Taxation on Crypto Unrealized Gains (Losses) for Entities
With the 2019 Corporate Tax Reform now in effect, unrealized gains (and losses) from cryptocurrencies held by entities will be subject to taxation.
The impact of this change is significant for entities that hold crypto (exchanges, funds, etc.).
I have summarized the effects below.
Mark-to-market of crypto held by entities at the end of the fiscal year
Crypto with active markets: Mark-to-market > M-t-M gains or losses included in the calculation of taxable income for the year
Crypto without active markets: No mark-to-market (keep at cost)
Calculation of cost-basis
Moving average or Total average methods are permitted
Treatment of crypto margin transactions
Unsettled crypto margin transactions: Unrecognized gains or losses are included in the calculation of taxable income for the year
Effective for fiscal years ending on or after April 1, 2019
Impact on operations
The volatility of crypto prices is still very high and management will need to carefully think of tax planning strategies to mitigate any unexpected tax consequences due to market movements.
For exchanges, assets held on behalf of customers are recorded as both assets and liabilities in the same amounts on the balance sheet.
The M-t-M gains and losses for these cryptos offset each other, so there is no tax impact.
For the cryptos that the exchanges hold for themselves, these are exposed to the price movements and therefore require tax planning.
If taxable income is expected for the year, management should consider whether it is necessary to convert crypto into cash to pay off the tax liability.
Management can also consider the use of derivatives to hedge the effects of price movements.
If the exchange is receiving fees from customers (ex. transaction fees, withdrawal fees) in crypto, management should consider whether periodically converting that crypto into fiat makes sense.
Impact on the financial statements
As a result of this change in tax rules, the treatment of unrealized gains and losses are aligned between tax and accounting and therefore will generally not result in temporary differences.
Any deferred taxes recorded on the balance sheet from M-t-M of cryptos in previous years would generally be reversed.
Management will have to consider the impact of this change in tax treatment for cryptos as the impact on business and cash flow is significant.
As a reminder, this change in tax treatment regarding unrealized gains and losses is relevant for entities only.
For individuals, the gains and losses from crypto are not subject to taxation if they are not realized.