Over the last 3 years, the Internal Revenue Service has been engaged in a virtual currency compliance campaign to address tax noncompliance related to cryptocurrency use. The IRS’ efforts have included outreach to taxpayers through education, audits of taxpayers’ returns and even criminal investigations.
Soon the IRS will have another arrow in its quiver. Thanks to a requirement included by Congress in the Infrastructure Investment and Jobs Act (IIJA) of 2021, signed into law November 15, 2021, cryptocurrency exchanges will be subject to information reporting requirements similar to those that stockbrokers have to follow when a taxpayer sells stock or other securities.
These new rules generally will apply to digital asset transactions starting in 2023, so the first reporting forms related to cryptocurrency transactions will be issued to the IRS and crypto investors in January 2024.
Form W-9 – As crypto exchanges gear up for the new reporting requirement, and if they don’t have a record of their users’ taxpayer identification numbers (usually a Social Security number), they will contact their users for the information, likely using IRS Form W-9, Request for Taxpayer Identification Number and Certification. If the taxpayer doesn’t complete and return the W-9 to the requestor, the taxpayer may be subject to back-up withholding, which means the exchange would have to withhold 24% of future transactions and submit the withheld tax to the IRS.
Form 1099-B – At this time it’s not known if the IRS will modify Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, currently most commonly used by brokers to report stock sales, for reporting crypto transactions, or if a new form will be created.
As with the information on the 1099-B that brokers report, the IRS will then use the reported crypto transaction details – sales proceeds, acquisition and sale dates, tax basis for the sale, and character of the gain or loss – to match to the information reported on the taxpayer’s tax return. Those who don’t report, or don’t properly report, their cryptocurrency transactions will be liable for the tax, penalties, and interest. In some cases, taxpayers could be subject to criminal prosecution.
Crypto is Treated as Property – Although cryptocurrency may seem like money, according to the IRS it is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency. So, it is necessary to report the disposition of cryptocurrency when it is sold for cash, used to buy something or traded for another cryptocurrency. But just transferring the currency from an on-line wallet to an exchange, or vice versa, is not a disposition.
The character of the gain or loss from the transaction generally depends on whether the cryptocurrency is a capital asset in the hands of the taxpayer. Generally, a taxpayer realizes capital gain or loss on the sale or exchange of cryptocurrency that is held as a capital asset. On the other hand, a taxpayer generally realizes ordinary gain or loss on the sale or exchange of cryptocurrency that he or she does not hold as a capital asset. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset.
Digital Assets – The IIJA defines a digital asset as any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology. Furthermore, the IRS can modify this definition. As it stands, the definition will capture most cryptocurrencies as well as potentially include some non-fungible tokens (NFTs) that are using blockchain technology for one-of-a-kind assets like digital artwork.
Transfer Reporting – Based on the IIJA change, the definition of brokers who will need to furnish Forms 1099-B (or whatever new form the IRS might design) includes businesses, referred to as crypto exchanges, that are responsible for providing any transfer services for the transfer of digital assets on a taxpayer’s behalf. So, any platform on which a taxpayer can buy and sell cryptocurrency will be required to report digital asset transactions, both to the taxpayer and the IRS.
Of course, not every transfer transaction is a sale or exchange. An example would be transferring cryptocurrency from a wallet at Crypto Exchange #1 to the taxpayer’s wallet in Crypto Exchange #2. In this case, Crypto Exchange #1 will be required to provide relevant digital asset information to Crypto Exchange #2. Such a transaction is not a reportable sale or exchange, and similar to when a taxpayer switches stock brokers, the prior exchange must provide the new exchange with the basis, and purchase dates, just as a stock broker must when the brokerage firms are changed.
Cash Transaction Reporting for Businesses – Currently when a business receives $10,000 or more in cash in a transaction, the business is required to report the transaction on IRS Form 8300, including the ID of the person from whom the cash was received. Under the IIJA rules, businesses will be required to treat digital assets like cash for purposes of this reporting requirement. The $10,000 may occur in a single transaction, or a series of related transactions. Transactions between a buyer, or agent of the buyer, and a seller that occur within a 24-hour period are related transactions.
1040 Crypto Question – Starting with the 2020 tax return, the IRS asks a question on the return that requires a yes or no answer. The draft of the 2021 Form 1040 shows the following question will be posed: “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” Once the IIJA crypto reporting requirement is effective, the IRS will know if the taxpayer’s response to the question is correct. Taxpayers should consider that when signing their Form 1040, they are attesting under penalties of perjury to filing a true, correct and complete return. A response contrary to the 1099-B reporting information could lead to unwanted interaction with the IRS.
If you have questions about reporting cryptocurrency transactions, please don’t hesitate to contact our office for assistance.