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.