The US Internal Revenue Service (IRS) released instructions to the draft 2020 Form 1040 on Oct 23rd. It may be recalled that a virtual currency question was introduced for the first time on the 2019 Form 1040 on Schedule 1. Not all taxpayers are required to complete Schedule 1. Now, the 2020 Form 1040 places the question smack dab on the front page of the Form so that all taxpayers must answer it.
The question: “At any time [during 2019] did you receive, sell, send, exchange, or otherwise acquire any financial interest in virtual currency?”. The question remains the same on the draft 2020 Form 1040, but some elucidation on the matter appears in the draft instructions.
According to the newly released draft 2020 Form 1040 instructions, taxpayers do not need to check “yes” for the virtual currency question, if they only held virtual currency in a wallet or account or transferred such currencies between wallets they owned or controlled during 2020. The relevant draft instructions are copied below (pages 15-16):
If, in 2020, you engaged in any transaction involving virtual currency, check the “Yes” box next to the question on virtual currency on page 1 of Form 1040 or 1040-SR.
A transaction involving virtual currency includes:
- The receipt or transfer of virtual currency for free (without providing any consideration), including from an airdrop or hard fork;
- An exchange of virtual currency for goods or services;
- A sale of virtual currency; and
- An exchange of virtual currency for other property, including for another virtual currency.
A transaction involving virtual currency does not include the holding of virtual currency in a wallet or account, or the transfer of virtual currency from one wallet or account you own or control to another that you own or control. If you disposed of any virtual currency that was held as a capital asset through a sale, exchange, or transfer, use Form 8949 to figure your capital gain or loss and report it on Schedule D (Form 1040).
If you received any virtual currency as compensation for services or disposed of any virtual currency that you held for sale to customers in a trade or business you must report the income as you would report other income of the same type (for example, W-2 wages on Form 1040 or 1040-SR, line 1, or inventory or services from Schedule C on Schedule !. For more information, go to https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions
Clarification Still Needed
While the instructions provide a certain amount of clarity, they are far from being comprehensive and I can see taxpayers in certain situations struggle with how to answer the question. Based on the draft instructions, for example, it appears to me that if a taxpayer holds virtual currency in accounts strictly as a nominee, but without any beneficial interest, he must still check “yes” to this question (assuming the taxpayer has engaged in transactions) since that taxpayer would literally meet the terms set out in the question. Some, however, may disagree with my view.
While the Form 1040 question uses the term “financial interest”, this term is not defined and thus open to much interpretation. If one looks to the Bank Secrecy Act (the notorious FBAR, Form 114) FBAR instructions, the term “financial interest” is clearly defined to cover a nominee situation:
Financial Interest. A United States person has a financial interest in a foreign financial account for which: 1. the United States person is the owner of record or holder of legal title, regardless of whether the account is maintained for the benefit of the United States person or for the benefit of another person;
What about the taxpayer who owns virtual currency through a pass-through entity such as a partnership, or who owns the majority shares in a corporation that engages in virtual currency transactions? Again, the FBAR instructions provide answers for FBAR filing on FinCEN Form 114, but we are still waiting for the IRS to provide clarification for the Form 1040.
Taxpayers should remember that virtual currency is one of the IRS “campaigns” and criminal investigations related to crypto already started last year. Taxpayers are being sent “educational” letters to remind them and warn them of their tax obligations when it comes to the use of cryptocurrency.
Speaking of FBARs, a quick reminder that taxpayers in declared disaster areas have until December 31 to file the 2019 FBAR (all others are late if the 2019 FBAR has not been filed). The latest news from FinCEN is that virtual currency held in an offshore account is not reportable on the FBAR. While this is good to know, the FBAR regulations may change and mandate FBAR reporting for such accounts in the future.
Posted December 10, 2020
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