The IRS continues to increase their scrutiny of cryptocurrency and virtual currency activity in an effort to eliminate widespread noncompliance. The prioritization of virtual currency above other current tax issues reflects the scale of noncompliance and potential revenue collection opportunities. This is most evident in the annual revisions to 2020 Form 1040, where The Virtual Currency Question has been moved to the first page and is prominently featured—front & center.
The Virtual Currency Question reads, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”. This question could be interpreted in several ways. In the absence of formal guidance, the conservative approach would be to check the box and respond “Yes” if there was even the slightest virtual currency activity in 2020, including the mere purchase of virtual currency.
In October 2020, the IRS published the initial draft version of the 2020 Form 1040 instructions, which sought to clarify uncertainties surrounding The Virtual Currency Question. Responding to concerns from tax practitioners, the IRS followed up in December 2020 by publishing a revised draft version of the 2020 Form 1040 instructions, which expanded the scope of The Virtual Currency Question. Shortly thereafter, in January 2021, the IRS issued the final version of the 2020 Form 1040 instructions, which reversed course and narrowed the scope of The Virtual Currency Question.
All the while, Bitcoin and other cryptocurrency values were reaching all-time highs, leading many investors to sell out and still more investors buying in. The former investor group who is selling their currency and potentially triggering very significant tax consequences is most likely the focus of IRS enforcement efforts, not the latter investor group who is simply acquiring virtual currency. Nevertheless, both groups could be required to respond “Yes” depending on which version of instructions were taken into consideration.
As the 2020 tax prep season got underway, further clarification was needed but there was not enough time for the IRS to issue additional formal guidance. So they took the step of informal guidance in the form of “New FAQ 5” which explains, “If your only transactions involving virtual currency during 2020 were purchases of virtual currency with real currency, you are not required to answer yes to the Form 1040 question.” This clarification is only slightly helpful, as it does not carry statutory authority and can not be relied on to take a tax return position and note that FAQ’s frequently change and or are removed. It is always best practice to print a dated copy of any relevant FAQ when considering risky situations.
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Bennett Thrasher’s Individual Tax practice helps clients navigate these complexities and ensures that they are in compliance. To learn more about our services, contact Michael Klug or Zack Leder by calling 770.396.2200.
The above information is general in nature and should not be relied upon for any specific tax implication or investment decision. Actual results may differ, and readers are cautioned not to place reliance on these general observations. Consult with your adviser or counsel before undertaking any specific action.