. These are written so that if a business buys $100,000 worth of a cryptocurrency that drops to $50,000 in its fair value, the company must record it as a loss even if the fair value later increases to above $100,000. This has the potential to both be unfavorable for a business’s investment portfolio and be misleading for readers of a business’s financial statements.
These are some of the issues driving many to request the Financial Accounting Standards Board (FASB) to create new standards for crypto and other digital assets.
Pay attention to new regulations
On February 1st, 2023, the FASB allowed the public 75 days to leave comments on a proposal for cryptocurrencies. The subsequent proposal is to be completed by the end of March, and it will build the first explicit standard on crypto assets in the US.
Currently, financial reporting for cryptocurrencies simply does not fit existing GAAP guidance. The final proposal will help eliminate the confusion surrounding the successful accounting of digital assets.
Some changes are already taking effect in the world of cryptocurrency and accounting. One example is the ruling on October 12th, 2022. The FASB decided that tokens like Bitcoin and Ethereum should be measured at fair market value, a win for investors. Overall, the FASB is attempting to help investors by aligning the measurement of crypto assets with other financial assets.
Also Read: Tips to Mitigate Tax Extension Liabilities and Risks
Making sure your firm is protected
CPA firms seeking to outsource their accounting services must understand the risks. No matter how in-depth your preparation is, mistakes can happen and are risky when sending confidential client information to a third party. The firm’s reputation is at stake.
Protect your business by preparing for the unexpected. McGowan PRO’s Accountants Professional Liability/Errors & Omissions Insurance offers specialized risk management and protection against professional liability claims. Additionally, we provide broad coverage options and education in risk management strategy, giving you confidence in your coverage.