How to Tame & Untangle your Crypto Tax and Accounting Activity on Ethereum by Mackenzie Patel

all right hi everyone thanks for joining me uh this early in the morning really excited to be here and chat about how to tame and untangle your crypto tax and accounting activity on ethereum okay first here's our agenda I'll give you a quick intro to myself and my company hash faces then we'll talk about some first principles of crypto tax and accounting finally we'll dive into my favorite part which is going through all the different activity on ethereum mostly the most popular ones and then finally I'll go into how to set up a crypto cell Ledger all right but first off hi everyone I'm Mackenzie Patel I'm the CEO and partner of hash basis your crypto native accounting firm I got my start in crypto accounting by working at figment which is a purpose Tech validator on over 60 different blockchains prior to that I was doing Revenue accounting at Honeywell and before that I was studying accounting at the University of Florida and so my business partner Courtney who is also there and we work together at figment we wanted to bring our accounting and tax skills as it applies to crypto to the broader ecosystem because we noticed that there was a general lack of accountants in this area all right but first I just want to touch base on some first principles of crypto tax and accounting and this is not Financial advice so disclaimer okay so the way this presentation is structured is I split it between the tax treatment and then the accounting treatment for whatever ethereum activity I'm talking about so just want to give a primer um so let's start off with the tax side so tax code is governed by the IRC Internal Revenue code basically the IRS puts out this code and tells you how to tax certain transactions and so the most important thing to know about how crypto is taxed is that crypto is actually treated as property so if you think of your house or an apartment building which is also property the same rules that apply to that also apply to crypto which I find to be interesting because you know an apartment building is physical property and so any income that applies to your digital assets is either characterized as ordinary or as capital income and so you might hear in tax lingo is called the character of income that's just what's referring to ordinary capital and so in a really important related concept is cost basis you probably have heard that a lot in the context of crypto and so cost basis basically just means what's the price at which you first originally acquired your digital asset now on the not so fun part we have some taxable events here and so the most basic one is basically just any sense of crypto not in the ones that are non-taxable we're going to exclude those for a minute but basically any sends a crypto so if you're sending it for like interest expense or sending to pay for a contractor basically any send is going to be taxable and give rise to a capital gain or a capital loss down beneath that we have any trading swapping exchanging they're all kind of synonymous I mean the same thing but any trades let's say I'm trading like rat Bitcoin for rap ease that's an exchange that is taxable and that is capital gain or Capital loss now on the income side we have mining or staking income so let's say you run an East validator on the beacon chain and you're earning staking rewards that is treated as ordinary income and is taxable and then finally any airdrops air drops or Forks so that ens airdrop everybody got like a few years ago that was taxable as ordinary income and now let's move on some more fun stuff which is the non-taxable event so anytime you buy crypto through an exchange that's non-taxable but the caveat there is they have to pay with Fiat so let's say I take my bank account I hook it up to coinbase I buy some eth that's actually non-taxable which is great and then also donating that's a fun one so if you donate crypto it's non-taxable there's a lot of different caveats to that so you could donate to a 501c3 registered charity in order for it to count and there's also phase outs and limitations another note on that is that there's only really a tax advantage if you itemize your deductions if you take the standard then donating doesn't really apply as much any internal transfer so if I'm if I got crypto I've got some eth in my Med Mass I'm transferring it over to a ledger that is non-taxable just think of you know transferring money between two bank accounts and then also gifting is on taxable which I think is pretty cool so you can gift up to 16 000 per person per year and it's not taxable so if I'm gonna give my mom some eth up to 16k I can just do that and it's non-taxable and so you'll also probably hear the term holding period a lot as it applies to crypto and so basically that means let's take long term so if you hold your crypto for longer than a year and let's say you sell it there's a capital gain you're actually eligible for capital gains rates and they're called more preferential rates and they're either taxed at 0 15 or 20 contracts out to crypto you hold for short term so less than a year any income is going to be taxed at ordinary rates and when I say ordinary just like think of those tax brackets that your normal W-2 income is taxed at they just tend to be a little bit higher than your preferential rates okay so that's the tax side I want to hop over to the accounting side real quick and so accounting rules are governed by U.S Gap stands for generally accepted accounting principles basically it's the rules that accountants have to follow and this more applies to entities so like public companies are going to follow U.S Gap in the U.S so under us gaap digital assets are actually treated as intangible assets so think of like intellectual property or Goodwill any sort of branding basically assets you can't really touch those are intangible assets and under U.S Gap digital assets are treated as intangibles now the kicker there is that intangibles under us Gap are subject to impairment tests at least once a year and basically that means that you have to always write your crypto assets down to the lowest price that they were basically ever in the time that you held them so let's say you bought some ease at a thousand dollars the cost basis is at 100 but the price tumbles to like 600 and then like 400 and then 200.

you basically have to write your assets down all the way to 200 recognized impairments expense and you can't ever write that back up now U.S gaap will likely change with regards to that they call it a fair value treatment this year so that is changing um but that's right now what the rules are and I just want to touch base real quick on like assigning cost basis methods so you might have heard of lifo or fifo or hifo spec ID there's a bunch of them but it's just a way to assign a unit of cost basis to your digital assets that are leaving and just note that that applies to both tax and gaap okay so enough of that lecture um I want to get into more of some fun stuff so basically I'm giving a high level overview of some of the most popular activity on ethereum and what the tax implications are and then what the accounting implications are so we're going to start off pretty simple and I call this like easy activity and so I'm going to start with simple sense and simple receives and so a simple send I'm just sending crypto the example I have here is that I'm sending usdc to a contractor let's say that she performs some developer services for me and so under the tax side there's this is going to give a rise to some capital gain or loss because I'm sending crypto which is taxable and so on the tax side you really have to break it down between two different pieces so the first one is called fair market fair market value FMV for short basically what's the current value of the crypto that you're sending so amount of crypto you're sending times the current price and then you look at what's the cost basis of this crypto so what price did you originally acquire this crypto ad and chances are they're going to be different so you take your current price which is fair market value minus the cost basis which is like the original price and that difference is going to be a capital gain or loss now with stable coins there likely won't be a lot of gains or losses because it theoretically should be picked to the dollar but if you have a non-stable coin like flow or near or something there might be like dramatic fluctuations in that and you might have a pretty large capital gain or loss which is taxable on the accounting side I just have a bunch of journal entries because I I think in journal entries and so if you send something that's going to give rise to an expense so debit expense and then I'm disposing of some assets some crypto assets so crediting them at the cost basis and then again that difference is going to be gain or loss now on the flip side of that we have SIMPLE receives so let's say I'm not developer I'm getting my usdc back and so that's actually ordinary income to me because I performed a service and I'm getting paid for it and so it's just ordinary income at the fair market value so the current price at the time that I received it and then the journal entry is just increasing digital assets and I'm increasing income now a little bit more complicated than this is rapping and bridging so an example of wrapping let's say I've got some Bitcoin on the Bitcoin blockchain and I want to move it over to ethereum I can deposit it into a contract and then I get wbtc or wrapped Bitcoin back that's wrapping example of bridging um have Axl usdc up here that's a stable coin on the axelr network I can actually bridge that over to ethereum and have my stable coin on ethereum and they act very very similarly and so under the more conservative view um this is actually considered a trade which would give rise to a capital gain or loss because I'm putting one asset in let's say Bitcoin I'm getting another asset back rat Bitcoin that that's an exchange and that is taxable now again that's more conservative there's a lot of gray areas around this per the IRC so you know you could always take a more aggressive position but that's more conservative one and on the accounting side we just have the journal entry for that okay so a step up um in in levels of complication is dex's so I'm going to use uniswap as an example here and I'm specifically talking about any swapping or trading activity so I have an example because I thought that would be more fun um so we have crypto Punk Courtney she has five eth and they're worth five thousand dollars and so the fair market value is a thousand dollars per eat but she originally bought the tokens when each was 200 so our cost bases and each of the eighth is 200 and then no fees occurred incurred on the original purchase now let's say Courtney was a swap for eth on uniswap for 10 000 GRT or graph tokens and it costs .01 each to execute the swap now what does this look like from attacks and accounting perspective so you on the tax side you want to break it down so on the first side you think about what's the fair market value like what's the current price of this trade that's going on and so I break it down into first proceeds from sale and so we sold four e's for a thousand dollars each which is the current price and so the current proceeds from the east four thousand dollars now the cool part about crypto tax is that you can actually take the gas fee that was incurred and add it to the overall fair market value of the trade and so fair market value the gas fee is just .01 East times ten thousand dollars and so your gas fee the current price is ten dollars and so basically what happens is that the cost basis of the new assets that were acquired so the cost basis of the GRT is basically the fair value of the eth that was disposed and so now we have the cost basis of GRT four thousand and ten dollars which is just the four thousand plus ten so okay that's the fair market value side of it now we have to look at okay what's the cost basis of the digital assets that I disposed of and So Courtney um she bought it when it was 200 so my cost base is four eth times two hundred dollars equals eight hundred dollars that's my cost basis now where the gain comes into play here I take the fair market value which is at 4010 minus the cost basis of 800 and that's our gain three thousand two ten taxable at capital gains rates so that's how it works on the tax side the accounting side is pretty much the same I just have it in journal entry format okay so interest of time gonna go ahead and skip that but I really want to get into liquidity providing because I think it's really interesting and I'm using Sushi swap as an example here and so I basically broke down the different steps of liquidity providing just because it makes it easier to identify from attacks an accounting perspective okay so step one I'm depositing a pair of assets into a pool and then I'm receiving an LP token back in exchange and take note of that phrasing I just used now step three because I'm a d-gen I want to earn more rewards I'm going to stake my LP token and that's going to accrue some rewards maybe it's a governance token based on earning more tokens and then step five I'm done with this I want to unwind I want to exit my position I'm going to unstake my LP token and receive my original pair back but let's take a look at an example and so bit wave actually had a very great article about this um they have a really cool D5 treatment where you can actually categorize all this stuff like right within their UI and so the first one I have up here let me zoom in a little bit um this is us actually entering the pool and so I'm putting in a rap Bitcoin in a wrapped each pair and I'm getting an LP token back and Sushi swap they called an SLP token and so this could be viewed as a trade right because I'm putting two tokens in I'm getting one token back could be viewed as an exchange taxable gains um this is a more conservative view by the way okay so that's step one now step two I'm staking my SLP or my LP token and you can see that's an outflow step three I'm uh earning Sushi rewards because I'm yield farming right now basically and so I've unstaked my SLP token at the same time I've gotten some sushi rewards cool thing about bit wave is that you can actually categorize your sushi rewards immediately within the UI basically the rule of thumb is that anytime you're earning new tokens or any sort of liquidity providing they're like LP rewards those are taxable as ordinary income and I can just call it income income call the sushi income right in the UI all right and then the next part this is me unwinding my position so I'm putting my SLP token back in I'm getting my original pair back again this could be viewed as a trade right because I'm putting one token in getting a new token back so capital gains applies and so this isn't really great from a tax perspective because let's say you have a really low cost basis of the assets you're putting in that could be a really big gain or loss um that you've got there and so there is a more aggressive position you could take which is saying when you enter an exit a pool that's not actually taxable but what you have to do then is basically measure all the like gains and losses that are happening in the pool at the time your position is active and so you're basically recognizing mini gains or losses against people trading on your tokens that you've staked and so that's fine it's just really complicated to track because a lot of these dexes like don't provide great reporting and so if you can swing it great but it's just really hard from a reporting perspective all right so hopefully I didn't totally lose everyone um with that but I want to jump into protocol and look what's taking because of course that's very relevant for ethereum with the merge and everything like that so protocol staking let's say that I'm running an eat validator and I send 32 East into the beacon deposit contract good news is that that's actually not taxable it's more of an internal transfer because I'm not getting another token back right I'm just putting 32 eth into the contract I I own that eat I can't really access it but it's mine so that's great non-taxable but since I'm a validator and I'm validating transactions I am earning staking rewards and so that is taxable as ordinary income liquid staking is kind of same thing think of like a protocol like Lido or something like that but the only difference is that when you stake your eth you're getting another token back you're getting the St ether staked eth and again that could be an exchange a trade which is taxable capital gains um so just something to note there so again the treating staking rewards as ordinary income is the more aggressive position or the more conservative position but there is a more aggressive position with says staking rewards are not taxable upon receipt they're more taxable upon disposition and you're basically saying staking rewards are more akin to a stock split but depends on your risk appetite okay it's gonna skip nfts but just real quick wanted to go into setting up a crypto sub Ledger and when I say sub Ledger it's a giant database basically where you're plugging in all your different crypto activity and there's a lot out there it can be very overwhelming um so tldr there's a lot of options but choose a self-ledger that fix your activity the most and so you really need to evaluate like what different networks am I on am I just on eath but am I also unlike polygon am I also on like flow Cosmos chains because each of these sub ledgers supports different networks and also what's my activity am I mainly doing defy am I a validator am I nfts like what are you actually doing because I find each of these different sub ledgers has different strengths and you really need to evaluate holistically like what are you doing to see which subledger best applies to you okay so real quick just wanted to get into the quick and dirty guide is setting up a sub Ledger so step one um where the gleaming arrow is you want to import all of your data into the sub ledger so I mean all of your wallets all of your exchange activity um any custodians you're on basically put everything into this database step two is cleaning and verifying this data I have an explosion because this is such a long like laborious process and it takes forever let's say you're on a chain that's had like multiple upgrades then it's like well and like the first chain or the first version doesn't actually have any data then how are you going to find that okay so I have to get off stage now but I am so happy to be here today scan is QR code um you can find out more about hash basis and how we can help you with your crypto tax and accounting and the slides are also posted on our website um so thanks so much everyone thank you