Taxing cryptocurrency is no longer just a problem for young people. This changed the day the United States Internal Revenue Service made cryptocurrency a central enforcement point and added a crypto disclosure question on its Form 1040. Unsuspecting parents with dependent children should be on their guard. The IRS is looking for non-compliance, and crypto issues create a potentially marital trap. Failure to do so can sleep many careless parents in the basement.
As of October 2019, nearly 40 million Americans own some form of cryptocurrency, and the average account value is over $ 5,000. And Google Analytics data shows that over 40% of all crypto owners over the age of 18 are millennials, and nearly 17% have recently graduated from high school. It is the latter group that should concern parents. These numbers correspond to millions of college-age or younger crypto owners. This creates a potential “crypto trap” for parents who describe crypto-savvy young people as dependent on their tax returns.
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Most parents claim their children under the age of 18 as dependent, and some claim their children in college. Parents should be extra careful this tax return season as they may fall into accidental secrecy and not report crypto kiddie income.
The IRS is watching
For the past two years, the IRS has launched a campaign to stamp out non-compliance with crypto taxes. It is estimated that crypto users have a tax gap of $ 25 billion. And because cryptocurrency is taxed as “property”, unearned income can arise when relatives trade crypto or buy and sell goods with crypto.
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The unsuspecting parent could have dependent children who trade crypto, trade crypto, buy and sell with crypto, and earn crypto from staking activities. In these cases, the dependent has both reportable capital transactions and unearned income – income that would be taxed at their parents’ marginal tax rate.
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Unsuspecting parents who are completely unfamiliar with Bitcoin (BTC) and other digital assets may never even think about asking their kids about crypto activities. It is easy to imagine that a young person – under the protection of their parents – engages in crypto activities without telling mom and dad the details. All it takes is a cell phone to do this. And why should young people? They are the least experienced group and least understand the tax ramifications of cryptocurrency for themselves, let alone their parents. It’s hard to imagine a young person coming up to their parents at tax time and saying, “Hey, mom and dad, your CPA might want to know about my Kraken cryptocurrency.” That’s about as likely as mom and dad Understand decentralized finance, sidechains or crypto mining.
The child tax
But parents with dependents should ask their children about crypto activities. Income is a big problem. The tax code provides for a “child tax” for the unearned income of children under 19 (under 24 if a student). The current threshold is only $ 2,200. If a qualified child has unearned income in excess of $ 2,200, child tax may be applied to the excess at the parent’s marginal tax rate in place of the child’s tax rate. The child tax is to be reported on the form 8615 “Tax for certain children with undeserved income”. If a parent fails to report a dependent’s cryptocapital gains greater than $ 2,200, the parent will omit the taxable income on their tax return.
And having a dependent child making income is not hard to imagine. At the time of writing, Bitcoin is up nearly 300% in the past 12 months, and the second most widely traded cryptocurrency, Ether (ETH), is up 700% over the same period. BTC and ETH can be said to be too rich for young addicts with spot prices of around $ 37,000 and $ 1,600 respectively, but consider others: Polkadots DOT, number three by market cap, is up over 300% since December, and so is its price is only $ 20. Cardano’s ADA, number six by market cap, is around $ 0.45, and it’s also up 700% over the same period. If their son or daughter uses crypto to buy or sell goods and the market value of those goods exceeds the base, mom and dad may have to enter into a taxable transaction. In the end, parents may have to parentally control their child’s record.
The IRS has done little to inform parents with dependent children of this compliance trap. Ignorant parents are likely to stay the course at tax time and think little about Bitcoin or Altcoin headlines. However, if their dependent child is keeping it, trading it, buying it and selling it, or earns it by staking or otherwise, parents could potentially file an incorrect tax return. When tested, things could get even stickier. There is no indication that the IRS will forgive crypto-compliance. Here, too, a tax gap of $ 25 billion has to be closed – big enough to be intolerant.
The question about disclosure of cryptocurrency
Perhaps a larger underlying problem lies in the question of disclosing cryptocurrency on Form 1040. Again, unsuspecting parents can be at risk. The question is:
“Have you received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency at any time during 2020?”
Ward Cleaver would surely look at June Cleaver and say, “Of course we didn’t, honey,” without thinking about The Beaver.
There are no instructions on what a “financial interest” means or how far it goes. If a parent has to report their relative’s crypto income, does this parent also have to answer “yes” to the cryptocurrency disclosure question? This question remains unanswered. But when you look at it through the lens of current crypto tax enforcement policy, the answer gets grimmer. The IRS can answer this question in line with its general crypto tax policy objectives. It tries to get information about crypto positions and it may not be satisfied just knowing about obscure “kiddie” crypto earnings reported through an IRS Form 8615. The IRS may want to know more.
If one parent “takes possession” of a dependent child’s unearned income (for tax purposes), the same parent may take similar “ownership” of their child’s crypto positions (for disclosure purposes). After all, it’s not the parents’ income that they need to report on IRS Form 8615, but that of the child. It may not matter that the parent does not fully own the crypto account as long as the account is owned by their dependent child and the parent is aware of it. Knowledge is also a difficult complication. Currently, most of the crypto exchanges do not issue information tax forms to users. Rather, parents have to rely on their children for answers.
The child tax and crypto
The political reasons for the child tax can provide answers. The child tax was introduced in part to address tax loopholes – that is, to remove the renaming of investment properties to the names of dependent children in order to avoid paying higher tax rates. Likewise, a similar political argument could be made regarding cryptocurrency disclosures. For example, if a parent were a large cryptocurrency holder and avid trader, they could simply claim the accounts under their child’s name with no disclosure requirement and avoid the crypto disclosure issue entirely. That is, the capital gains from crypto activities are darkly reported on Form 8615, but the accounts are protected from disclosure. The IRS is unlikely to find such a tactic available.
Unfortunately, a rhetorical question doesn’t answer whether a parent needs to disclose their dependent child’s crypto accounts on Form 1040. Taxpayers will have to guess until further guidance is published or the tax authorities respond. The idea that a parent should disclose a child’s financial positions is not a foreign one. Under the Bank Secrecy Act, underage children have an obligation to report foreign bank accounts (FBAR) if their foreign accounts meet certain thresholds. In this case, the legal guardian or parent must file the FBAR for the child if the child is unable to file the FBAR themselves. If the finance department expects disclosure assistance in one context, it is not difficult to see how they might expect it in another context.
Income and voluntary disclosures are at the forefront of the IRS ‘crypto tax initiative, and both may be affected by the kiddie tax and 1040 crypto disclosure issue. Parents need to remember that they are signing tax returns under the penalty of perjury. These days, Johnny does more than mow lawns for extra “coins” in his pocket.
The views, thoughts, and opinions expressed here are the sole rights of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Jason Morton practices law in North Carolina and Virginia and is a partner at Webb & Morton, PLLC. He is also an attorney for the judge in the Army National Guard. He focuses on tax defense and tax disputes (domestic and international), estate planning, business law, asset protection and cryptocurrency taxation. He studied blockchain at the University of California at Berkeley and law at the University of Dayton and George Washington University.