Opinion: Unveiling the Essential Information on the IRS’s Cryptocurrency Query in Tax Forms
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The issue of crypto investors and tax compliance has been a hot topic of discussion lately, but a seemingly simple yes or no question can actually have significant implications. The IRS is now asking everyone about their crypto transactions, and this question appears on various tax forms such as Forms 1040, 1040-SR, 1040-NR, 1041, 1065, 1120, and 1120S. The wording of the question was updated for the 2023 returns. Additionally, the question was added to other forms related to corporations, partnerships, estates, and trusts.
When the IRS refers to a digital asset, they mean “a digital representation of value recorded on a cryptographically secured distributed ledger or similar technology.” For federal income tax purposes, any asset that possesses the characteristics of a digital asset is treated as one. Examples of digital assets include convertible virtual currency, cryptocurrency, stablecoins, and Non-Fungible Tokens (NFTs).
It is important to note that you should not leave this question blank. All individuals filing the aforementioned forms must select either “Yes” or “No” and report all income related to digital asset transactions. If you held a digital asset as a capital asset and sold, exchanged, or transferred it in 2023, you must use Form 8949 to calculate your capital gain or loss and report it on Schedule D (Form 1040), which deals with capital gains and losses. If you gifted a digital asset, you may also be required to file Form 709, which is the United States Gift (and Generation-Skipping Transfer) Tax Return.
So, does this yes or no question really matter? While it may not ask for specific numbers or details, it does have implications for your tax return. Since the IRS classified crypto as property a decade ago, any sale of crypto should result in a capital gain or loss. One might speculate that the IRS is simply gathering information about who is using crypto, but it is not that simple. A simple yes or no answer can be significant.
This question is reminiscent of the foreign account question found on Schedule B to Form 1040. Answering this question incorrectly can lead to hefty penalties or even perjury charges. If you answer “no” and it is later discovered that you engaged in cryptocurrency transactions during the year, your explicit “no” answer (under penalties of perjury) can be used against you.
We have seen this scenario play out with foreign bank accounts. In that context, the Department of Justice Tax Division successfully argued that the failure to check a box related to foreign account reporting is automatically considered willful. Willful failures carry higher penalties and a greater risk of criminal investigation. The IRS’s Criminal Investigation Division has collaborated with tax authorities from other countries to share data and enforcement strategies in order to identify potential instances of cryptocurrency tax evasion.
One might think that the safest option is to answer “yes” to the question. However, what if you are unsure whether you can accurately say that you are the one who conducted the transactions? What if you are acting on behalf of your company rather than personally? Or, in a less formal scenario, what if you have “signature authority” over crypto owned by your less technologically savvy parents or relatives? In such cases, you may assist them in managing their crypto.
If you sell your parent’s crypto on their behalf, at their request, and/or for their benefit, should you answer “yes” or “no” to the question? Should you attach an explanatory statement to the return explaining your relationship to the virtual currency? There may not be perfect answers to these questions. The IRS has stated that you have a financial interest in a digital asset if you are the owner of the record of a digital asset, have an ownership stake in an account that holds digital assets, or own a wallet that holds digital assets.
However, the IRS has provided some guidance on actions or transactions in 2023 that generally do not require you to answer “yes”:
– Holding a digital asset in a wallet or account.
– Transferring a digital asset from one wallet or account you own or control to another wallet or account that you own or control.
– Purchasing digital assets using U.S. or other real currency, including through electronic platforms like PayPal and Venmo.
The IRS advises against leaving the question unanswered and urges individuals to select either “Yes” or “No.” For more information on cryptocurrency transactions, you can visit the IRS’s FAQs webpage. One thing is clear: answering “no” when the truth is “yes” is a significant mistake. While completely skipping the question may not be as detrimental, it is still not advisable. If the truth is “yes,” it is best to acknowledge it and remember to disclose and report all relevant income, gains, losses, etc. Perhaps the purpose of the question is to serve as a prominent reminder.
If you realize that you forgot to report your crypto gains in previous years, it is recommended to amend your tax returns to rectify the situation. Don’t wait for the IRS to discover the oversight, even if you did not receive one of the 10,000 IRS crypto warning letters sent out in the past. It is worth revisiting your past tax returns and considering amending them.
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