Are you ready for this new crypto question on Schedule 1?
How to pick the right crypto tax software
February/March 2020 Footnote
Editor's note: Updated January 31, 2020
If you or any of your clients had any cryptocurrency transactions during 2019, a crypto tax software is an essential tool to calculate your cryptocurrency gains and losses.
Think this doesn’t affect you? Think again.
Starting this tax season, Schedule 1 of Form 1040 will ask every taxpayer (or their preparer) whether they have had any crypto transactions during the tax year. If you check yes, you need to figure out how to calculate gains and losses and apply the correct rules. As anyone who has done this can attest, this is difficult to do manually.
Cryptocurrency exchanges are different compared to traditional brokerages like Td Ameritrade or JPMorgan. At the end of the year, these brokerage houses issue a consolidated Form 1099 listing all your annual proceeds, cost basis and gains/losses arising from stock transactions. However, crypto exchanges like Coinbase and Gemini do not issue such forms at year-end. They may issue a Form 1099-K listing all your gross transactions, but this is not useful in preparing a tax return. Therefore, the burden of properly calculating gains and losses to be reported on the tax return falls with the taxpayer and/or their CPAs.
The question is: How do you do that? Trust me, you cannot do this on spreadsheets.
Luckily, there are software products in the market that can help you reconcile your cryptocurrency gains and losses. Although many of them claim that they calculate your “crypto taxes,” this is not the case. What these platforms are really doing is compiling all your cryptocurrency transactions from various sources and calculating gains and losses in U.S. dollars by following IRS guidance. The actual taxes you owe on crypto gains are calculated on your tax return, not on these crypto tax software platforms.
How does crypto tax software work?
In short, crypto tax software functions as third-party data aggregators. Users can purchase an annual subscription and connect with their crypto exchanges, wallets, addresses, etc. Then, the software reconciles the transactions and produces detailed gain and loss reports compatible with the IRS guidelines. Generally, these reports include Form 8949, Schedule D and, in some cases, Schedule 1.
For the naked eye, all these platforms may look like a good solution in the upcoming tax season. However, each platform is different and has its own strengths and weaknesses. Because there are many choices, the following is a list of items you should look at when choosing a crypto tax software tool for the 2020 tax season.
Integrations and bandwidth
The No. 1 item you should look at when selecting a crypto tax software is the number of integrations.
There are mainly two types of integrations: Application Programming Interface (API) import and Comma Separated Values (CSV) import. API is the most seamless and accurate way to import your wallet and exchange data into a tax platform. This may sound very technical, but the process is simple. You must copy the API key from your exchange/wallet and paste it into the crypto tax software platform. Once this is completed, the platform automatically downloads all the transactions and reconciles the transactions. CSV imports are a bit inconvenient and time-consuming. It involves downloading the transaction history report in CSV format and uploading it into the crypto tax software. In some cases, you will have to edit this transaction history report to comply with the format required by the software platform. You may also encounter more bugs in this process compared to API import. Therefore, the more API integrations a platform has, the more seamless and easier your life will be.
Bandwidth is another important item to consider. This may not be advertised on the homepage, but look at the fine print or ask customer service before purchasing software. For example, there are many crypto tax software platforms that offer a subscription relatively cheap. However, if you have a lot of transactions, those platforms fail to process them and crash. This is extremely important if you are an active cryptocurrency trader with thousands of transactions in different exchanges and wallets.
Credibility and legitimacy
Because crypto tax software is an emerging space, checking the credibility and legitimacy of the software you use is imperative. At the end of the day, liability falls to the taxpayer for information reported on the tax return, so you should do due diligence when picking a software provider. One factor you can explore is the team behind the platform. Check if the team has any members from the tax compliance/regulatory space. For instance, teams with only technologists may lack the tax experience required to navigate this murky space. Ask the platform (or search online) the initiatives they have taken with the IRS and other regulators.
Other questions to ask and consider: Have you successfully helped taxpayers in defending amounts reported by their platform? How secure is my data? What kind of trade and industry organizations are they affiliated with? What kind of media presence does the company and its members have? Does the website/blog have up-to-date content on crypto taxes?
The price may be the most important factor for you. Keep in mind that paying a small premium for higher integrations, bandwidth and credibility is well worth the cost. To give you an overview, for most platforms, pricing tiers depend on the number of transactions you have in a given tax year. Make sure to take advantage of platforms that provide a free account if you meet the criteria. If you have a lot of transactions, be prepared to pay higher prices.
Tip: Sometimes you get bumped into the next pricing tier if you surpass the number of transactions in the previous tier by a small margin. In those cases, you can reach out to these platforms to make an exception so you can pay a lower fee.
Also, there are platforms that charge based on the value of funds you have and other criteria.
Look for other perks that come with the subscription. In addition to gain/loss reconciliations, some software platforms offer perks like free portfolio tracking, educational webinars, tax planning tools, etc. Another handy option offered by platforms is the ability to invite the CPA to view the account without the client sharing their own username and password. This is very convenient for CPAs and good for privacy. I imagine you, as the CPA, will love this feature, and it will save the client money by saving you time.
Mainstream, here we come
With the addition of the crypto question on Schedule 1, crypto is headed mainstream. Properly calculating your crypto gains and losses and producing the right tax forms is your responsibility. It’s incumbent on you to leverage a good crypto tax software moving forward in order to meet filing requirements.
Shehan Chandrasekera, CPA is the head of tax strategy at CoinTracker.io. He is one of the handful of CPAs in the country who is recognized as a real-world operator and a conceptual subject matter expert on cryptocurrency taxation. He is a Forbes tax contributor and a CPE instructor who has been awarded with various awards, including the 2019 CPA Practice Advisor 40 under 40 accounting professionals, Outstanding Young CPA of the year, and among 21 accountants mentioned on Accounting Today who will help shape (and reshape) accounting in 2020 and beyond. You may reach him at firstname.lastname@example.org.