Worsening a Disastrous Year for Bitcoin and Other Cryptocurrencies: IRS Proposes Controversial New Question on Digital Assets


By Andrew Keshner

Investors may need all the help they can get from the tax code’s capital loss rules

Cryptocurrency investors endured a year in which their holdings plunged in value as some hoped the asset could be a hedge against searing inflation

The Internal Revenue Service might have a potential headache question about your crypto investments and what’s taxable, according to a major accounting association.

For the past two years, the IRS has been asking whether taxpayers have bought or sold cryptocurrency in the main “Form 1040” document that taxpayers submit for their federal income taxes. The investigation also covers other potential crypto-related tax events. It’s a “yes” or “no” question that taxpayers can’t leave blank

Last year, Form 1040 asked, “Have you received, sold, traded, or otherwise disposed of a financial interest in virtual currency?” (The wording differed slightly from the language that appeared on Form 1040 the previous year. The question first appeared in tax year 2019, on Schedule 1.)

The prominent placement is a nod to the IRS’ increasingly sharp focus on ensuring cryptocurrency investors fully meet their tax obligations.

Fast forward to next year’s tax returns: The IRS has proposed a draft question asking for next year’s Form 1040: “At any time in 2022, have you: (a) received (at as a reward, reward, or compensation); or (b) sell, trade, gift, or otherwise dispose of a digital asset (or financial interest in a digital asset)?”

However, after the IRS unveiled the proposed wording of this question before the 2023 tax season, the American Institute of CPAs recommended that the tax agency get out its pencils and erasers. The tax agency needs to clarify the issue to avoid taxpayer confusion, the organization said in its comment letter.

Generally speaking, capital gains taxes will come into effect on sales, coins traded, obtaining cryptocurrency through mining, and other scenarios. But buying cryptocurrency and simply holding it was not considered a taxable event. When jobs pay with cryptocurrency, for example, they are generally treated as wages subject to employment tax, according to the IRS.

In some ways, the latest version of the question is an improvement, said Annette Nellen, a tax professor at San Jose State University who chairs the AICPA’s Virtual Currency Task Force. But including the phrase “‘digital asset’ is going to create new problems and confusion,” she said.

Besides cryptocurrencies such as Bitcoin or Ethereum, the use of a phrase such as “digital asset” has raised questions if the IRS is also asking about non-fungible tokens (NFTs) and gaming currency like Fortnite V-Bucks or Robux offered on Roblox (RBLX), AICPA noted.

The IRS previously removed V-Bucks and Robux from examples of virtual currency that can be converted into real money. But creating, buying and selling NFTs can have tax implications

So what is the solution ? The best approach would be a question asking whether taxpayers during the year had “a taxable event involving virtual currency” and then providing instructions on what that means, the AICPA said in its comment letter.

These instructions, he added, should clarify that an individual filer does not have to tick “yes” if their child or dependent had their own cryptocurrency-related tax events generating lower income. reporting thresholds.

The back and forth over the wording of tax documents may seem like dry semantics, but they underscore just how much there is to understand about cryptocurrency, taxes — and the public’s continued need to understand how the two interact.

The AICPA comment letter wants the IRS to stick with the term “virtual currency” instead of “digital asset” for now. But even still, he notes, there are variations in how the IRS formally and informally defines “virtual currency” in its advice and guidance.

One of the reasons investors need to understand the tax rules now is that it could help reduce their 2022 losses. Investors can use capital losses to offset their gains. If the losses exceed the gains — and that could be the unfortunate case for some hard-hit cryptocurrency investors — a taxpayer can claim up to $3,000 in capital loss. Any remaining loss can be carried forward to future tax years.

Bitcoin was trading just over $20,000 on Thursday, down nearly 57% year-to-date. Ethereum is down over 57% year-to-date.

Nearly two in ten American adults said they owned a cryptocurrency in August, according to an ongoing Morning Consult poll. The 18% in August roughly corresponds to the beginning of the year.

Matt Metras of MDM Financial Services in Rochester, NY, has a more optimistic view of the question the IRS is trying to ask. “It’s not perfect, but it’s better than last year,” said Metras, which specializes in preparing tax returns for cryptocurrency holders. “The use of digital assets is more inclusive,” he said.

Still, Metras doesn’t know if there will ever be a clear, concise, and perfectly worded way for the IRS to question cryptocurrency holdings. The landscape continues to change so quickly, he noted.

The agency thinks of “readability and information gathering” when putting new language on a tax form, said Michael Kramarz, director of Kaufman Rossin’s tax services 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 does not understand the language of a tax form, the IRS will not be able to collect the type and extent of information it seeks,” said Kramarz, a former IRS attorney.

The IRS will consider feedback from tax professionals and the general public as it proposes tax document language, Kramarz noted. They can submit comments here

Typically, finalized tax forms start rolling out around November and December, Nellen said. The IRS declined to comment.

According to Metras, “there is a lot of confusion among the general public about what should be reported and what should not,” with cryptocurrency. As a result, “there are people trying it out who aren’t sure about the issue”.

Now, cryptocurrency owners and tax practitioners will have to wait for the final wording from the IRS. “How it ends is always a fun surprise,” Metras said.

-Andrew Keshner


(END) Dow Jones Newswire

09-03-22 1104ET

Copyright (c) 2022 Dow Jones & Company, Inc.


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