The IRS Cryptocurrency Crackdown

Trading in Bitcoin? Getting paid by a client via Coinbase? It’s clear the IRS is no longer ignoring cryptocurrency activity. In fact, it’s planning to spotlight virtual currency front-and-center on the first page of your 2020 personal income tax return.

“It first became part of the wider 1040 individual tax return form for 2019, but those pulling up the 2020 form will now see it almost immediately,” says Andrew Hayward, reporting for Decrypt.

Once you enter standard personal details, the draft version of Form 1040 released earlier this month asks, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

“It’s a broad question, but the placement suggests that the IRS doesn’t want anyone to gloss over it—or consider withholding their crypto transaction details,” Hayward points out. The question is deemed too broad by many experts and may need to be tweaked before the final version of the tax form is ready. One thing will certainly remain: The IRS will take a closer look at virtual currency transactions than it ever has before.

You can find the IRS definition of virtual currency here, but it’s not an easy read. Investopedia boils it down to this: “A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers.”

The definition goes on to explain that a defining feature of cryptocurrencies is that they are generally not issued by a central authority, which renders them “theoretically immune to government interference or manipulation.”

So how can the IRS get involved? According to the IRS, it becomes taxable when it becomes “convertible.”

“Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as ‘convertible’ virtual currency,” the IRS explains. “Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.”

Virtual currencies like Bitcoin were once traded “off the radar” without taxes or other regulations. But by 2014, the IRS began recognizing this type of convertible virtual currency as property and now taxes it as such. So, when you sell virtual currency, the IRS says you must recognize any capital gain or loss on the sale, subject to any limitations on the deductibility of capital losses. If you receive virtual currency as payment for a job or service, it’s usually considered ordinary income.

There’s been a learning curve for the IRS and taxpayers alike in enforcing this rule, however. For instance:

  • In 2019, the IRS issued a revised ruling stating that a taxpayer would not need to report gross income on cryptocurrency if they don’t actually receive units of the increase in a distributed form. Simply not receiving a payee statement or information return like a Form W-2 or Form 1099, however, doesn’t permit you to skip the reporting process.
  • A bipartisan group of U.S. Congress members sent a letter asking the IRS to go further by offering a fairer tax on staking rewards. In simple terms, if a user receives ten units of a crypto reward but sells just one, they should only be taxed on the one. At the moment, that’s not the case.
  • The IRS FAQs section for virtual currency transactions is continually updated, including recent guidance on the tax treatment of virtual currencies donated to charity.
  • Tens of thousands of cryptocurrency holders report receiving IRS letters this year and last, alerting them about their tax filing obligations. One such letter, IRS Letter 6173, requires a taxpayer response by an included date. These letters are being called out as deceptive and confusing, but they’re critical indicators that the IRS is watching your virtual transactions.

The IRS even has its eye on virtual currencies said to be untraceable—often called “privacy coins.” The agency recently announced a reward of up $625,000 for anyone able to crack through the privacy screens of Monero. This famous off-chain privacy coin hides the transaction amounts and wallet addresses of both the sender and receiver.

If you’re involved in cryptocurrency transactions—particularly if you’ve received an IRS letter acknowledging your virtual currency assets—it’s time to wrap your head around your tax obligations. As the IRS becomes more sophisticated in the matter, punishments will be swift. Feel free to contact us with questions.

Photo from 123rf.com

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