The tax season is rapidly approaching, and the IRS is keeping a close eye on cryptocurrency investors.
A question about “virtual currency” appears near the top of the first page of Form 1040, which is used by U.S. taxpayers to file an annual income tax return.
The federal government requires investors to report taxable 2021 transactions involving bitcoin, ethereum, dogecoin, and other cryptocurrencies.
According to Shehan Chandrasekera, an accountant and head of tax at CoinTracker, such transactions include receiving compensation in crypto, rewards for crypto mining, or free coins via “Airdrops” or “hard forks” (when a cryptocurrency splits into multiple branches and creates a new coin).
He claims that converting cryptocurrency to cash, purchasing goods or services with it, and converting one coin to another all qualify.
Although enquiring about cryptocurrency transactions isn’t new, the IRS has recently placed a greater emphasis on such tax reporting.
The move coincides with the White House’s and Democratic lawmakers’ efforts to crack down on tax evaders. According to a report released earlier this year by the US Department of the Treasury, the crypto economy contributes to the so-called tax gap by facilitating tax evasion through lax reporting requirements.
Beginning in 2023, a new $1.2 trillion bipartisan infrastructure bill requires digital currency brokers to file annual tax returns.
It also comes at a time when investors are becoming more interested in cryptocurrencies. Elon Musk, the CEO of Tesla and a crypto enthusiast, announced this week that the automaker would accept dogecoin as payment for some of its products.
′′[The IRS] is attempting to capture tax revenue from that expanding market,” Chandrasekera explained. “Every year, a new wave of people come into crypto believing it is tax-free.”
For the 2019 tax year, the IRS asked taxpayers about their cryptocurrency transactions for the first time. However, the question was asked on a Schedule 1 form, which is not used by all taxpayers. (This form reports certain types of income that do not appear on the main 1040, such as unemployment benefits or rental income.)
The IRS moved the crypto question to the top of the 1040 the following year, and it stayed there until the 2021 tax year.
The question for 2021, however, is phrased differently than it was for 2020. “Did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency at any time during 2021?” it asks taxpayers.
According to Chandrasekera, last year’s phrasing included some non-taxable transactions, such as simply holding crypto or sending holdings from one digital wallet to another. According to him, the change in wording results in a smaller number of transactions.
“This year, the question only inquires about events that may result in taxable events,” he explained.