By Robert Wood; Compiled by TaxDAO
There’s a lot of talk about cryptocurrency investors and tax compliance, but one yes or no question may be surprisingly important. The IRS is asking everyone about their cryptocurrency transactions. Variants of this seemingly innocuous question appear at the top of Form 1040, Individual Income Tax Return; 1040-SR, U.S. Senior Citizen Tax Return; and 1040-NR, U.S. Nonresident Alien Income Tax Return, and have been revised for 2023 returns to update the wording. The question has also been added to these forms: Form 1041, U.S. Income Tax Return for Estates and Trusts; Form 1065, U.S. Return of Partnership Income; Form 1120, U.S. Corporation Income Tax Return; and Form 1120S, U.S. Income Tax Return for S Corporations.
The IRS asks different questions for corporations, partnerships, estates, and trusts: "At any time in 2023, did you: (a) receive (as an award or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?" Yes or No?
By digital asset, the IRS means "any digital representation of value recorded on a cryptographically secure distributed ledger or any similar technology. Examples of digital assets include non-fungible tokens (NFTs) and virtual currencies, such as cryptocurrencies and stablecoins."
You shouldn't leave it blank, everyone filing Forms 1040, 1040-SR, 1040-NR, 1041, 1065, 1120, 1120, and 1120S must check a yes or no answer. In addition to checking the box, you must report all income related to digital asset transactions. Therefore, investors who hold digital assets as capital assets and sell, exchange or transfer them during 2023 must use Form 8949, Sales and Other Dispositions of Capital Assets, to calculate their capital gain or loss on the transaction and then report it on Schedule D (Form 1040), Capital Gains and Losses. Taxpayers who make gifts of digital assets may need to file Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return.
So, does this “yes” or “no” question really matter? It’s not asking for numbers or details, and if you sell some, that information must be noted on your tax return. Since the IRS classified cryptocurrencies as property a decade ago, any sale should have resulted in a gain or loss. You might think that maybe the IRS is just investigating who is using cryptocurrencies? Not necessarily, a simple “yes” or “no” could be important.
This sounds similar to the foreign account question on Schedule B of Form 1040. This question could subject you to heavy penalties for checking the wrong box, or even perjury for checking the wrong box. If you select “no” and are then found to have engaged in cryptocurrency trading during the year, the fact that you specifically answered “no” could be used against you under penalty of perjury.
We learned this with foreign bank accounts. In that case, the Department of Justice’s Tax Division successfully argued that the mere failure to check the box associated with foreign account reporting was in itself willful. Willfulness carries higher penalties and more threat of criminal investigation. The IRS Criminal Investigation Division has met with tax authorities in other countries to share data and enforcement strategies to uncover potential cryptocurrency tax evasion.
That might suggest that the safe thing to do is to say “yes,” right? But what if you don’t know if you can definitively say you were the one doing the trading? What if you’ve been acting for a company, not an individual? Or less formally, what if you simply have a kind of “signature authorization” for cryptocurrency owned by your computer-savvy parents or other relatives to help them manage their crypto?
If you are selling cryptocurrency on behalf of your parents, at their request and/or for their benefit, should you answer "yes" or "no"? Either way, should you include an explanatory statement with your tax return explaining your relationship to virtual currency? There may be no perfect answers to these questions. The IRS says you have a financial interest in a digital asset if you are the owner of record of the digital asset, have an ownership interest in an account holding one or more digital assets, including the right and obligation to receive a financial benefit, or if you own a wallet holding the digital asset.
But the good news is that the IRS also said that for 2023 only, the following actions or transactions generally will not require you to check "yes":
holding digital assets in a wallet or account;
transferring digital assets from one wallet or account that you own or control to another wallet or account that you own or manage;
purchasing digital assets using U.S. or other real currency, including through the use of electronic platforms such as PayPal and Venmo.
Don't leave the question unanswered, answer "yes" or "no," the IRS said. More information is available at IRS.gov/VirtualCurrencyFAQs. What's obvious is that answering "no" is a big mistake if the fact is "yes." Skipping the box entirely may not be that bad, but it's not good either. As an important reminder, if the truth is "yes", then say so, and remember to disclose and report your income, gains, losses, etc. Maybe that's the point of the question.
If this makes you realize that you forgot to report cryptocurrency gains from past years, consider amending your tax return to fix this. Don't wait until the IRS finds you, even if you don't receive one of the 10,000 cryptocurrency warning letters the IRS has sent to 10,000 cryptocurrency taxpayers, you may want to erase past tax returns and consider amending your taxes.
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