How to Protect Your Crypto in an LLC

Crypto has generated a lot of attention from those who enjoy privacy. Crypto is decentralized, and you can keep your trades private. Yes, your wallet address is public on the blockchain, but the string of numbers and letters can not be used to identify the individual behind the funds.

The IRS is aware of all of this involving crypto. The IRS realized that early crypto investors were hoping the private nature may mean they won’t have to pay taxes or couldn’t be found. This is not the case.

In December 2016, the IRS issued a summons to Coinbase asking for records of over 500,000 customers that had traded crypto over the past few years. The initial stipulation was that Coinbase had to provide user details if a single transaction – deposit or withdrawal larger than $20,000. Now they are being looked at for selling unregistered securities.

The information they had to provide was:

• Taxpayer ID number
• Name
• Birthdate
• Address
• Transaction logs
• Periodic accounts statements

With this information, it’s clear that the IRS would be able to identify who owed them money and even how much in most cases.

More recently, crypto exchanges must issue 1099-K and 1099-B forms. If you have more than $20,000 in proceeds and 200 or more transactions on an exchange, the exchange must submit that information to the IRS.

Starting in the 2020 tax season, on schedule 1, every taxpayer has to answer a crypto-specific question – if during the year you have received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency.

In the role of asset protection, privacy is like icing on the cake. You first want to have solid asset protection, meaning an adequately structured LLC, and assign your crypto to the LLC, or open your exchange in the name of the LLC, operate the LLC as a separate legal entity, even if holding safe assets, and you will have a level of protection if you are sued personally. The creditors will be limited to a “charging order.”

If someone is going to bring a lawsuit against you first, they may do an asset search to determine which assets will appear in your name. Again, you can’t go on the blockchain and figure out who did what transactions unless you have someone’s public key.

If you don’t have a lot of assets in your name, including real estate businesses, you may be less likely to become a target. If privacy makes it harder to determine what you have in assets, that is a bonus. But don’t sacrifice privacy for asset protection.

California is experiencing a mass exit of residents moving to Nevada

It is not just to follow the Raiders but to get out of California’s oppression and crazy taxes. A Californian can sell their home and move to Las Vegas, in most cases, for ⅓ the price, plus have a bigger home.

If you formed a Nevada LLC in this situation and foreign qualified into California and later moved to Nevada, you would withdraw from California and continue to operate only out of Nevada.

Ethereum has recently banned users from certain countries, Venezuela and Iran. How is this possible to ban people from certain countries if Ethereum is decentralized? To connect to ETH, you need a wallet such as Metamask, and Metamask is a centralized company. Here is an overview and another reason to form a U.S. company to own some of your cryptos.

Decentralized is only strong as it’s the weakest link.

What about moving to hardware wallets for privacy?

It does not matter. If you use a ‘dapp*” like Uniswap, you will still be in centralized control of Infura**unless you host a full ETH node yourself. Hosting a full ETH node requires you to hold a lot of ETH, which is not practical. The only option is a centralized service like Infura or Alchemy, which hosts them on AWS.

If you are not in a sanctioned country, you are safe. Remember, Metamask can blacklist your wallet if the government wants them to.

In the end, there is not a best-decentralized wallet to replace Metamask. Accept that ETH is centralized from the standpoint that the tooling built around Ethereum is highly centralized. In other words, you can’t use ETH without the tooling around it.

Another way of saying this is that ETH is only as decentralized as its weakest link. For example, you can actually use ETH through Metamask or Uniswap, and everything else uses Infura.

Can you use a hard wallet to bypass this issue? Yes, but all the dapps* (such as Uniswap and Opensea) use Alchemy/Infura, and they can still block you.

*Decentralized applications—also known as “dApps” or “dapps”—are digital applications that run on a blockchain network of computers instead of relying on a single computer.

**Infura provides the tools and infrastructure that allow developers to easily take their blockchain application from testing to scaled deployment – with simple, reliable access to Ethereum and IPFS.

As seen in the IRS virtual currency guidance, the following are all considered taxable events for cryptocurrency:

• Trading crypto to fiat currency like the US dollar
• Trading one crypto for another cryptocurrency
• Spending crypto to purchase goods or services (becoming more popular).
• Earning crypto as income

The tax code allows you to use any amount of your short-term capital loss to offset capital gains for the year.

First, you must offset any other short-term capital gains. If you still have short-term capital losses, you can use the excess to offset long-term capital gains.

Only after you’ve offset all of your other capital gains can you use any of your short-term capital losses to offset ordinary income.

Capital Loss Offsetting Ordinary Income

 

Unlike the unlimited ability to offset capital gains, if your short-term capital loss exceeds all of your capital gains, you’re limited as to how much of your ordinary income you can offset, depending on your filing status.

If your short-term capital losses exceed the limit for your filing status, you can carry forward the excess losses into future years when you can use them.

• Form 8949 & Schedule D – to report the sale of crypto assets, crypto futures income, crypto options income & crypto perpetual swap income.
• Schedule 1 – to report income from airdrops, forks, crypto wages, and hobby income.
• Schedule A – to report crypto donations. If your deduction is more than $500, you will have to complete Form 8283 as well.
• Schedule B – to report DeFi income, crypto interest income, and staking income.
• Schedule C – to report crypto mining income and business income earned in crypto.
• Schedule E – used as another option to report staking income.
• Form 8275 – to report additional disclosures (Optional).

W‍hen Don’t You Owe Taxes on Your Crypto? 

You do NOT trigger a taxable event when you:

1. Buy and hold crypto, also called HODL (When you sell, trade, or dispose of the coin, it is when you realize a capital gain or loss). 
2. Transfer crypto from one wallet you own to another wallet you own. That is similar to transferring stock from an E-trade account to a TD Ameritrade account. In the end, you still own the same crypto. 

To calculate your capital gains and losses from each of your crypto sells, trades, or disposals, you simply apply the formula:

Fair Market Value – Cost Basis = Capital Gain/Loss

Fair Market Value

Fair Market Value is simply the price an asset would sell for on the open market. In the case of cryptocurrency, this is typically the sale price in USD terms.

Cost Basis

Cost Basis represents how much money you put into purchasing your property.

Cost basis includes the purchase price plus all other costs associated with purchasing your cryptocurrency (fees, etc)? The same process, but more transactions are involved.

To determine the order in which you sell various cryptocurrencies, accountants use specific costing methods like First-In-First-Out (FIFO) and specific identification method (the IRS did not include LIFO as a permissible method). 

Here is a summary of the 5 steps to file your cryptocurrency taxes:

1. Calculate your crypto gains and losses
2. Complete IRS Form 8949
3. Include your totals from 8949 on Form Schedule D
4. Include any crypto income on Schedule 1 (or Schedule C if you are engaging in crypto taxes as self-employed)
5. Complete the rest of your tax return

Crypto income should be reported in one of two ways: either as personal income or as self-employment income.

The IRS mainly relies upon the 1099 reporting system to track accurately reporting your crypto transactions on your taxes.

Major exchanges report specific customer activity to the IRS using form 1099-K and/or other related 1099s.

These 1099’s all served the same general purpose: to report non-employment-related income to the IRS.

Both you and the IRS get sent copies of these forms at year-end. Your copy should go to your accountant to tell them what should go on your taxes.

If the IRS receives 1099 from your crypto exchange but sees no cryptocurrency income reported on your taxes, your account will be flagged, and an automated CP2000 letter will be sent alerting you of your non-reported income and tax liability. The IRS started sending out over 10,000 cryptocurrency holders, alerting them that they may not have correctly reported their crypto holdings on their tax returns in the spring of 2021. The CP2000 letter is more severe than the 6174 and 6174-A crypto letters.

The CP2000 letter will give you a proposed amount due in taxes. If you receive one, we recommend you reach out to your accountant (or us for a recommendation) to make sure you pay the correct amount.

Not reporting your cryptocurrency gains, losses, and income on your taxes INTENTIALLY is considered TAX FRAUD!  

IRS PENALTIES: The IRS can enforce several penalties for tax fraud, including criminal prosecution, five years in prison, along a fine of up to $250,000.

As you know, the IRS has aggressively been cracking down on cryptocurrency tax compliance.

As this asset class grows, you will likely see more audits and criminal tax prosecutions, which is how the IRS quickly gets taxpayers to conform.