Crypto News: IRS Tax Compliance and Enforcement

The cryptocurrency crash in 2022 understandably has some investors worried. But for those of you who haven’t been running for the hills, it’s worth knowing that cryptocurrency currently has the attention of not only the Biden administration and Congress, but also the IRS. On crypto news and taxes, the IRS recently proposed changes to the cryptocurrency tax reporting question on Form 1040. The agency will also receive $80 billion from the Inflation Reduction Act, some of which will be directed toward digital asset enforcement — including cryptocurrency tax compliance.

In addition, you may have heard that the IRS continues to obtain court orders requiring cryptocurrency brokers and exchanges to provide information to the IRS. This information concerns investors who failed to report and pay taxes on cryptocurrency transactions.

And while this IRS enforcement focus isn’t new, recent crypto announcements and developments from Congress, the Biden administration, and the IRS mean it’s important to stay current on crypto tax reporting and compliance. So here is some information to get you started.

How is crypto taxed?

A common question about cryptocurrency is about how crypto is taxed. The answer is that cryptocurrency is considered property, so it is taxed by the IRS in the same way that other capital assets are taxed. As a result, when you sell or trade crypto, you may have asset losses and potential taxable gains depending on the fair market value of the virtual currency and your basis in the crypto.

Given that, it is important to remember that payments made with virtual currency are subject to IRS information reporting. For federal tax purposes, that basically means all taxpayers must provide a yes or no answer to a virtual currency question at the top of their Form 1040.

For 2021, the check box asked the question: “Have you received, sold, exchanged, or otherwise disposed of any financial interest in a virtual currency at any time during 2021?”

You can answer “no” if you “only owned” crypto, ie the cryptocurrency was in your own wallet or account or was transferred between your own wallets or accounts. You can also answer no to the virtual currency question if you bought crypto with real currency.

You should answer “yes” to the virtual currency question if you received cryptocurrency as payment for goods or services. A yes answer will also be required if you received or transferred crypto for free (but did not receive it as a gift). Other reasons for answering yes included receiving new crypto due to mining and staking or due to a hard fork, or if you exchanged virtual currency for property, goods or services, or for another virtual currency.

Proposed changes to cryptocurrency tax reporting

Recently, however, the IRS proposed a change to the issue of virtual currency. On the 2022 draft Form 1040, the proposed question reads: “At any time during 2022, did you: (a) receive (as a reward, prize, or compensation); or (b) sell, exchange, give, or otherwise dispose of of a digital asset (or an economic interest in a digital asset)?”

It can be a signal that the tax authorities are interested in whether you have received or sent crypto as a gift. Or it could indicate a focus on other digital assets such as NFTs.

For 2021, when the tax authorities didn’t do it asking about cryptocurrency received as a gift, the gift tax credit was $15,000. So a gift of cryptocurrency under that amount was not taxable. For 2022, the gift tax deduction is $16,000, so a crypto gift below this amount will similarly not be taxable. But remember that if you were to sell or transfer the cryptocurrency you received, it may later be subject to capital gains tax.

Final instructions for 2022 Form 1040 should be coming soon from the IRS.

Is cryptocurrency reported to the tax authorities?

The IRS emphasizes the longstanding requirement that taxpayers maintain records that establish the positions they take on their tax returns. That means with cryptocurrency you should keep accurate and detailed records. Records must show the sale, exchange or disposition of your cryptocurrency or other digital assets and show the fair market value of the assets.

And as previously mentioned, the IRS has repeatedly taken legal action through court orders (ie, so-called John Doe subpoenas), to require cryptocurrency brokers to provide information about customers engaged in cryptocurrency transactions. A recent subpoena involves clients of SFOX, a prime cryptocurrency broker.

These subpoenas are due in part to the IRS’s focus on closing the tax gap (ie the difference between what taxpayers owe and what they actually pay). The agency has said significant tax compliance issues are linked to cryptocurrencies and other digital assets.

On the legislative front, the bipartisan Infrastructure Act, passed earlier this year, requires cryptocurrency brokers to report more information about their clients’ trading activity. The requirement, which was opposed by some lawmakers and some in the crypto industry, was set to begin in 2023. However, a bipartisan group of senators recently proposed legislation to further clarify the definition of broker in the Infrastructure Act. If enacted, the proposed legislation would essentially exempt digital asset and wallet providers, and software developers, from the information reporting requirements intended for cryptocurrency brokers.

The Inflation Reduction Act and Crypto

The newly proposed issue of virtual currency and increased focus on digital assets comes as the IRS is set to receive $80 billion under the Inflation Reduction Act — massive climate, energy, tax and health care legislation signed by President Biden on Aug. 16. About $46 billion of the IRS- the funding from the new law is designated for enforcement. And while enforcement will encompass a variety of activities, the Inflation Reduction Act mentions that IRS funds can be used for digital asset enforcement — including cryptocurrency tax compliance.

Biden’s Cryptocurrency Framework: In the latest crypto news, on September 16, President Biden also released a comprehensive framework for digital assets. The framework follows Biden’s March 9 Executive Order that calls for a holistic approach to government to address risks associated with digital assets, including cryptocurrency. Biden’s framework for regulating digital assets points to the volatility of crypto — and a multi-trillion dollar crypto crash in 2022 — as reasons for increased scrutiny and enforcement of digital assets.

All of these developments mean that significant resources and attention continue to be given to cryptocurrency tax enforcement. As a crypto investor, you must therefore be diligent and accurate with your tax reporting and compliance. Also, stay tuned for digital asset enforcement and related crypto news from Congress and the Biden administration.