This blog post summarizes recent federal bills that have been introduced (but not yet passed), proposals by the Biden Administration, and guidance issued by the Internal Revenue Service with respect to the taxation of digital assets.
IRS Commissioner Charles Rettig, testifying before Congress in April 2021, estimated the gap between taxes owed and taxes collected in the United States to be close to $1 trillion. While there is some debate as to how much lax reporting on cryptocurrency transactions contributes to this so-called “tax gap,” with a market capitalization hovering at the time of writing around $2 trillion, cryptocurrency investments have increasingly become an object of regulatory scrutiny.
Virtual currency disclosure on Form 1040
Beginning with Notice 2014-21, the IRS has consistently taken the view that cryptocurrencies are property for U.S. federal income tax purposes. Absent any specific statutory or regulatory exception, U.S. individual taxpayers are generally required to report gains realized on the sale of property (including cryptocurrency) and pay tax on these gains. To remind taxpayers of this requirement, Form 1040 now specifically asks taxpayers whether they have received, sold, exchanged or otherwise disposed of any financial interest in any virtual currency. (The instructions define “virtual currency” for this purpose as a digital representation of value other than a representation of a “real” (i.e., fiat) currency that functions as a unit of account, a store of value, or a medium of exchange. Cryptocurrencies are included in this definition). The question on Form 1040 requires an affirmative answer of “yes” or “no” from all taxpayers.
A version of the virtual currency question was included on Schedule 1 of Form 1040 when it was introduced in 2019 but, beginning with the 2020 tax year, the question has had a more prominent position on page 1 (and, at that time, asked: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”). The wording of the question has been modified for the 2021 tax year to remove the word “send” and replace “otherwise acquire” with “otherwise disposed of,” consistent with the IRS’s focus on identifying taxable events involving cryptocurrency. Generally any transaction involving cryptocurrency during the tax year will require a taxpayer to answer “yes” to this question, with the exception of purchases of virtual currency with real currency (with no further activity).
The first official guidance on the taxation of cryptocurrency transactions in more than five years has been issued.
The guidance includes both a Revenue Ruling (Rev. Rul. 2019-24, 2019-44 I.R.B. 1) and answers to Frequently Asked Questions on Virtual Currency Transactions (the “FAQs,” together with Revenue Ruling 2019-24, the “Guidance”) was issued on October 9, 2019 by the U.S. Internal Revenue Service (the “IRS”). The Guidance provides much sought information concerning the tax consequences of cryptocurrency “hard forks” as well as acceptable methods of determining tax basis for cryptocurrency transactions. The Guidance also reasserts the IRS’s position, announced in Notice 2014-21, 2014-16 I.R.B. 938, that cryptocurrency is “property” for U.S. federal income tax purposes and provides information on how the rules generally applicable to transactions in property apply in the cryptocurrency context. However, important questions remain unanswered. It remains to be seen whether more definitive regulatory or administrative guidance is forthcoming.
The Guidance comes amidst an ongoing campaign by the IRS to increase taxpayer compliance with tax and information reporting obligations in connection with cryptocurrency transactions. In 2017, a U.S. district court ordered a prominent cryptocurrency exchange platform to turn over information pertaining to thousands of account holders and millions of transactions to the IRS as part of its investigation into suspected widespread underreporting of income related to cryptocurrency transactions. Earlier this year, the IRS sent more than 10,000 “educational letters” to taxpayers identified as having virtual currency accounts, alerting them to their tax and information reporting obligations and, in certain cases, instructing them to respond with appropriate information or face possible examination. Schedule 1 of the draft Form 1040 for 2019, released by the IRS shortly after publishing the Guidance, would require taxpayers to indicate whether they received, sold, sent, exchanged, or otherwise acquired virtual currency at any time during 2019.
Taxpayers who own or transact in cryptocurrency or other virtual currency should consider carefully any tax and information reporting obligations they might have. Please contact the authors of this post or your usual Proskauer tax contact to discuss any aspect of the Guidance. Read the following post for background and a detailed discussion of the Guidance.
Except where the context indicates otherwise, the tax consequences discussed in this post generally apply to transactions involving cryptocurrency held by a taxpayer as a capital asset. This post does not consider tax consequences other than U.S. federal income tax consequences.
A U.S. federal district court judge on Tuesday, November 29 ordered Coinbase Inc., the largest cryptocurrency exchange and storage platform in the world, to provide information about certain of its account holders to the U.S. Internal Revenue Services (IRS). Information pertaining to as many as 14,355 account holders and 8.9 million transactions could be covered in this order, according to estimates provided by Coinbase. The full order by Judge Jacqueline Scott Corley of the U.S. District Court for the Northern District of California can be found here.