A survey conducted by CoinLedger of US crypto crypto investors found that only 58% of the sample size reported crypto holdings on their taxes in 2022. That was an improvement of 4% year-over-year. Meanwhile, 31% did not report (11% would not answer). Let’s look at the non-reporters: 50% said the primary reason was that they did not profit from trading; 18% said they did not know they had to report; 12% said they did not know how to report; 7% said they did not want to pay tax (haha); and 4% said they did not report tax because the Internal Revenue Service (IRS) does not know about their crypto holdings (oh really!!!).
Just a quick reminder for those who think the IRS does not know about crypto holdings. It is just a matter of time until it does! I’ve seen it all –disgruntled lovers, friends and associates turning into an IRS whistleblower; crypto firms going bankrupt and public listings of creditors including names of the investors who haven’t been tax compliant, the exchange turning over names to the IRS….
Meanwhile – IRS continues to educate taxpayers. Such agency efforts whittle away the defense that the taxpayer “did not know” of a duty to report or did not know how to report crypto. The latest agency action is detailed below.
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IRS News Release of January 24, 2023 (IRS News Release) is a small but subtle reminder that the IRS means business when it comes to “digital assets”. The reminder comes in the form of revisions to the most common tax forms used by individual taxpayers. Unlike in previous years, for tax year 2022, everyone who files Form 1040, Form 1040-SR, or Form 1040-NR must check one box, answering either “Yes” or “No” to the digital asset question. The question must be answered by all taxpayers – regardless of whether the taxpayer has engaged in a digital asset transaction during 2022.
Copied below are the questions from the Form 1040, page 1. Compare the wording for the tax year 2021 and 2022. Among other changes indicating the IRS is delving deeper for information, in earlier years the 1040 question asked about “virtual currency”; now the broader term, “digital assets.” is used.
2021
Form for the 2021 tax year: “At any time in 2021, did you receive, sell, exchange, or otherwise dispose of financial interest in any virtual currency?”
2022
Form for the 2022 tax year: “At any time during 2022, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, gift or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”
What is a Digital Asset for Purposes of this Tax Form Question?
The IRS News Release provides:
A digital asset is a digital representation of value recorded on a cryptographically secured, distributed ledger. Common digital assets include:
- Convertible virtual currency and cryptocurrency
- Stablecoins
- Non-fungible tokens (NFTs)
Note the IRS use of the words “common” and “include”! Don’t be fooled. Taxpayers and their advisors need to understand terminology and consider what else might possibly be considered a “digital asset” for tax purposes. There are many kinds of digital assets. A PowerPoint I create is a digital asset and it certainly has value, but it is not recorded on a cryptographically secured, distributed ledger and thus, does not need to be considered for purposes of the Form 1040 question! However, a “security token” is a digital asset that must be so considered. A security token is a tokenized version of something tangible or intangible such as stocks (equity) and bonds or tokenized versions of real-world assets (real estate, tangible property, machinery, plant, equipment and so on).
Central bank digital currencies (CBDCs) are another example. These are a type of digital asset that represents a nation’s fiat currency (e.g., yen, euros, pesos) and is backed by its central bank. CBDCs are digital assets but are different from digital assets such as Bitcoin or Ethereum which are decentralized (meaning their ledger of transactions is maintained and checked by a distributed network of validators). In the case of CBDCs, these are centralized (meaning they are controlled by central power, government or the country’s central bank. Not all nations issue CBDCs but over 100 countries are now seriously considering them. China, India, Nigeria and the Bahamas, have already rolled out CBDCs; Sweden and Japan are getting ready for the possibility. CBDCs can be used for payments and cross-border payments/ transfers.
Everyone Must Answer the Question!
Unlike previous tax years, the 2022 form requires that every taxpayer who files Form 1040, Form 1040-SR, or Form 1040-NR must check one box, answering either “Yes” or “No” to the digital asset question. So, the question must be answered even if the individual did not engage in any transactions involving digital assets in 2022. And remember, Form 1040 is signed under penalties of perjury. Think carefully before you check the box.
When to check “Yes” or “No”
The IRS News Release provides general guidance as to when a taxpayer must check the “Yes” box. A taxpayer will check “Yes” if they:
- Received digital assets as payment for property or services;
- Transferred digital assets for free (without receiving any consideration) as a bona fide gift;
- Received digital assets resulting from a reward or award;
- Received new digital assets resulting from mining, staking and similar activities;
- Received digital assets resulting from a hard fork (a branching of a cryptocurrency’s blockchain that splits a single cryptocurrency into two);
- Disposed of digital assets in exchange for property or services;
- Disposed of a digital asset in exchange or trade for another digital asset;
- Sold a digital asset; or
- Otherwise disposed of any other financial interest in a digital asset.
The IRS News Release provides general guidance as to when a taxpayer can check the “No” box. A taxpayer who merely owned digital assets during 2022 can usually check the “No” box provided the taxpayer did not engage in any transactions involving digital assets during the year. Checking “No” is appropriate if the taxpayer’s activities were limited to one or more of the following:
- Simply holding digital assets in a wallet or account;
- Transferring digital assets from one wallet or account owned or controlled by the taxpayer to another wallet or account that the taxpayer owns or controls; or
- Purchasing digital assets using US or other real currency, including through electronic platforms such as PayPal and Venmo.
Reporting Income Related to Digital Assets
Besides checking the “Yes” box, taxpayers must report on their tax return all income related to their digital asset transactions.
Taxable gain or loss may result from transactions including, but not limited to:
- Sale of a digital asset for fiat
- Exchange of a digital asset for property, goods, or services
- Exchange or trade of one digital asset for another digital asset
- Receipt of a digital asset as payment for goods or services
- Receipt of a new digital asset as a result of a hard fork
- Receipt of a new digital asset as a result of mining or staking activities
- Receipt of a digital asset as a result of an airdrop
- Any other disposition of a financial interest in a digital asset
- Receipt or transfer of a digital asset for free (without providing any consideration) that does not qualify as a bona fide gift
While not resulting in income, transferring a digital asset as a bona fide gift if the giver of the gift (donor) exceeds the annual gift exclusion amount (for 2022 USD16,000 per gift recipient) can result in gift tax liability to the donor.
Resources
Want more information? I have an entire blog post category that deals with Virtual Currency / Blockchain Digital Assets. Mine it….Dig in.
Posted Februrary 16, 2023
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