The growing popularity of virtual currencies and their potential to facilitate tax evasion has prompted the Internal Revenue Service (IRS) and Congress to impose additional reporting requirements on taxpayers who hold or use virtual currencies. The IRS has also issued significant guidance about the federal income tax consequences associated with virtual currency transactions. Finally, the Build Back Better Act expands two tax provisions to include virtual currencies.
Reporting Requirements
The IRS began inquiring about taxpayer holdings of virtual currency on the 2019 Form 1040 which included a question at the top of Schedule 1 that asked taxpayers if they received, sold, exchanged, or otherwise acquired “any financial interest in any virtual currency” during 2019. The IRS included the same question on the 2020 Form 1040, but moved it to the front of Form 1040 to ensure that all Form 1040 filers, and not only those with additional income or adjustments reported on Schedule 1, provided virtual currency information. The IRS has changed the wording of the question on the 2021 Form 1040 to inquire whether the taxpayer received, sold, exchanged, or otherwise “dispose[d] of any financial interest in any virtual currency” during 2021. The revised question clarifies that the IRS is focusing on virtual currency transactions that may be taxable events.
The recently passed Infrastructure Investment and Jobs Act amended IRC Section 6050I(d) to treat digital assets as “cash” when received in the course of a trade or business. As a result, beginning in 2024, taxpayers who receive virtual currency in the course of operating a trade or business must treat those receipts as cash for purposes of reporting to the IRS cash receipts of more than $10,000 from one transaction or two or more related transactions.
Tax Treatment of Virtual Currency Transactions
In 2014, the IRS issued Notice 2014-21 which “describes how general tax principles apply to transactions using virtual currency.” In 2019, the IRS issued Rev. Rul. 2019-24 which addresses whether or not a taxpayer has gross income as a result of a “hard fork” of virtual currency. Both the notice and the revenue ruling define virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value,” and the notice states that, for federal tax purposes, “virtual currency is treated as property.” As a result, the receipt, sale, or exchange of virtual currency often has federal income tax consequences.
