Hedging Bets, Hedging Taxes As Taxman Cometh For Cryptos

If the world of cryptocurrencies is relatively nascent, unformed, without a clear roadmap … guess what else is equally opaque?

Tax policy.

Specifically, as Fortune points out, some of the biggest investors in the sphere are scratching their proverbial heads, wondering how much is owed to Uncle Sam.

The investors are dozens of hedge funds, the financial publication has said, with billions of dollars invested in cryptocurrencies. The marquee names are there, of course, in terms of cryptos, including bitcoin and Ethereum. The move to grab billions of dollars in holdings amid wild speculation has come against a backdrop where tax policy remains unsure.

The Internal Revenue Service (IRS) said last month that it would train its sights on virtual currencies, with a focus on larger firms and international companies. The upshot may be taxes owed, or penalties looming … or both.

You can’t tax something – a least not easily – without defining what is being taxed. And as has been well-documented, there is not much out there that defines, clearly, what exactly a virtual security is and is not. A currency? An asset?

Depends on which agency you ask. The IRS defines crypto holdings as property. But then again, as Fortune notes, the Commodity Futures Trading Commission (CFTC) says that cryptos are commodities. Should those two agencies agree – on the commodities definition – then there could be relatively positive tax implications.

No agreement is in the offing yet, and the IRS stance may be in keeping with a 2014 ruling that treats virtual currency as property. That means any gains on losses would be recorded, and would have the same tax impact, as would similar activity logged on real property held by an individual or firm.

There could be some penalties afoot. The IRS has said it has a “compliance campaign” in place that is tied to virtual currencies. Taxpayers need to report their transactions, the IRS has said. One lure to do so is absent: There is no “voluntary disclosure” program in place that would let those holders who have yet to disclose transactions do so with limited liabilities tied to civil or criminal fines.

The impacts of nebulous tax policy and possible penalties loom large for institutional investors, where 84 crypto hedge funds were launched last year, according to Morgan Stanley, and where the funds’ coffers were filled with $2 billion in virtual securities.

The funds have been actively setting up offshore investment structures to house investor holdings in countries that are relatively low-tax areas. Income generated from commodities located in those countries does not get tied to U.S. taxes.

Fortune noted that there is not an official policy in place stating that these hedge funds can avoid filing a U.S. tax return, which means they can be on the hook for monies owed. The IRS reportedly has a list of issues that need attention, and the Treasury Department may have guidelines in place this year.

But in the meantime, some large holders must go on assumptions, which is always a dangerous game to play when the taxman cometh.