Take the time to consider how you’ll report digital asset transactions up front, and filing taxes with cryptocurrency, NFTs and other investments doesn’t need to be something you fear. Tax reporting requirements for digital assets have changed yearly since 2019, when the IRS added a question about crypto to IRS Forms 1040 and 1040-SR. All taxpayers must answer the crypto question, without regard to whether they had a crypto transaction that meets the definition of a “digital asset.”
Each new iteration of the crypto question, however, shows that the IRS is struggling to find effective ways to identify taxpayers who engage in crypto transactions.
The cryptocurrency question is now near the top of page one of the Form 1040. This serves a couple of important purposes. First, the question is conspicuous and cannot be missed. Second, failing to correctly answer the crypto question could expose the taxpayer to a tax audit or a charge of tax fraud in egregious and intentional misstatements.
What’s New About Reporting Cryptocurrency on Your Taxes
There have been significant changes in the crypto question over the past year. To start with, the 2021 crypto question asked about virtual currency transactions, defining “virtual currency” as a “digital token that functions as a unit of account, a store of value, or a medium of exchange.”
The 2022 crypto question is much broader than it was in 2021. It now asks about digital assets,” defined as
any digital representations of value that are recorded on a cryptographically secure distributed ledger or any similar technology. For these purposes, digital assets include non-fungible tokens (NFTs) and virtual currencies such as cryptocurrencies and stablecoins. If a particular asset has the characteristics of a digital asset it will be treated as a digital asset for federal income tax purposes.
With this broad digital asset definition, the 2022 crypto question asks, “At any time during 2022, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset? (See instructions.) Yes or No.”
The 2022 crypto question explicitly asks taxpayers about items that they and their advisors might have previously thought were not reportable, such as NFTs and play-to-earn game tokens received and used as in-game currency. The question has also been expanded to include within the scope of the term “receive” a “reward, award, or payment for property or services.” Thus, digital assets received as compensation are reportable for 2022.
How Digital Assets are Reported on Form 1040
To help taxpayers complete the 2022 crypto question, the instructions that accompany the Form 1040 set out a list of transactions that require taxpayers to answer “Yes”:
Received digital assets as payment for property or services provided
Received digital assets as a result of a reward or award
Received digital assets as a result of mining, staking, and similar activities
Received digital assets as a result of a hard fork
Disposed of digital assets in exchange for property or services
Disposed of a digital asset in exchange or trade for another digital asset
Sold a digital asset
Transferred digital assets for free (without receiving any consideration) as a bona fide gift
Otherwise disposed of any other financial interest in a digital asset (A taxpayer has a financial interest in a digital asset if the taxpayer is the owner of record of the digital asset, or has an ownership stake in an account that holds one or more digital assets, including the rights and obligations to acquire a financial interest, or the taxpayer owns a wallet that holds digital assets.)
Not all digital asset transactions need to be reported. Transactions that do not require a “Yes” include (1) holding a digital asset in a wallet or account without a transfer; (2) transferring digital assets between wallets or accounts owned or controlled by the same taxpayer; and (3) purchasing digital assets using U.S. dollars or another fiat currency, including through electronic platforms such as PayPal and Venmo.
What the New Taxable Digital Asset Definitions Mean for You
What if taxpayers don’t agree with the digital assets definition? What if taxpayers believe they have legal authority to take a different tax position for NFTs, staking, and mining transactions?
What is clear is that whether taxpayers disagree with the IRS definitions, if they engage in crypto activities they must check the box “Yes.” All other taxpayers must check the box “No.” The IRS included NFTs and play-to-earn game tokens in the definition of digital assets. Does this setting out the IRS’s view on the taxation of such items? Or, does this mean nothing more than that the IRS is requiring all taxpayers to respond “Yes” to the crypto question if they hold such assets? Can taxpayers then take the position that their specific activities are not taxable? In this regard, it is important to keep in mind that IRS forms and instructions — just as certain other IRS pronouncements — do not have the force of law. Does the list of transactions set out in the instructions — which includes mining, staking, and similar activities, mean anything more than requiring taxpayers to say “Yes” to the crypto question? Obviously, taxpayers should consult with their tax advisors to sort out these tax considerations.