Cryptocurrency and Reporting to the IRS

Bitcoin currency and dollar

Tax season is quickly approaching and investors who have made virtual currency transactions need to be prepared to report this activity to the IRS. Like any other transactions, cryptocurrency transaction is taxable by law. As such, taxpayers who have taken the cryptocurrency plunge must report their transactions on their tax returns, and they may be filing out more IRS forms than they have in the past. However, those taxpayers who have purchased crypto assets using U.S. dollars, and have left those funds in a cryptocurrency wallet or an exchange, will not have to report anything as there is no tax liability there.

As the 2022 tax deadline gets closer and closer, those operating in the crypto space need to pay attention, as filing taxes related to virtual currencies has become a bit more complicated. The IRS treats virtual currencies such at ether, bitcoin, and even NFTs in a different manner compared to typical investments and assets. For tax purposes, the IRS handles cryptocurrency like property – this means reporting gains and losses on a tax return.

Again, purchasing crypto using U.S. dollars, or fiat currency, does not require reporting. But as the crypto space continues to evolve at such rapid rates, the tax law will follow. Understanding the current tax laws as they relate to virtual currencies is critical. The following is a list of crypto events that the IRS would require to be reported:

  • Cryptocurrency assets are being held and are used to purchase goods or services
  • One cryptocurrency is traded for another cryptocurrency
  • Cryptocurrency was cashed out or sold for fiat currency (government-issued currency not backed by a commodity)
  • An employer paid an employee in cryptocurrency
  • Free tokens were administered via an airdrop

Any of the above scenarios would require reporting in a tax return. As millions of Americans are continuing to jump into cryptocurrency, tax filing this year is bound to be more complicated. While all of the above events would require reporting, they may not all result in owing tax money. Transactions resulting in gains would be taxed, whereas transactions resulting in losses would not be taxed.

While the IRS has been asking about cryptocurrency on tax returns since 2019, this year a new question will be featured on the 1040 U.S. Individual Income Tax Return which asks, “At any time during 2021, did you receive, sell, or otherwise acquire any financial interest in any virtual currency?” So, if a person only bought cryptocurrency with U.S. dollars and did not making any trades with cryptocurrency, they can answer “no” to that question.

On the IRS virtual currency FAQ page, they further delve into this issue stating, “If your only transactions involving virtual currency during 2020 were purchases of virtual currency with real currency, you are not required to answer yes to the Form 1040 question.”

As cryptocurrency continues to expand its reach throughout taxpayers in the U.S., investors must prepare to report relevant transactions to the IRS. Reaching out to your tax professional in advance to let them know that you have made cryptocurrency transactions is critical to making reporting as straightforward and thorough as possible.