The recent crypto crash understandably had some investors concerned. But for those who haven’t run for the hills, it’s worth knowing that cryptocurrency currently has the attention of the Biden administration, Congress, and the IRS. In terms of crypto news and taxes, the IRS proposed changes to the cryptocurrency tax reporting question on Form 1040. The agency now will also get a little less than $80 billion from the Inflation Reduction Act, but some of those funds will likely be directed to digital asset 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 concerns investors who 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 that it’s important to stay up-to-date on crypto tax reporting and compliance. So, here’s some information to get you started.
How Crypto is Taxed
A common question about cryptocurrency concerns how crypto is taxed. The answer is that cryptocurrency is considered property, so it’s taxed by the IRS in the same way that other capital assets are taxed. As a result, when you sell or trade crypto, you can have asset losses and potential taxable capital gains depending on the fair market value of the virtual currency, and your basis in the crypto.
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Given that, it’s important to remember that payments made using virtual currency are subject to IRS information reporting. For federal tax purposes that initially means that all taxpayers are supposed to provide a yes or no response to a virtual currency question on the top of Form 1040.
Previously, 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 could answer “no” if you “merely owned” crypto, i.e., the cryptocurrency was in your own wallet or account or was transferred between your own wallets or accounts. You could also answer no to the virtual currency question if you purchased your crypto with real currency.
- You were supposed to respond “yes” to the virtual currency question if you received cryptocurrency as a payment for goods or services.
- A yes answer would also be required if you received or transferred crypto for free (but didn’t receive it as a gift).
- Other reasons to answer yes included receiving new crypto due to mining and staking, because of a hard fork, or if you exchanged virtual currency for property, goods, services, or another virtual currency.
Cryptocurrency Tax Reporting Changes
Recently however the IRS changed the virtual currency question. On Form 1040 for the 2022 tax year, the digital asset 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)?"
That could be a signal that the IRS is interested in whether you’ve received or sent crypto as a gift. Or it could indicate a focus on other digital assets like NFTs.
When the IRS didn’t ask about cryptocurrency received as a gift, the gift tax allowance was $15,000. So, a gift of cryptocurrency under that amount wasn't subject to tax. For the 2022 tax year, the gift tax allowance was $16,000, so a crypto gift under that amount similarly wouldn’t be taxable.
But keep in mind that if you were to sell or transfer the cryptocurrency that you received, it could later be subject to capital gains tax.
Is Cryptocurrency Reported to the IRS?
The IRS stresses the long-standing requirement that taxpayers maintain records that establish the positions they take on their tax returns. That means that with cryptocurrency, you should keep accurate and detailed records. Records should show any sales, exchanges, 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 (i.e., so-called John Doe summonses), to require cryptocurrency brokers to provide information about customers engaged in cryptocurrency transactions. One recent summons involves customers of SFOX, a cryptocurrency prime broker.
These summonses are due in part to the IRS’s focus on closing the tax gap (i.e., the difference between what taxpayers owe and what they actually pay). The agency has said that significant problems with tax compliance relate to cryptocurrencies and other digital assets.
On the legislative front, the Bipartisan Infrastructure Law, enacted last year, requires cryptocurrency brokers to report more information on clients’ trading activity. The requirement, opposed by some lawmakers and some in the crypto industry, begins in 2023.
However, a bipartisan group of Senators has recently proposed legislation to further clarify the definition of broker in the Infrastructure Law. If passed, 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 revised virtual currency question and stepped-up focus on digital assets come as the IRS is set to receive close to $80 billion in funding under the Inflation Reduction Act —massive climate, energy, tax, and healthcare legislation that was signed by President Biden last year. Though the debt ceiling agreement has reduced the amount of funding, previously about $46 billion of the IRS funding was designated for enforcement. And while enforcement will include a range of activities, the IRA mentions that IRS funding could 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. The framework follows Biden’s 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 last year's multi-trillion-dollar crypto crash — as reasons for increased scrutiny and enforcement of digital assets.
All these developments mean that significant resources and attention continue to be paid to cryptocurrency tax enforcement. Consequently, as a crypto investor, you’ll need to remain diligent and be accurate with your tax reporting and compliance. Also, stay tuned to digital asset enforcement and related crypto news from Congress and the Biden administration.
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