Cryptocurrency Transactions Face Further IRS Scrutiny – What You Need to Know

The IRS has made some minor changes to the individual income tax return forms over the past few years. In case you have missed it, the IRS modified a specific question that they asked in prior years at the top of the 2020 Form 1040: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in virtual currency?” The question on its face infers that by answering, “yes,” a taxpayer would have a taxable event resulting in the reporting of a transaction on a taxpayer’s tax return. But simply purchasing virtual currency in a calendar year would not give rise to a taxable event. Recently released IRS’ FAQs on virtual currency transactions clarified that taxpayers do not have to answer this question “yes” merely due to the purchase of cryptocurrency.

The IRS is cracking down on taxpayers who do not report their virtual currency transactions on their income tax return. There have been multiple John Doe summonses issued by the IRS to various cryptocurrency exchanges, where the IRS is requesting the identity of taxpayers whose transactions are greater than $20,000 on an annual basis during the years 2016-2020.

Finding taxpayers with cryptocurrency transactions is half the battle for the IRS. The other half is determining whether or not taxpayers are reporting the transactions correctly on their income tax return. To assist the IRS in determining the “correct” tax treatment for these transactions, the IRS has contracted with a technology firm, TaxBit, to help analyze the correct tax treatment for these transactions. There are many unanswered questions as to how TaxBit will be analyzing the data and how they determine what the correct tax treatment will be for certain transactions. Anchin will monitor this and provide updates going forward.

Cryptocurrency exchange platforms are currently not required to produce Form 1099s to their users. The tax reporting for cryptocurrency transactions has fallen on the users’ / taxpayers’ shoulders.  Key considerations include:

Are you investing in cryptocurrency that offers a rewards program? 

Are you investing in a grantor trust investment vehicle holding cryptocurrency? 

As the rules governing this asset class evolves, it is essential to have trusted advisors who understand how best to report your cryptocurrency transactions. For more information or to discuss specific matters, please contact your Anchin Relationship Partner or Edward Kim, a member of Anchin Private Client, at [email protected].