Will PayPal’s crypto offer turn into a tax nightmare?

The news that payments company PayPal will support cryptocurrencies has given the industry a major boost — but there are tax implications that are little understood by crypto noobs.

PayPal users will soon be able to use digital assets as a funding source for purchases at its 26 million merchants worldwide. The company has almost 350 million active users worldwide and Alex Mashinsky, the CEO of crypto lending platform Celsius, has predicted the integration could result in “millions of new users” getting into crypto.

Unfortunately, they could face a tax nightmare arising from the volatile nature of crypto assets and the tax reporting requirements.

According to the Internal Revenue Service (IRS), digital assets such as Bitcoin are treated like property, not currencies. This means that every time you sell, exchange or dispose of a cryptocurrency to buy something else, that becomes a taxable event. PayPal’s press release states that it will be acting as an exchange in addition to a payments gateway;

“Consumers will be able to instantly convert their selected cryptocurrency balance to fiat currency, with certainty of value and no incremental fees.”

However, it will not allow cryptocurrencies to be taken off the platform and sent to a bank, or back to the wallet from which they came. Selling crypto within PayPal triggers a taxable event as does using the crypto to buy anything, as PayPal converts the funds into fiat first before paying the merchant.

Because Bitcoin and crypto assets are volatile, users will be liable for significant capital gains tax   on the amount the asset has gained between the time it was acquired and spent.

That’s not a problem as long as users keep records and put tax aside — but most new users are unlikely to understand the tax implications and requirements. Gains and losses ultimately need to be reported on IRS Form 8949 and submitted with your tax return each year, according to Cryptotrader.tax.

It used an example of buying a new TV from one of PayPal's merchants using 0.1 BTC as payment. The consumer would incur a capital gain (or loss) depending on the value change of that 0.1 BTC since they first purchased or acquired it. Let's say the 0.1 is now worth $1000 more than when you bought it:

"You must report this gain on your tax return, and depending on what tax bracket you fall under, you pay a certain percentage of tax on the gain"

PayPal explained that it will be participating in relevant 1099 tax information reporting for users, but said that individuals are responsible for their own tax affairs:

“It is your responsibility to determine what taxes, if any, apply to transactions you make using your Cryptocurrencies Hub. You can access your transaction history and account statements through your PayPal account for purposes of determining any required tax filings or payments”. 

It is likely that the U.S. tax authorities will request access to user account information to see which users should be reporting gains.

Initially, PayPal will only offer its new crypto payments services to U.S. account holders, but it could be rolled out globally next year.

The U.K. also has similar capital gains tax implications and HMRC (Her Majesty's Revenue and Customs) began actively chasing crypto traders in late 2019. Australian cryptocurrency traders and investors are also subject to capital gains taxes and even income tax if they earn digital assets. Reporting is required in both countries.