The IRS’s enforcement of cryptocurrency tax dodging appears to be going mainstream, with a yes-or-no question on virtual currency trades now on the front page of its draft 2020 individual tax form.
The answers to that question aren’t so simple, given gaps in IRS guidance for what the agency considers virtual currency, as well as what it considers to be an event triggering tax liability, according to tax professionals who specialize in this area.
“While it seems like a really straightforward question, there’s actually a lot of nuance around it,” said Chandan Lodha, co-founder of the cryptocurrency portfolio and tax managing software CoinTracker. “Does it include whether you’ve acquired cryptocurrency in a previous year but not this tax year? What if you transferred cryptocurrency between wallets you already have?”
The draft of the 2020 Form 1040, released last week, asks taxpayers whether they received, sold, exchanged, or acquired financial interest in any virtual currency. The agency included the question last year, but placed it on the draft Schedule 1 of the Form 1040, which is where individuals can report other income they wouldn’t put on the main form, such as unemployment payments, rental income, and royalties.
The IRS has been increasingly focused on cryptocurrency tax compliance. Last summer, the agency sent letters to thousands of traders suspected of failing to report their assets, and issued income-reporting guidance in October 2019.
Estimates of the portion of Americans who hold cryptocurrency vary, with the financial information service site Finder.com pegging the number at 14.4% in 2019, while a survey by the cryptocurrency blog CryptoRadar put it at 6.2%.
While tax software companies like H&R Block Inc. have already incorporated the cryptocurrency question into their filing processes, moving it to the front page of the Form 1040 means that taxpayers and tax return preparers can’t miss it, tax professionals said.
“I think this is putting a lot of preparers on notice,” said Joshua Azran, an accountant and founder of Azran Financial in Los Angeles. The IRS, he added, appears to be saying, “We want you to take an active decision as a preparer and as a professional and actually ask the client the question and go through this.”
Not So Straightforward
The wording of the question still raises additional questions, said Annette Nellen, an accounting professor at San Jose State University.
“What if you received it by gift? Arguably, you did receive it but there’s no tax consequences of it. Do you attach an explanation?” she said. “We don’t know all of what ‘yes’ means.”
Earlier this year, the IRS revised a webpage to remove currency used in the video games Fortnite and Roblox from its definition of “virtual currency,” a sign that the agency’s own terminology—and by extension, whether a taxpayer answers the form question correctly—is evolving, Nellen noted. She added that she hopes to see additional guidance in future form instructions.
Lisa Zarlenga, a partner at Steptoe & Johnson LLP in Washington, said she was “disappointed” that the IRS hadn’t revised the wording of the question when moving it to the front of the Form 1040, but said tax professionals generally advise clients to check the “yes” box if they have had any dealings with cryptocurrency, whether they triggered taxes or not.
“I would split it up into multiple questions, so they can see what happened,” said Zarlenga, a former Treasury Department official.
For instance, if a taxpayer sold virtual currency, the agency could look for gains, unlike situations in which taxpayers merely received it as a gift.
Omri Marian, a professor at the University of California, Irvine School of Law, said it is clear taxpayers need to answer yes if they had any interaction with virtual currency, whether it triggers tax liability or not.
“People may interpret it as suggesting there’s something actually negative about owning virtual currencies, which should not be the case,” Marian said. “I would love to see the IRS elaborate a bit about why they’re asking this question in this manner,” or note that interaction with cryptocurrency doesn’t necessarily mean a person owes taxes, he added.
“We continually look for ways to revise our forms for optimal use and understanding,” an IRS spokesperson said in an emailed statement, declining to comment further.