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Individual taxpayers must answer crypto-asset questions, IRS notes

The question, which on Form 1040 is just below the address block,
asks, “At any time during 2021, did you receive, sell, exchange, or
otherwise dispose of any financial interest in any virtual currency?”
Taxpayers must check either the “yes” or “no” box that follows,
regardless of whether they engaged in any transaction involving
virtual currency during the tax year, the IRS said in the news
release.

The release also reiterates the Form 1040 general instructions
describing what it said were the most common transactions involving
virtual currency that require answering “yes” to the question:

The receipt of virtual currency as payment for goods or services provided;
The receipt or transfer of virtual currency for free (without
providing any consideration) that does not qualify as a bona fide
gift;
The receipt of new virtual currency as a result of “mining” and
“staking” activities;
The receipt of virtual currency as a result of a “hard fork”;
Exchange of virtual currency for property, goods, or services;
Exchange or trade of virtual currency for another virtual currency;
A sale of virtual currency; and
Any other disposition of financial interest in virtual currency.

Also from the instructions, the release states taxpayers may check the
“no” box if their transactions or actions were limited to:

Holding virtual currency in the taxpayer’s own wallet or account;
Transferring virtual currency between wallets or accounts the taxpayer
owns or controls; or
Purchasing virtual currency using real currency, including purchases
using real currency electronic platforms such as PayPal and Venmo.

The release further states that any combination of holding,
transferring, or purchasing virtual currency in the above three ways
will not require a “yes” answer.

The emphasis comes as the IRS seeks to increase taxpayers’ reporting
compliance and ramp up enforcement. Last month, the IRS released a new
version of Form 14457, Voluntary Disclosure Practice Preclearance
Request and Application, with an expanded new section and instructions
for reporting virtual currency transactions.

And Congress has placed crypto assets in the sights of broker
reporting. The Infrastructure Investment and Jobs Act, P.L. 117-58,
will require Forms 1099-B, Proceeds From Broker and Barter Exchange
Transactions, required to be filed and furnished after Dec. 31, 2023,
to include certain cryptocurrency transactions, including those
involving “digital assets” in which a person is responsible for
regularly providing a service effectuating transfers of digital assets
on behalf of another person (Secs. 6045(c)(1)(D) and (g)(3)(B)(iv)).
While guidance on the scope of the requirement is still awaited, a
letter from a Treasury official to six U.S. senators on Feb. 11
indicates that “ancillary parties” without access to relevant
information about transactions but merely validating them, selling
storage devices for private keys, or writing-related software code
will not likely be considered brokers for this purpose.

This is the second tax year in which the question has been on the
front of Form 1040 and the other returns; for 2019, it was on Form
1040’s Schedule 1, Additional Income and Adjustments to Income, where
it would have been answered only by taxpayers who were required to
include the form in their return because either they had an income of
the types entered there, such as business income or loss reported on
Schedule C, Profit or Loss From Business (Sole Proprietorship), or
adjustments to income, such as a deduction for student loan interest.

For the tax year 2019, of an estimated 142.2 million e-filed
individual returns, 67.7 million filed Schedule 1, according to IRS
Publication 4801, Individual Income Tax Returns, Line Item Estimates,
2019, the most recent tax year for which the publication is available.
Of those 67.7 million, nearly 928,000 taxpayers checked “yes” to the
virtual currency question. For 2020 and 2021, with the question
required of all individual filers, the total is likely higher.

The question is worded slightly differently for 2021 than for the
previous years, when it asked whether taxpayers received, sold, sent,
exchanged, or otherwise acquired virtual currency.

The news release and instructions note that acquiring virtual currency
can require reporting on the return if it was received as compensation
for services, in which case it must be included in income just as
wages would be. Or if it was held for sale to customers in a trade or
business, it would be reported as inventory. If taxpayers disposed of
by sale, exchange, or transfer of any virtual currency that they held
as a capital asset, they must check “yes” and report any resulting
capital gain or loss, the release said.

While the release does not use the term “crypto-assets” or discuss
specific types of them, such as nonfungible tokens, the IRS has used
the term “virtual currency” broadly to encompass a range of digital
representations of value that function as a unit of account and store
of value, of which only “some … are convertible” into the U.S. or
foreign currency (see Frequently Asked Questions on Virtual Currency
Transactions, Q1: “Regardless of the label applied, if a particular
asset has the characteristics of virtual currency, it will be treated
as virtual currency for Federal income tax purposes.”) Other guidance
includes Notice 2014-21, also Rev. Rul. 2019-24 on “hard forks.”

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