Crypto investors get some answers in US tax form instructions

(Bloomberg Law) — The IRS has given U.S. cryptocurrency holders some more clarity on how to report digital assets on their 1040 income tax forms, a likely precursor to regulatory guidance.

In 2022 tax form draft instructions released late Monday, the Internal Revenue Service expanded how taxpayers should list their crypto transactions, including changing wording from “virtual currency” to “digital assets.”

“They are a little more attuned to the terminology of the industry and are more inclusive of potential crypto transactions,” said Adnan Islam, tax partner with Marcum LLP.

The added clarity is welcome, tax professionals said, but getting guidance remains their No. 1 ask.

In August, the IRS expanded the crypto question on the 1040 tax form to specify that taxpayers should report whether they had received crypto as a “reward, prize or compensation.”

The latest instructions change “virtual currency” to digital assets, a nod to the definition in Section 6045 as amended in the 2021 infrastructure bill that expanded cryptocurrency reporting requirements. This change addresses ambiguity about whether a non-functional token, or NFT, is considered virtual currency. In its updated form, the agency explicitly says, digital assets include NFTs and virtual currencies.

The change in terminology is a good sign that the agency is preparing more guidance, said Miles Fuller, head of government solutions at TaxBit and former senior counsel in the Office of Chief Counsel at the IRS.

“The IRS is stepping up by bundling their terminology around this digital asset concept that was in the statute,” he said. “So that means that more likely than not in the near future, we’re going to see these rules come out and the IRS continue to move forward with some sort of implementation of a regulatory regime. Probably sooner rather than later.”

While there is no penalty for not checking “yes” on the 1040 form, a taxpayer who underreports their income may be subject to penalties and interest on the unreported crypto income. The prepared forms help taxpayers get clarity on preventing it, tax experts said.

Economic interest is further defined in the updated draft instruction form, another area where the industry sought guidance. “Financial interests,” it says, are present “if you are the owner of a digital asset, or have an ownership interest in an account that holds one or more digital assets, including the rights and obligations to acquire a financial interest, or you own a wallet containing digital assets.”

“They never really defined what that meant,” Fuller said.

The definition of economic interest is what tax professionals expected, said Kevin Ainsworth, a partner at BDO. Ainsworth said he would like to see more specific examples so taxpayers know whether to check the box on the form.

The draft form elaborates that if a taxpayer received digital assets as a “result of mining, staking, and similar activities,” they should check the “yes” box on the form. The “similar activities” could include decentralized finance, or DeFi, activities such as liquidity pools, said Lisa Zarlenga, a partner at Steptoe & Johnson LLP and a former Treasury Department tax lawmaker.

In a tax dispute, instruction forms are not binding guidance, so taxpayers may not be able to rely on them, she noted.

“When you think about it, as a practical matter, most everyday taxpayers rely on the instructions when they fill out their tax forms,” ​​Zarlenga said. “And so it seems a little unfair that if they relied on something that those instructions said, and the IRS then challenged it, they wouldn’t be able to point to this in court and say this is something I relied on.”

The question about digital assets on the 1040 form “doesn’t have anything to do with tangible tax,” and it’s more disclosure-based, Fuller said, so it could potentially be used as “sort of a defense” to an argument.

Guidance or legislation – particularly in staking and mining, and in the treatment of NFTs – is what industry professionals say they want most.

Trying to understand the instructions and changes to the forms is “like reading the tea leaves,” Zarlenga said. She said she prefers guidance.

To contact the reporter on this story: Erin Slowey in Washington at [email protected]

To contact the editors responsible for this story: Meg Shreve at [email protected]; Butch Maier at [email protected]

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