The 2022 crypto price crash understandably has some investors worried. But for those of you who haven’t been running for the hills, it’s worth knowing that cryptocurrency currently has the attention of not only the Biden administration and Congress, but also the IRS. In crypto news and taxes, the IRS recently proposed changes to the cryptocurrency tax reporting question on the Form 1040. The agency will also receive $80 billion from the Inflation Reduction Act, some of which will be directed toward digital assets -enforcement – including cryptocurrency tax compliance.
Additionally, you may have heard that the IRS continues to successfully obtain court orders to require cryptocurrency brokers and exchanges to provide information to the IRS. That information pertains to investors who have failed to report and pay taxes on cryptocurrency transactions.
And while this IRS enforcement focus isn’t new, recent crypto announcements and developments from Congress, the Biden administration, and the IRS mean it’s important to stay current on crypto tax reporting and compliance. So, here’s some information to get you started.
How crypto is taxed
A common question about cryptocurrency is about how crypto is taxed. The answer is that cryptocurrency is considered property, so it is taxed by the IRS in the same way that other capital assets are taxed. As a result, when you sell or trade crypto, you may have asset losses and potential taxable gains, depending on the fair market value of the virtual currency, and your basis in the crypto.
Given this, it is important to remember that payments made with virtual currency are subject to IRS information reporting. For federal tax purposes, this initially means that all taxpayers are supposed to provide a yes or no answer to a virtual currency question at the top of the Form 1040.
For 2021, the check-the-box question asked, “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”
You can answer “no” if you “only own” crypto, ie the cryptocurrency was in your own wallet or account or was transferred between your own wallets or accounts. You can also answer no to the virtual currency question if you bought your crypto with real currency.
You were supposed to answer “yes” to the virtual currency question if you received cryptocurrency as payment for goods or services. A yes answer will also be required if you received or transferred crypto for free (but did not receive it as a gift). Other reasons to answer yes include receiving new crypto as a result of mining and staking or as a result of a hard fork, or if you exchanged virtual currency for property, goods or services, or for another virtual currency .
Proposed amendments to cryptocurrency tax reporting
Recently, however, the IRS proposed a change to the virtual currency question. On the 2022 draft Form 1040, the proposed question reads: “At any time during 2022, did you: (a) receive (as a reward, award, or compensation); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”
This could be a sign that the IRS is interested in whether you received or sent crypto as a gift. Or it could indicate a focus on other digital assets such as NFTs.
For 2021, when the IRS do not have ask about cryptocurrency received as a gift, the gift tax allowance was $15,000. So, a gift of cryptocurrency below that amount was not subject to tax. For 2022, the gift tax allowance is $16,000, so a crypto gift below that amount will similarly not be taxable. But keep in mind that if you were to sell or transfer the cryptocurrency you receive, it may be subject to capital gains tax later on.
Final instructions for the 2022 Form 1040 should be coming from the IRS soon.
Is Cryptocurrency Reportable to the IRS?
The IRS is emphasizing the longstanding requirement that taxpayers maintain records that determine the positions they take on their tax returns. This means that with cryptocurrency you need to keep accurate and detailed records. Records must show any sale, exchange or disposition of your cryptocurrency or other digital assets and show the fair market value of the assets.
And as mentioned earlier, the IRS has repeatedly taken legal action through court orders (ie so-called John Doe subpoenas), to require cryptocurrency brokers to provide information about clients involved in cryptocurrency transactions. One recent subpoena involves clients of SFOX, a cryptocurrency prime broker.
These subpoenas are due in part to the IRS’s focus on closing the tax gap (ie, the difference between what taxpayers owe and what they actually pay). The agency said that significant problems with tax compliance are related to cryptocurrencies and other digital assets.
On the legislative front, the Bipartisan Infrastructure Act, enacted earlier this year, requires cryptocurrency brokers to report more information about client trading activity. The requirement, opposed by some lawmakers and some in the crypto industry, began in 2023. However, a bipartisan group of senators recently proposed legislation to further clarify the definition of broker in the Infrastructure Act. If approved, that proposed legislation would essentially exempt digital asset mining and wallet providers, and software developers, from the information reporting requirements intended for cryptocurrency brokers.
The Inflation Reduction Act and Crypto
The newly proposed question about virtual currency and increased focus on digital assets comes as the IRS is set to receive $80 billion under the Inflation Reduction Act – massive climate, energy, tax and health care legislation signed into law by President Biden on August 16 . About $46 billion of the IRS funding from the new law has been designated for enforcement. And while enforcement will include a range of activities, the Inflation Reduction Act states that IRS funds can be used for digital asset enforcement — including cryptocurrency tax compliance.
Biden’s Cryptocurrency Framework: Also in recent crypto news, President Biden released a comprehensive digital asset framework on September 16. The framework follows Biden’s March 9 Executive Order calling for a whole-of-government approach to address risks associated with digital assets, including cryptocurrency. Biden’s digital asset regulation framework points to the instability of crypto — and the 2022 multi-trillion dollar crypto crash — as reasons for increased scrutiny and enforcement of digital assets.
All of these developments mean that significant resources and attention continue to be devoted to cryptocurrency tax enforcement. Accordingly, as a crypto investor, you will need to remain diligent and accurate with your tax reporting and compliance. Also stay up to date on digital asset enforcement and related crypto news from Congress and the Biden administration.