According to a major accounting association, the Internal Revenue Service could have a potential headache over your crypto investments and tax liability.
For two years, the IRS has been asking whether taxpayers have bought or sold cryptocurrencies in the main Form 1040 document that taxpayers file for their federal income taxes. The investigation also asks about other potential crypto-related tax events. It’s a “yes” or “no” question that the taxpayer cannot leave unanswered.
Last year’s Forms 1040 asked, “Have you received, sold, exchanged, or otherwise disposed of any financial interest in virtual currency?” (The wording differed slightly from the language that appeared on the Form 1040 the year before. The question appeared for the first time in tax year 2019 in Appendix 1.)
The prominent placement is a nod to the IRS’ increasing focus on ensuring that cryptocurrency investors fully comply with their tax obligations.
Fast forward to next year’s tax returns: The IRS has proposed a draft question that will query next year’s Form 1040: “Did you receive at any time in 2022: (a) (as a reward, award, or compensation); or (b) sell, trade, gift or otherwise dispose of a digital asset (or financial interest in a digital asset)?”
“For 2023, the IRS proposes to ask: “At any time in 2022, did you: (a) receive (as a reward, award, or compensation); or (b) sell, trade, give away or otherwise dispose of a digital asset (or financial interest in a digital asset)?”
However, after the IRS revealed the proposed wording of this question ahead of the 2023 tax season, the American Institute of CPAs recommended the tax agency get out their pencils and erasers. The tax agency needs to clarify the issue to avoid confusion among taxpayers, the organization said in its comment letter.
In general, capital gains taxes will apply to sales, coin exchanges, acquisition of cryptocurrency through mining, and other scenarios. But buying cryptocurrency and then just holding it did the trick Not counted as a chargeable event. For example, when jobs are paid for in cryptocurrency, they’re typically treated as payroll wages, the IRS says.
In some ways, the latest version of the question is an improvement, said Annette Nellen, a tax professor at San Jose State University who leads the AICPA’s virtual currency working group. But the inclusion of the phrase “‘digital asset’ will create new problems and new confusion,” she said.
Apart from cryptocurrencies like Bitcoin BTCUSD,
or Ethereum ETHE,
The use of a phrase like “digital asset” raised questions about whether the IRS was also asking about non-fungible tokens (NFTs) and in-game currencies like Fortnite’s V-Bucks or the Robux offered on Roblox RBLX.
The IRS previously removed V-Bucks and Robux from examples of virtual currency that can be converted into real money. However, creating, buying and selling NFTs can have tax implications.
“After the IRS unveiled proposed wording for a new digital asset question ahead of the 2023 tax season, the American Institute of CPAs recommended the tax agency get out their pencils and erasers. ”
So what’s the solution? The best approach would be to ask whether taxpayers had “a taxable virtual currency event” during the year and then refer to instructions on what that means, the AICPA said in its comment letter.
Those instructions, she added, should specify that an individual applicant need not check “yes” if their child or dependent had their own cryptocurrency-related tax events that generated income below filing thresholds.
The back-and-forth of wording tax documents might sound like dry semantics, but it underscores just how much is still being found out about cryptocurrency, taxes — and the public’s ongoing need to understand how the two interact.
The AICPA comment letter wants the IRS to stick with the term “virtual currency” rather than “digital asset” for now. But still, it notes, there are differences in the formal and informal definition of “virtual currency” by the IRS in its guidance and guidance.
One reason investors need to understand tax rules now is that it could help mitigate their losses somewhat in 2022. Investors can use capital losses to offset their gains. When losses exceed gains — and that could be the unfortunate case for some hard-hit cryptocurrency investors — a taxpayer can claim up to $3,000 in capital losses. Any remaining losses can be carried forward to future tax years.
“Investors can use capital losses to offset their gains. When losses exceed gains — and that could be the unfortunate case for some hard-hit cryptocurrency investors — a taxpayer can claim up to $3,000 in capital losses.”
was trading just above $20,000 on Thursday, down nearly 57% from where the year started. Ethereum ETHUSD,
is down more than 57% year to date.
According to an ongoing Morning Consult survey, nearly two in 10 US adults said they owned cryptocurrencies in August. The 18% in August is roughly on par with the start of the year.
Matt Metras of MDM Financial Services in Rochester, NY has a rosier view of the question the IRS is trying to ask. “It’s not perfect, but it’s better than last year,” said Metras, who specializes in tax preparation for cryptocurrency holders. “The use of digital assets is broader,” he said.
Despite this, Metras doesn’t know if there will ever be a crystal clear, concise, and perfectly articulated way for the IRS to query about cryptocurrency holdings. The landscape changes so quickly, he remarked.
The agency is considering “readability and the information to be collected” when adding new wording to tax forms, said Michael Kramarz, director of Kaufman Rossin’s tax advisory group.
“A taxpayer’s response to a request for information on a tax form is only as good as the question asked. If a taxpayer cannot understand the language on a tax form, the IRS is unable to collect the type and breadth of information desired,” said Kramarz, a former IRS attorney.
The IRS will consider comments from tax professionals and the public when it comes to wording tax documents, Kramarz noted. Here you can make comments.
Typically, final tax forms begin filing in November and December, Nellen said. The IRS declined to comment.
According to Metras, “there is a lot of public confusion about what is reportable and what is not” when it comes to cryptocurrency. As a result, “there are people out there who are looking into this and aren’t sure about the question.”
Now cryptocurrency owners and tax professionals will have to wait for the final formulation of the IRS. “How it ends is always a fun surprise,” Metras said.