Crypto-Currency, Cyber-Currency and Virtual Currency
Q5(a). The 2021 Form 1040 asks whether at any time during 2021, I received, sold, exchanged, or otherwise disposed of any financial interest in any virtual currency. During 2021, I purchased virtual currency with real currency and had no other virtual currency transactions during the year. How do I answer the question on the Form 1040? (added March 10, 2022)
A5(a). If your only transactions involving virtual currency during 2021 were purchases of virtual currency with real currency, you are not required to answer “yes” to the Form 1040 question, and should, instead, check the “no” box.
Under currently applicable law, virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets.
A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. For example, Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset.
Additionally, a taxpayer generally owes self-employment tax (SECA) on the sale or exchange of inventory and other property held mainly for sale to customers in a trade or business.
The income taxation with Hard Forks is not clear:
- The new item could be taxable as gross income.
- It could be considered a tax-free stock split with some of the original tax basis assigned to each portion.
- It could be considered much like livestock giving birth to a foal, and a zero tax basis assigned to the new item.
The sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability.
Virtual Currency
The Virtual Currency Compliance campaign will address noncompliance related to the use of virtual currency through multiple treatment streams including outreach and examinations. The compliance activities will follow the general tax principles applicable to all transactions in property, as outlined in Notice 2014-21. Taxpayers with unreported virtual currency transactions are urged to correct their returns as soon as practical. The IRS is not contemplating a voluntary disclosure program specifically to address tax non-compliance involving virtual currency.
In July 2019 the Internal Revenue Service has been sending letters to taxpayers with virtual currency transactions that potentially failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly.
The names of these taxpayers were obtained through various ongoing IRS compliance efforts.
“Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties,” said IRS Commissioner Chuck Rettig. “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”
For taxpayers receiving an educational letter, there are three variations: Letter 6173, Letter 6174 or Letter 6174-A, all three versions strive to help taxpayers understand their tax and filing obligations and how to correct past errors.
The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.
Virtual currency is an ongoing focus area for IRS Criminal Investigation.
The IRS anticipates issuing additional legal guidance in this area in the near future.
Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.
Tax Treatment of Cryptocurrency Hard Forks for Taxable Year 2017
IRS reminds taxpayers to report virtual currency transactions