Coming soon to the US: crypto cards, and all the associated tax headaches

An assortment of crypto payment cards will soon become available to U.S. customers, perhaps reflecting a growing awareness and demand for cryptocurrency by mainstream consumers.

But unless U.S. tax policy changes dramatically, these new services are bound to induce tax-related headaches. 

A bevy of crypto companies — including Coinbase, Paxful and Bitpay— have recently launched or are planning to soon launch cards that will let U.S. users pay with various cryptocurrencies. That may make it easier to spend crypto, but there’s a catch.

Any time cryptocurrency is sold — which is what happens when these debit cards are used, since vendors ultimately receive fiat from the transaction — that’s considered a “taxable event” by the Internal Revenue Service (IRS).

So if you pay with crypto to buy a cup of coffee at the drive-through, and the price of the crypto-asset has gone up since you bought it, you owe capital gains tax. 

Meanwhile, the IRS appears to be watching closely. Last year, it sent letters to thousands of crypto users warning them that they may be out of compliance with their taxes. The agency also included a question about cryptocurrency-related activities on its Form 1040 for the first time. This year, it has sent out more letters and moved the question to the top of the form. 

Capital gains and losses are calculated by determining the “cost basis” of the purchase — the price at which you bought the asset — and the spread of your gain or loss when the asset is sold. This would matter a lot if you, for instance, bought bitcoin six months ago and sold it today. The price has increased by thousands of dollars during those months.

There is no standardized reporting requirement for the firms issuing these cards, so ultimately, the law places the responsibility on the card user to track all their crypto-spending.

Many exchanges issue Form 1099s to help users with their accounting. But third party crypto platforms often have incomplete information, since users could be moving funds in and out of private wallets, making it impossible for the companies to establish a cost basis for every transaction. 

Crypto tax software firms have emerged to fill the void. These firms usually get transaction history from the exchange through an API call and then match them to the historical prices in fiat terms to establish the cost basis and gain or loss on each transaction.

But the danger is that prospective users may be unaware of all these tax burdens, said David Kemmerer, CEO of CryptoTrader.Tax. The card issuers “have no incentive to alert their users,” he said. 

“If they alert them that they’re going to incur a bunch of tax consequences every time they use these cards, well, that's going to extremely limit growth and deter people from using these cards,” said Kemmerer.

Some crypto card issuers, like BlockFi and Fold, will avoid those issues by only letting users spend fiat money. BlockFi plans to introduce a more traditional credit card that rewards users in bitcoin instead of airline miles or cash back, and Fold’s card will be a conventional debit card that pays users bitcoin rewards.

Receiving bitcoin rewards is not a taxable event, according to BlockFi CEO Zac Prince. It only establishes a cost basis, the same as any other bitcoin purchase.

The stablecoin factor

Why would anyone use a crypto debit card to buy things, given all the hassle? It starts to make more sense if the crypto is a stablecoin, which some of the cards will allow users to spend.

Stablecoins tend to fluctuate so little that any capital gains users would pay on their transactions would usually be negligible, said Joseph Ryan, CFO of crypto accounting firm Gilded.

Even if you are executing a huge number of transactions, "the net effect — even if it's going up or down by a penny or two pennies — the net effect is going to be pretty immaterial," he said.

But you're still responsible for the headache of documenting all of your crypto spending for the IRS, because you might end up owing a few dollars in taxes. 

“Your proceeds and your cost basis basically match up to be one to one so your capital gain or loss is minimal if anything, but you still do need to track it just to verify that,” said Ryan.

A policy prescription?

That would no longer be the case if a proposed bill in the U.S. House of Representatives is ever passed into law, however — as long as you spend less than $200.

The Virtual Currency Tax Fairness Act of 2020, introduced last January by Congresswoman Suzan Delbene of Washington and Congressman David Schweikert of Arizona, would enact a de minimis tax exemption for day-to-day cryptocurrency purchases.

Under the proposed law, all cryptos would still be taxed as property, which means even dollar-pegged coins will still be taxed the same way a stock would be. But it would also recognize that crypto used for small transactions is being used as currency rather than property, and would exempt crypto transactions under $200. 

In other words, that crypto card swipe at the coffee shop drive-through would no longer be cause for a headache.