The IRS has given US crypto holders more clarity on how to report digital assets on their 1040 income tax forms.
The IRS has given US crypto holders more clarity on how to report digital assets on 1040 income tax forms, a possible precursor to regulatory guidance.
In a draft 2022 tax form instruction released late Monday, the Internal Revenue Service expanded how taxpayers can list their crypto transactions, including converting speech from “virtual currency” to “digital assets.”
“They are more in line with industry terminology and more inclusive of potential crypto transactions,” said Adnan Islam, tax partner at Marcum LLP.
Tax experts said the extra clarity is welcome, but getting guidance is still the number one question.
In August, the IRS expanded the crypto question on tax form 1040 to specify that taxpayers must report whether they received cryptocurrency as a “reward, prize, or compensation.”
The latest instructions change “virtual currency” to digital assets, referring to the definition in Section 6045 as amended in the 2021 Infrastructure Bill that expands reporting requirements for cryptocurrencies. This change addresses the ambiguity over whether a non-transferable token, or NFT, is considered a virtual currency. In the 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, TaxBit’s head of government solutions and a former senior advisor in the IRS’s Office of Senior Adviser.
“The IRS is ramping up by integrating its terminology around the term digital assets that was on the platform,” he said. “So it means that it is more likely than not in the near future, that we will see those filings come out and the IRS continue to move forward with some sort of regulatory system implementation. Perhaps sooner rather than later.”
Although there is no penalty for not checking a “yes” on Form 1040, a taxpayer who does not report their income may be subject to penalties and interest on unreported crypto income. Tax professionals said the detailed forms help taxpayers get clarity to prevent this.
Financial benefit is further specified in the updated draft instruction form, another area where the industry has been seeking guidance. “Financial interests,” she says, exist “if you are the owner of a digital asset registry, have an ownership interest in an account containing one or more digital assets, including rights and obligations to acquire a financial interest, or own a wallet containing digital assets.” .
“They never really defined what that means,” Fuller said.
The definition of a financial interest is what tax experts have come to expect, said Kevin Ainsworth, partner at BDO. Ainsworth said he’d like to see more specific examples, so taxpayers know if they want to check the box on the form.
The draft form states that if a taxpayer receives digital assets “as a result of mining, storage and similar activities,” they must check the “yes” box on the form. Lisa Zarlinga, a partner at Steptoe & Johnson LLP and a former legislative advisor on Treasury taxation, said “similar activities” could include decentralized finance, or DeFi, such as liquidity pools.
She noted that in a tax dispute, instruction forms are not binding guidelines, so taxpayers may not be able to rely on them.
“When you think about it, in practice, most taxpayers rely every day on the instructions when filling out their tax forms,” Zarlinga said. “And so it seems kind of unfair that if they relied on something that these instructions say, and then the IRS contests the matter, they wouldn’t be able to point this out in court and say that’s something that I rely on.”
Fuller said that the digital asset question on Form 1040 “has nothing to do with substantive taxation,” and is more dependent on disclosure, so it is likely to be used as “a kind of defense” for the argument.
Guidance or law — particularly in the fields of exploration and mining, and in processing NFTs — is what industry professionals say they want the most.
Trying to understand instructions and changes to forms is “like reading tea leaves,” Zarlinga said. She said she prefers guidance.
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