Cryptocurrency, or virtual currencies, are digital representations of value, other than a representation of the U.S. dollar or foreign currency. They generally function as a unit of account, a store of value, and a medium of exchange – think about stocks and bonds. Some virtual currencies are convertible, which means that they have an equivalent value in real currency or act as a substitute for currency.
Unfortunately, as cryptocurrencies and virtual currencies have grown in popularity, so too have issues they create for taxation. In response thereto, the IRS has issued limited guidance, including Notice 2014-21 which explains the IRS’s position that cryptocurrency (or virtual currency) is treated as property for Federal income tax purposes. The same Notice 2014-21 includes examples of how longstanding tax principles apply to transactions involving the taxation of cryptocurrency or virtual currency.
To add even more questions and concerns, the IRS has now begun asking if taxpayers engaged in transactions involving crypto or virtual currencies as part of their Form 1040, U.S. Individual Income Tax Return. Specifically, the IRS is now asking: “At any time during 2020, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?” Moreover, the IRS expects taxpayers to answer simply “Yes” or “No.” A concern has since arisen in that many taxpayers “acquire” a financial interest in a crypto or virtual currency which may not otherwise trigger a taxable event. Are they still expected to answer “Yes” to the new question on their income tax return?
Fortunately, on March 2, 2021 the IRS issued FAQ 5. Specifically, the question addressed is:
The 2020 Form 1040 asks whether at any time during 2020, I received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency. During 2020, I purchased virtual currency with real currency and had no other virtual currency transactions during the year. Must I answer yes to the Form 1040 questions?IRS FAQ 5 “Frequently Asked Questions on Virtual Currency Transactions”
The FAQ 5 goes on to give the IRS position that no, taxpayers are not required to answer “Yes” on their 1040 if their only crypto or virtual currency transaction during 2020 was the purchase of virtual or crypto currency with real currency.
However, there still remains numerous unresolved issues surrounding the Federal taxation of crypto or virtual currencies. If you have questions or issues about your tax obligations in light of crypto or virtual currencies, please feel free to contact McLaughlin Legal today.