The taxation of cryptocurrency is no longer just a young person’s problem. That changed the day the United States Internal Revenue Service made cryptocurrency a focal point of enforcement and added a crypto disclosure question on its Form 1040. Unsuspecting parents with dependent children should be on guard. The IRS is looking for noncompliance, and crypto questions create a possibly perjurious trap. Noncompliance may be sleeping in the basements of many unwary parents.
As of October 2019, nearly 40 million Americans own some form of cryptocurrency, and the average account value is over $5,000. And Google Analytics data shows that over 40% of all crypto owners over the age of 18 are millennials, and nearly 17% are recently out of high school. It is the latter group that should concern parents. Those numbers equate to millions of crypto owners being college-aged or younger. This creates a potential “crypto trap” for parents who claim crypto-savvy young persons as dependents on their tax returns.
Most parents claim their children under 18 as dependents, and some claim their children in college. Parents should use extra caution this tax filing season, as they may be stepping into an inadvertent nondisclosure and nonreporting of crypto “kiddie” income.
The IRS is watching
Over the last two years, the IRS has launched a campaign to snuff out crypto tax noncompliance. It is estimated that crypto users account for a $25-billion tax gap. And because cryptocurrency is taxed as “property,” unearned income may arise when dependents are trading crypto or buying and selling goods with crypto.
The unsuspecting parent could have dependent children swapping crypto, trading crypto, buying and selling with crypto, and earning crypto from staking activities. In those instances, the dependent has both reportable capital transactions and unearned income — income that would be taxed at their parents’ marginal tax rate.
Unsuspecting parents, altogether unfamiliar with Bitcoin (BTC) and other digital assets, may never think to ask their children about crypto activities. It is easy to imagine a young person — under the shelter of their parents — engaging in crypto activities without telling Mom and Dad the details. It takes nothing more than a cell phone to do so. And why would young people? They are the least experienced group and the least likely to understand the tax consequences of cryptocurrency for themselves, much less their parents. It is difficult to imagine a young person coming to their parents at tax time and saying, “Hey, Mom and Dad, your CPA might want to know about my cryptocurrency at Kraken.” That is about as likely as Mom and Dad understanding decentralized finance, sidechains or crypto mining.
The “kiddie” tax
But parents with dependents should quiz their children about crypto activities. Income is one big concern. The tax code imposes a “kiddie tax” on the unearned income of children who are under 19 (under 24, if a student). The current threshold is only $2,200. When a qualified child has unearned income in excess of $2,200, the kiddie tax may be applied to the excess at the parents’ marginal tax rate instead of the child’s tax rate. The kiddie tax is reportable on Form 8615, “Tax for Certain Children Who Have Unearned Income.” If a parent fails to report a dependent’s crypto capital gains in excess of $2,200, then the parent is omitting taxable income from their tax return.
And a dependent child earning income is not hard to imagine. At the time of writing, Bitcoin has gone up nearly 300% in the past 12 months, and the second-most traded cryptocurrency, Ether (ETH), is up 700% for the same time period. One may say that BTC and ETH are too rich for the young dependent, having spot prices of around $37,000 and $1,600, respectively, but consider others: Polkadot’s DOT, number three by market capitalization, is up over 300% since December, and its price is just $20. Cardano’s ADA, number six by market cap, rests at about $0.45, and it is also up 700% for the same time period. If Son or Daughter buys or sells goods with crypto, and the fair market value of those goods exceeds basis, then Mom and Dad may have a taxable transaction to be concerned with. By the end of it, parents may need to parentally control their child’s balance sheet.
The IRS has done little to advise parents with dependent children of this compliance trap. Unknowing parents will likely stay the course at tax time, giving little thought to Bitcoin or altcoin headlines. Yet if their dependent child holds it, trades it, buys and sells with it, or earns it through staking or otherwise, parents could well be filing a false tax return. Upon audit, things could get even stickier. There is no indication that the IRS is going to be forgiving about crypto noncompliance. Again, there is a $25-billion tax gap to fill — large enough to be intolerant.
The cryptocurrency disclosure question
Perhaps a bigger underlying problem lies in the cryptocurrency disclosure question on Form 1040. Here, too, unsuspecting parents may be in danger. The question asks:
“At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
Ward Cleaver would certainly look to June Cleaver and say, “Of course we didn’t, honey,” without a thought to The Beaver.
There is no guidance on what a “financial interest” means or how far it extends. If a parent is required to report the crypto income of their dependent, is that parent also required to answer “yes” to the cryptocurrency disclosure question? That question remains unanswered. But looking at it through the lens of current crypto tax enforcement policy, the answer gets murkier. The IRS may answer this question consistent with its overall crypto tax policy goals. It seeks to know about crypto positions, and it may not be satisfied only knowing obscure “kiddie” crypto income reported through an IRS Form 8615. The IRS may want to know more.
If a parent takes “ownership” of a dependent child’s unearned income (for tax purposes), perhaps that same parent takes similar “ownership” of the crypto positions of his or her child (for disclosure purposes). After all, it is not the parent’s income they must report on IRS Form 8615, it is the child’s. It may not matter that the parent does not own the crypto account outright so long as the account is owned by their dependent child and the parent has knowledge of it. Knowledge is also a tricky complication. Presently, most crypto exchanges do not issue informational tax forms to users; rather, parents must rely on their children for answers.
The kiddie tax and crypto
The policy reasons behind the kiddie tax may provide answers. The kiddie tax was implemented, in part, to close tax loopholes — that is, eliminate the retitling of investment property into the names of dependent children in an effort to avoid paying higher tax rates. Likewise, a similar policy argument could be made in relation to cryptocurrency disclosures. For example, if a parent were a large holder of cryptocurrency and an avid trader, they — without a disclosure obligation — could simply claim the accounts under the name of their child and avoid the crypto disclosure question entirely. That is, obscurely reporting the capital gains from crypto activities on Form 8615 but shielding the accounts from disclosure. It is unlikely the IRS would find such a tactic amenable.
Unfortunately, a rhetorical question does not answer whether a parent must disclose their dependent child’s crypto accounts on Form 1040. Taxpayers are left guessing until more guidance is published or tax enforcement answers it. The idea that a parent would need to disclose the financial positions of a child is not a foreign one. Under the Bank Secrecy Act, minor children have a foreign bank account reporting, or FBAR, obligation if their foreign accounts meet certain thresholds. In that instance, if the child is unable to file the FBAR themself, the legal guardian or parent must file it for the child. If the Treasury Department expects disclosure assistance in one context, it is not difficult to see how they might expect it in another.
Income and voluntary disclosures are at the forefront of the IRS’s crypto tax initiative, and both are potentially implicated by the kiddie tax and the 1040 crypto disclosure question. Parents need to remember that they sign tax returns under penalties of perjury. These days, Johnny is doing more than mowing lawns for extra “coin” in his pocket.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Jason Morton practices law in North Carolina and Virginia and is a partner at Webb & Morton, PLLC. He is also a judge advocate in the Army National Guard. He focuses on tax defense and tax litigation (foreign and domestic), estate planning, business law, asset protection and the taxation of cryptocurrency. He studied blockchain at the University of California, Berkeley and studied law at the University of Dayton and George Washington University.