How is Crypto Taxed with Micah Fraim

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Hey

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what’s up? This is George G and the time is right welcome today’s guest struggle powerful mica frame Mica. Are you ready to do this? Iron Man? Thanks for having me. I’m excited to have you on. Mike is a crypto and NFT obsessed CPA is a best selling author has been featured in NASDAQ, Forbes and money to name a few of the outlets. excited to have you on mica tell us a bit about your personal lives and more about your work and why you do what you do. So my name is Mike Aframe. I have a CPA firm, me and me and my partner, it’s called frame calling company. And for the past 10 or so years, we’ve really focused on growth centered businesses and online businesses. Mostly people had very quickly changing and dynamic situations that required a lot of planning.

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And then sometime around 2017, when everybody did I bought a little bit of cryptocurrency, the $3,000 I put into it very quickly turned into $1,000 Because like, as human nature we buy at the peak. I kind of forgot about it until a couple years ago and the market had recovered and that $1,000 had turned back into somewhere between like six to nine grand because the market had gotten so hot again. And around that time there was the I’d always everyone had said blockchain was a big deal and blockchain technology this is the future but I never understood why each particular crypto project would have value. Say okay, Blockchain is great, but what is Bitcoin? Aetherium Cardano? Why does this ecosystem itself have value? It was the first project that clicked where I understood the use case. So we started getting more and more into it just US investors and very quickly found that there is next to no tax guidance on crypto, because it’s such an emergent market. So partially just to do the planning for our own taxes. But then also, we were getting more and more clients who are asking us about this almost on accident, and just from our own little passion of crypto, this turned into one of the bigger parts of our practice. So that’s what got us here over the over the past couple of years at least.

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And have you you’ve you’ve grown to really enjoy it. You’re like this is awesome. I’m going to sink my teeth into it. I’m going to try to pop the hood and understand this as best I can. Yeah, it’s my it’s my favorite part of my practice. But the things that make me love it are also what makes it and nightmare investor. And the thing that I like is that it’s so rapidly there’s so little guidance out there that there’s so little guidance out there that you can just say, okay, the IRS said this. So this is what we’re going to do. For most things, the IRS has issued no guidance on crypto related tax matters. So we have to say, well, this is what they do for traditional securities, or this is what they do in business law, you find something that’s reasonably analogous to what you’re doing within crypto. And then you have to apply the precedent from those that case law. But it’s not like it’s a one to one.

Unknown Speaker 3:33
Issue got it. I’m saying this, because at least for crypto right now, the majority of the time, it just doesn’t exist. It’s fascinating.

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Do you how

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is it possible to look back and say, Okay, this thing was like this back in the day before we sort of got our arms around it.

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It’s going to be interesting, because right now, the IRS has issued guidance on a couple topics. But for the most part, the IRS typically is much happier enforcing regulations and laws than they are coming up with their own interpretation. So the IRS has issued some guidance on a number of things, but they’re largely at least appear to be at least waiting for Congress to pass some legislation or that and or the SEC to help give them a little bit more of a roadmap.

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So there’s a case right now in Tennessee where a couple is suing about the whether or not staking rewards within crypto should be tax.

Unknown Speaker 4:38
And the IRS initially offered them a settlement just to kind of make the case go away. Just look don’t pay the tax just but the couple doesn’t want that they want the precedent to be set so that there’s a clear answer. And last I checked the IRS filed a motion to dismiss with the court saying but we offered them a settlement. So the it’s a moot point.

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because they don’t even have to pay the tax, they just need they can take our settlement. Because they’re just that’s kind of the impression you get is that they’re just trying to defer it as much as they can. So with that, we just, there’s almost inevitably going to be some difference between the way people are filing their taxes and what the ultimate interpretation regulation is going to be. So that doesn’t leave taxpayers in this down Dingley. Great position, because we’re having to guess the through large extent, we’re having to guess what the right interpretation is gonna be. So we just tell people report all of your income. That’s the that’s the main thing, because a lot of crypto zealots and especially because crypto started as this vaguely anarchist type thing of decentralization, the government not being and not not being controlled by some some central bank all that

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a lot of people want to say, Well, no, the government can’t, can’t have my crypto, the government doesn’t know anything about my crypto, they’re not going to pay any tax. Those are the people who are going to get absolutely destroyed as the IRS and just the US government in general starts getting more their hands around this. So if you’re reporting all of your income, and we’re strokes, and with that, based on the information we do have available to us trying to structure it in the most tax advantaged way. That’s really all you can do. And if you’re reporting the income, it’s very easy. It’s much easier if the IRS does later on kind of as long winded answer to your question. But if the IRS does later on coming out with a totally polar opposite interpretation, then we’re able to point to, okay, well, I reported all the income. So clearly, I’m not trying to defraud the government. And also you didn’t have any guidance. So I wasn’t going contrary to what you told me to do. And what I was basing this off of was this established case law and this other area of finance or business, good or bad, that’s all you can do right now. you position yourself for success.

Unknown Speaker 7:19
Worst case scenario, the IRS does or Congress, the SEC creates law, the IRS then goes to enforce it. Can they look backwards at my at my previous tax returns?

Unknown Speaker 7:32
They can, it’s it’s probably relative to the scope of what your activity was. Because the IRS is they got a big infusion of financing here recently. But historically, especially over the past decade or two, the IRS funding has just gone down and down and down. So they’re understaffed and underfunded typically.

Unknown Speaker 7:55
So the IRS can look back and say, Okay, well, you you report it this way, you should have done that. The likelihood of that do them bothering with that is it’s probably two things. One will most IRS audits or, you know, put in sort of an air quotes, audits, a lot of those are based on just mismatches with the IRS is system.

Unknown Speaker 8:20
So dependent, especially now more and more, there are all these what they call centralized exchanges, so Coinbase, Kraken crypto.com, those type of ones that are that are tied to a single entity or community.

Unknown Speaker 8:38
They’re more and more going after those saying, hey, we want you to report this information to us, you got to keep track of this, you need to give us your customer information. If they meet XYZ criteria. A lot of the the letters people are going to be getting will be, hey, we got information from Coinbase that said you did X amount of trades, your return didn’t show any activity.

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You need to correct this.

Unknown Speaker 9:04
That’s what most people are going to have their eye there’s just gonna be a flurry of letters from people who didn’t think about their crypto forgot to report it. And then a centralized exchange gives

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conflicting information to the IRS. The other thing that could could happen is if you’re getting into a full blown actual audit, the IRS is going to dig into everything related to your your return. And that case, yeah, they’re going to dig into your, your defi wallets. They’re going to dig into how you classified it, what sort of deductions you took. And yeah, they can say, well, here’s the regulation. And even though you didn’t know it at the time, you didn’t do it correctly.

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At that point it becomes it becomes one a matter of negotiation with the saying, hey, well, I did the best I could based on that information. And also at the very

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At least you really fight to get rid of any penalties and tax penalties and interest that would have accrued on that base tax bill. Because you say, Well, how is I don’t know any differently. So it’s not a fun place to be in for anyone, which is one of the reasons why we’re, we’re really big on the need to plan around your crypto income. Because

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right, what we’re running into right now is,

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crypto, even people who are really into it will kind of refer to us like magic internet money, you know, kind of jokingly, the people who love NF T’s will talk about being JPEGs.

Unknown Speaker 10:42
So because it seems it’s so volatile, you’ve got people have such a high risk tolerance, investing in crypto, it’s a very theoretical type thing, it kind of goes now that Oh, this isn’t real money. So if I lose it no big deal, which is fine. From a pure investor standpoint, to an extent, the problem ends up being is that there’s no because they don’t consider it real for their portfolio, they don’t consider it real when it comes to their taxes.

Unknown Speaker 11:12
And what we’re running into this year is a ton of people who made crazy money in 2021, but did not do any tax planning for it did not cash out any of those earnings to pay their tax bill. And now their portfolios are down somewhere between 50 to 99%, of where of where they work, they’ve dropped 50 to 99% of where they work from their peak. And so they’ve got these huge 2021 tax bills, and they don’t have the assets to actually pay the bill now, because the market has gotten so bad.

Unknown Speaker 11:47
So in that example, somebody actually realized the gain and took income. Yeah, well, and that’s what people will run into is there’s there’s a couple things that people won’t understand with with crypto. One is that one of the main myths that you’ll hear in crypto circles is that it’s not taxable, until you cash it out for a fiat currency like US dollars. So it’ll be trading Bitcoin for Aetherium for all these, all these other alt coins, and they say, Well, none of that’s taxable, those trades aren’t taxable. It’s only taxable when I transfer it to my wall to my bank account. That’s not true. The IRS has said very explicitly that coin for coin or token for token trades are taxable events. So you have a lot of people who are trading throughout the year, but when they have those realized gains, they’re not taking a percentage of it to pay the tax bill.

Unknown Speaker 12:42
And since it’s all in the market, you have your you’ve got market exposure, good and bad. So you have this volatility of right now bitcoin is worth a third of what it was last year. So they’re making all these trades making all this income, but now they’ve got a depressed asset. And I know cash to pay the tax bill.

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The other thing is that for crypto, that’s just for trading, but there’s a lot of other types of crypto income that aren’t based on pure trading. A lot of the newer protocols within crypto are what they’re called this proof, it’s proof of steak. And with proof of steak, you’re taking your tokens and you’re sort of delegating them to a node operator a node validator and as reward for more or less voting with your with your tokens for that person, when the block is completed, when they distribute token rewards, you get a percentage of those rewards. So more or less, it’s effectively it’s kind of treated like interest or dividend income. So those are what staking rewards are taxable upon receipt. Same thing with a lot of these centralized exchanges have been trying to more or less buy deposits the way that that a traditional bank would. So some of those will pay anywhere from five to 20% interest for you depositing your tokens with them. So when you receive those interest deposits, those are taxable events. They have certain NF T’s will will pay you with reward tokens. Taxable upon receipt, if you have mining income, if you operate a node, if you do play to earn gaming and you receive rewards within the game, all of those are taxable events, once you receive the token, or or in some cases, the NFT.

Unknown Speaker 14:37
And so with that people will say well, I’m just I’m not cashing it out. I’m not doing anything with it. It’s sticking in there and they and they don’t realize that each of those are taxable events. So what will happen is you’re receiving all these rewards throughout the year, especially when you’re in a bull run. That can be a not inconsequential amount of money and

Unknown Speaker 15:00
And each of those is generating its own taxable, and then its own taxable income. But people don’t cash out, because they think Kryptos always going to go up. So why on earth would I want to cash out? Problem ends up being what we’re seeing right now. When in 2021, you were getting rewards that were valued

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at least three times what There they are right now. And you’ve got taxable income at three times what the asset is worth right now. And that can cause a big issue. Because if you do that, then you might have to start liquidating your portfolio to pay the tax bill, but you’re doing it at one of the most unfavorable times possible.

Unknown Speaker 15:44
That is a Yeah, what what a terrible scenario that is, it’s, it’s awful. It’s, I’ll give one example. And we changed some details just for anonymity. But people who have had seven figure 2020 ones have realized gains and other sources of income. But they were mostly involved in some what you call all coin projects riskier. Not exactly penny stocks, but but riskier projects.

Unknown Speaker 16:14
And they just kept reinvesting all of their earnings back into that project, while the project has dropped 99% from its peak.

Unknown Speaker 16:24
So they have a million they had over a million dollars and realized in gains and other income, which generate a $500,000 ish tax bill for them. And their portfolio now is maybe worth 100 to 200 grand.

Unknown Speaker 16:39
So even if they burn their entire portfolio, they’re still going to have a tax debt. It’s it’s awful. I mean, I It’s like you, I’ll smile when I talk about because it’s one of the things like Laugh, laugh to keep from crying, but it can be an absolutely brutal situation that nobody wants.

Unknown Speaker 16:59
What do you do? Do you declare bankruptcy? You can try to but I mean, what what most people are doing right now is we’re kind of hope we’ve got a lot of these people on extension, or they’re just waiting to file their tax returns for hoping for when the market will turn around. And then they’re able to liquidate and more favorable, right. But yeah, I mean, bankruptcy is, depending on what the disparity is between your assets and the tax bill, that might be something you have to do. And that’s just wild to think about that your investment income. You did so well, that you have to declare bankruptcy. It’s not something most people think, think about not something you have to deal with, with most investments, because there’s not that degree of volatility.

Unknown Speaker 17:45
It’s fascinating. I, I guess I still don’t necessarily know how common it is for people to be making trades within let’s say, I make a Buy Bitcoin at $10,000, shoots up to $60,000. And I transfer the entire 60,000 into Aetherium. Just as an example. My gain there is $50,000 that I own tax that I owe taxes on it bought it for 10 when it went up to 60. But I would never think oh, yeah, I just realized the gain by making that transfer, even though no money hit my account.

Unknown Speaker 18:27
This, for most of us, there’s always cash involved in a transaction. So that’s what people sort of intuitively think, is that, okay? I don’t pay tax on this until I actually receive cash.

Unknown Speaker 18:39
And again, that makes sense, because that’s the way that 99% of our transactions work. But the taxability is based not on the receipt of cash, it’s on the disposition of the asset, even though, you know, in this case, we’re more or less bartering for another token. So people will, especially the more into crypto people will get and more people will try to do short term trading and you know, their thoughts on where the market is going, the more people get into it, the more likely they are to have a higher volume portfolio. And the more potential there are for these realized gains, and then again that when tax time comes, you may or may not if you haven’t done tax planning around it, you may may or may not have the liquidity to actually pay the bill

Unknown Speaker 19:27
weren’t weren’t were

Unknown Speaker 19:31
Oh, my guy, I appreciate you coming on and, and, and, uh, certainly bringing my awareness to what is certainly a problem but what could be a massive problem for for for some people out there. Where can people learn more about you? How can they engage, they say, You know what, I probably better start doing a little bit of tax planning. Yeah, so if they’re involved in crypto, they can go to crypto tax cpa.com. We also have a book that the digital verse

Unknown Speaker 20:00
At least it’s free on Amazon right now. It’s called decrypt and crypto taxes. And then if, if they happen to just be regular growth centric business owners or something that’s a slightly more dynamic situation but unrelated to crypto, they can go to frame cpi.com.

Unknown Speaker 20:17
Excellent. If you enjoyed as much as I did show mica your appreciation and share today’s show with a friend who also appreciates good ideas, check out crypto tax cpa.com Pick up a copy of decrypt the decrypting crypto taxes on Amazon and then just interested in general regular tech stuff. So much easier. Go to Frame cpa.com Thanks again, Mike. Thanks for having me, man. And until next time, remember, do your part by doing your best

Transcribed by https://otter.ai