Hedge funds engaged in the cryptocurrency market are having a difficult time evaluating their tax burden. With unclear IRS guidelines, many of these funds run the risk of incurring steep penalties from inaccurately filed returns.

No Consensus on Cryptocurrency Asset Classification

In recent times, cryptocurrency investment has ceased to be the exclusive preserve of retail investors as hedge funds have started leaping into the market. Between 2017 and 2018, the number of cryptocurrency hedge funds has increased considerably. In fact, it is estimated that more than 100 crypto hedge funds will be launched in 2018 alone.

However, the unclear nature of the tax laws has left many of these funds uncertain of their tax burden. In the interim, fund managers try to minimize liabilities. With the announcement by the IRS last month that they would beam their searchlight on the activities of institutional crypto investors, however, hedge funds might be running the risk of incurring tax penalties.

Commenting on the present situation, a North Carolina based tax attorney, Clay Littlefield, told Bloomberg:

There is still a lot of uncertainty about how the IRS will come down on virtual currency. There are some good arguments for why this analogy or that analogy should apply, but there’s not a lot there.

Most of the problem stems from the lack of consensus surrounding the classification of virtual currencies among financial regulators. The IRS classified them as property for tax purposes in 2014. However, the CFTC has deemed cryptos to be commodities. Many hedge funds are inclined to side with the CFTC’s classification since it opens up the possibility of certain tax advantages as long as the IRS agrees. In fact, some federal judges have issued rulings stating that virtual currencies should be considered as commodities.

IRS Promises a More Robust Cryptocurrency Tax Framework

For its part, the IRS has promised to develop a more robust cryptocurrency tax framework to alleviate many of the difficulties encountered by both institutional and retail investors alike. Speaking at a conference of tax professionals earlier in the year, Karl Walli of the U.S. Treasury Department said that the IRS wasn’t ignorant of the problems caused by the lack of clear guidelines. According to Walli:

There’s no way in this environment that we’re going to be able to put out guidance on the majority of those issues.

The question presently on the minds of many hedge funds is undoubtedly their level of exposure once more explicit tax laws are put in place. There exists the possibility of many funds owing huge taxes if their tax returns fall significantly short of the IRS metric. However, it is expected that the IRS would show some leniency, especially if the variance isn’t significant to warrant punitive measures.

What do you think about the lack of clear IRA guidelines for cryptocurrency tax reporting? Let us know your views in the comment section below.

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