Crypto Tax & Unclaimed Property Compliance – A Year-Round Strategy for Success – Part I

This blog was last updated on September 24, 2024

Despite the reputation of being a “once a year” thing, tax information reporting and withholding is a year-round organizational compliance process. Add unclaimed property (UP) obligations and crypto tax compliance to the monthly to-do list, and businesses have a lot of compliance obligations to prepare for – all throughout the year.

This quarterly blog series will focus on tax information reporting (TIR) and UP issues impacting businesses facilitating transactions involving digital assets. Each quarter, Sovos experts will provide updates and reminders on tax and UP issues in advance of the next quarter – to help you have a line of sight into what to expect next.

We’ll also make sure to include legislative updates to call out key IRS and state regulatory changes we are tracking or that have occurred. With that –let’s have a look at what’s coming in Q2.

Tax information reporting (TIR) – looking ahead to Q2

We kick off this inaugural blog series looking ahead to the final stages of the 2021 TIR season. By now, most companies have completed some of the more complicated parts of the season processing including:

• Issuing 1099s to recipients by the end of January or early February
• Filing some 1099s/1042-S with the IRS and states
• Filing of withholding 945 returns by the end of January
• Issuing recipient copies and filing IRS versions of Forms 1042-S by March 15
• Filing of withholding 1042 return by March 15

As businesses prepare to complete the home stretch of 2021 TIR season, the following are some key activities that should be completed over the next few months.

• Verify IRS and state transmittals were received. April 1 is the day after the IRS transmittal is due for most Forms 1099, 1098 and other information returns. In the early days of April, make sure to confirm that files have been received successfully by the IRS and states and that no follow up issues need to be addressed to mark those tasks as “completed” for the season.
• Conduct post-tax season review to identify lessons learned. Almost as soon as possible after filing season, hit pause and regroup the key members of the organization that execute the year-end process. Identify the process details that worked and didn’t work and create an action plan for improvements for 2022 and beyond.
• File late original and corrected Forms 1099 with IRS to avoid a higher penalty rate. Inevitably, companies have minor compliance hiccups that result in late or corrected versions of Forms 1099 that need to be filed. Records filed with the IRS within 1-30 days after the March 31 deadline are subject to the lesser penalty of $50/failure. Identify late originals and corrections and ensure a file is transmitted to the IRS no later than the end of April to avoid the higher penalty rate applicable to penalties filed more than 30 days after the deadline. Identify late originals and corrections and ensure a file is transmitted to the IRS no later than the end of April to avoid the higher penalty rate applicable to penalties filed more than 30 days after the deadline.
• Issue recipient copies and file Form 5498 IRA Contribution Information. Businesses that maintain Individual Retirement Arrangements (IRAs) with assets invested in digital assets are obligated to issue to the recipient and file with the IRS Form 5498 to report the details. This includes the fair market value of the assets in the IRA as of December 31, the amounts of contributions and distributions that occurred during the calendar year, and other details applicable to the arrangement. This form is due to be issued to the recipient and filed with the IRS no later than May 31, 2022.
• Check the health of payee TINs often. The IRS issues annual backup withholding notices (B notices) and Proposed Penalties (P notices) for filing information returns that contained erroneous name and TIN combinations. Penalties for filing corrected information returns are updated annually. During June, take the opportunity to implement a real-time TIN matching program for new payees and a bulk TIN matching program for existing payees. Being proactive will help minimize the operational and legal expenses associated with the B and P notice processes.

Still awaiting regulations for infrastructure bill requirements 

• The Infrastructure Investment and Jobs Act included a change to § 6045 to require brokers to report information related to digital asset transactions.
• Generally, brokers will be required to report transfers of digital assets to unknown wallet addresses and report Forms 1099 with cost-basis details for sales of digital assets.
• The effective date of the new requirements is with returns issued for calendar year 2023 (due to be issued and filed in early 2024).
• The Treasury and IRS have not released regulations to describe how to comply with these legislative changes.

Unclaimed property: what to do now?

by: Kristine Butterbaugh, Solution Principal

In the world of unclaimed property, Q1 and Q2 are both busy with spring state reporting requirements. Many often think that unclaimed property is a part-time role with minimum exposure. Today, unclaimed property compliance is a year-round concern with compliance risks that should be prioritized for any business. By now, corporations have completed their spring due diligence and are finalizing the work to generate their April state reports for Pennsylvania and Florida. For cryptocurrency exchanges specifically, and for corporations involved with virtual currency payments and receipts, now is the time to be thinking about the following:

• Policies and procedures: One of the first components of a comprehensive compliance program is making sure there are documented policies and procedures in place. This should include an explanation of a company’s policies regarding unclaimed property and a detailed procedure for each policy.
• Proactive dormant customer engagement: Are you encouraging customers to engage proactively so that they do not become dormant or potentially fall into the definition of unclaimed property? If you have dormant accounts or accounts that have not been actively engaged, it is important to proactively reach out with the goal of eliciting a response. Keeping your customers engaged is a first line of defense for unclaimed property.
• Customer engagement tracking: Are systems tracking, effectively maintaining and documenting customer-initiated engagement? Owner-generated activity that is well documented and properly identified can help accounts avoid unclaimed property altogether. Also be sure you understand what qualifies as owner-generated activity for unclaimed property purposes.
• Communicate internally: If you do not have someone designated to stay on top of legislative changes and unclaimed property compliance requirements, it is time to define that role, either internally or by using a partner that has expertise in unclaimed property. Be sure to communicate the plans internally with all stakeholders and explain the importance of staying ahead of compliance requirements.

Crypto tax compliance are still works in progress at the federal and state level as regulations are pending in many areas. However, if you stick to the best practices outlined above, you’ll be in a good position to tackle cryptocurrency regulation.

Click here to read part II.