While the value of virtual currency continues to fluctuate, the
IRS’ interest in it has only increased. In 2021, for example,
the agency launched Operation Hidden Treasure to root out taxpayers
who do not report income from cryptocurrency transactions on their
federal income tax returns.
Moreover, the Inflation Reduction Act, enacted in 2022,
allocated $80 billion to the IRS, with much of it designated for
enforcement activities. However, the Fiscal Responsibility Act,
enacted in May 2023, will claw back $21.39 billion of that amount
by the end of 2025. The IRS’ strategic operating plan for 2023
through 2031 lays out the agency’s intention to ramp up
enforcement related to digital assets. If you buy, sell or
otherwise engage in transactions involving virtual currency, you
need to stay up to date with the latest tax developments.
TERMINOLOGY
The IRS defines a “virtual asset” as any virtual
representation of value that is recorded on a cryptographically
secured distributed ledger or similar technology. The term
includes:
- Convertible virtual currency (meaning it has an equivalent
value in real currency or acts as a substitute for real currency),
such as Bitcoin; - Stablecoins (a type of currency whose value is tied to the
value of another asset, such as the U.S. dollar); and - Non-fungible tokens (NFTs).
According to the IRS, cryptocurrency is an example of a
convertible virtual currency that can be used as a payment for
goods and services, digitally traded between users and exchanged
for or into real currencies or digital assets. Cryptocurrency uses
cryptography to secure transactions that are digitally recorded on
a distributed ledger (for example, blockchain).
TAXATION OF TRANSACTIONS
For federal tax purposes, digital assets are treated as
property. Thus, transactions involving virtual currency are subject
to the same general tax rules that apply to property transactions,
such as purchases and sales of stock or real estate.
Several types of virtual currency transactions can trigger
reporting obligations, including:
Sales
If you sell virtual currency, you must recognize any
capital gain or loss on the sale, subject to any limitations on the
deductibility of capital losses. The gain or loss equals the
difference between your adjusted tax basis in the currency and the
amount you receive for it. You should report the amount you receive
on your federal income tax return in U.S. dollars (see below for
more information on reporting obligations).
Your basis is the amount you spent to acquire the virtual
currency, including fees, commissions and other costs. Your
adjusted basis is your basis increased by certain expenditures and
reduced by certain deductions or credits.
Property Exchanges
If you exchange virtual currency that you hold as a
capital asset for other property (including goods or other digital
assets), you must recognize a capital gain or loss. The gain or
loss is the difference between the fair market value (FMV) of the
property you receive and your adjusted tax basis in the virtual
currency. Your tax basis in the property you receive is its FMV at
the time of the exchange.
Payment for Services
If you receive virtual currency for performing services
— regardless of whether you perform the services as an
employee or an independent contractor — you recognize the FMV
of the currency when received as ordinary income. The FMV will also
be your tax basis in that asset.
On the flip side, if you pay for a service using virtual
currency that you hold as a capital asset, you have exchanged a
capital asset for the service and will have a capital gain or loss.
In addition, the FMV of virtual currency that is paid to an
employee as wages is subject to federal income tax withholding,
Federal Insurance Contributions Act (FICA) tax and Federal
Unemployment Tax Act (FUTA) tax. It also must be reported on Form
W-2, “Wage and Tax Statement.”
Related Read: Got Crypto? Beware of Tax Surprises When Dealing
With Cryptocurrencies
REPORTING OBLIGATIONS
You may have noticed a new line on your individual federal
income tax return in recent years. The 2022 version asks:
“At any time during 2022, did you: (a) receive (as a
reward, award or payment for property or services); or (b) sell,
exchange, gift or otherwise dispose of a digital asset (or a
financial interest in a digital asset)?”
If you answer “yes,” you must report all related
income, whether as income, a capital gain or loss, or otherwise
(for example, as a gift).
The Infrastructure Investment and Jobs Act (IIJA), enacted in
late 2021, created additional new reporting requirements for
digital asset transactions. These provisions were enacted with an
eye toward generating additional tax revenues to help fund
infrastructure projects. The requirements provide the IRS with more
information to work from and establish more potential compliance
tripwires for taxpayers who engage in virtual currency
transactions.
The IIJA expanded the definition of brokers that are required to
report their customers’ gains and losses on the sale of
securities during the tax year to the IRS on Form 1099-B,
“Proceeds from Broker and Barter Exchange Transactions.”
The form generally requires a description of each sale, the cost
basis, the acquisition date and price, the sale date and price, and
the resulting short- or long-term gain or loss.
Under the IIJA, operators of trading platforms for digital
assets, such as cryptocurrency exchanges, are subject to the same
reporting requirements as traditional securities brokers. This
change is effective for returns required to be filed, and
statements required to be furnished, after December 31, 2023. To
comply, cryptocurrency platforms should collect a Form W-9,
“Request for Taxpayer Identification Number and
Certification,” from their customers.
The IIJA also amended existing anti-money laundering laws to
treat digital assets as cash for purposes of those laws. As a
result, beginning in 2023, businesses must report to the IRS when
they receive more than $10,000 in digital assets in one transaction
or multiple related transactions.
Such transactions should be reported on IRS Form 8300,
“Report of Cash Payments Over $10,000 Received in a Trade or
Business.” To complete the form, a business will need to
gather the name, address and taxpayer identification number, among
other information, from the payer. Failure to comply may lead to
significant civil and criminal penalties.
Related Read: Confused About Crypto? Welcome to the Wild West of
Tax Considerations for Investing in or Doing Business With
Cryptocurrency
ENFORCEMENT TOOL
One way the IRS may uncover digital assets is through the use of
a “John Doe Summons.” The U.S. Department of Justice
notes that “because transactions in cryptocurrencies can be
difficult to trace and have an inherently pseudo-anonymous aspect,
taxpayers may be using them to hide taxable income from the
IRS.” By asking a court to serve a John Doe summons on a
crypto dealer or exchange, the IRS can find out information about a
person’s account.
In one recent case, an individual challenged the IRS’ use of
a summons to obtain his account information from a virtual currency
exchange. He argued it was unconstitutional. A U.S. District Court
disagreed and ruled that the IRS’ actions “fall
squarely” within its powers to pursue unpaid taxes (Harper
v. Retting, DC NH, May 26, 2023).
AN EVOLVING AREA
With its new infusion of enforcement funding, the IRS’ focus
on virtual currency transactions is likely to intensify. your ORBA
advisor will help you stay in compliance with the applicable rules
and requirements.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
