The IRS wants to know of any bitcoins or other cryptocurrencies you have. It will appear at the top of the first page of your Form 1040, below your address and name. The IRS wants to monitor crypto purchases and sales starting this year.
Anyone filing a tax return must answer this question under penalty of perjury, irrespective of whether they know what cryptocurrency is or have never heard of Bitcoin. Unfortunately, this is a trick question. It seems so limited; you’d think any cryptocurrency transaction is in a yes box. But this is not so.
This article will give you the insight you need to answer yes to this question and what you should do if you answered the question wrong.
Explaining Virtual Currency?
Virtual currency is a digital asset that has value in the real world. It can be used to purchase goods and services like traditional currency. However, virtual currency is not regulated by governments like conventional currency is. This makes it a desirable investment for some people because its value is not tied to the performance of a specific country.
The IRS is interested in only convertible cryptocurrency that can be exchanged for real cash or functions as a surrogate for actual money. The most widely recognized form of convertible virtual currency is cryptocurrency. Cryptographic language is utilized for safeguarding crypto-transactions, thus making counterfeit exchanges or double-spending practically unachievable.
With cryptocurrency, there is no centralized issuing or regulating authority; transactions and other units are recorded in a decentralized system. Bitcoin is the most frequently utilized cryptocurrency, but there are plenty of others, such as Ethereum, Litecoin, Dogecoin, Tether, and Binance Coin. Different cryptocurrencies other than bitcoins are also known as altcoins.
Virtual currency is considered intangible property for tax purposes, not money. In financial terms, it is treated as equal value to a stock or gold share.
When should you Agree?
The IRS only cares about gain or loss from virtual currency transactions that must appear on your tax return. Thus, you must answer “Yes” to the question “Virtual Currency?” only if you engage in any of the following eight types of transactions:
- You paid for goods and services in crypto: You are supposed to reply “yes” if you’re an independent contractor who was paid in crypto and earned taxable earnings. The digital market value you receive for the goods or services is your income. Virtual currency is self-employment income if received by independent contractors or sole proprietors to purchase services or sell goods. It is taxable wages if paid as wages by employers.
- You acquired goods/services using crypto: If you purchase goods or services with digital currency, you will have to answer “yes.” The value of the items or services is lower than your basis in your crypto or deductible loss if the value of the item or service is more significant than your investment.
- You traded crypto for paper currency: the answer is “yes” because you made a profit from the proceeds (or loss) of your cryptocurrency investment or held it in a crypto account. You took in a positive amount or a negative amount. Exemptions or surcharges are capital gains or losses.
- You traded crypto for crypto: the answer will be “yes” because you have taxable income related to new crypto value.
- Through mining, you earn crypto: mining involves the usage of supercomputers, through which miners solve complicated mathematical questions and are rewarded in the form of crypto. So, the answer is “yes.”
- Through staking, you earned crypto: Staking involves exchanging crypto on a cryptocurrency exchange or with another crypto platform for a set period, essentially like making interest on a bank account. Staking gives rise to taxable income, so reply to the question with a yes.
- Through a hard fork, you earned crypto: A split is a circumstance whereby specific rules under the blockchain set to change, creating a new cryptocurrency. If you take gain of your forked cryptocurrency, then, as a rule, you must confirm that you received taxable income from it. This would also require you to answer “yes”.
- Miscellaneous crypto earnings: The IRS dictates that you answer “yes” if you had any other disposition of a financial interest in virtual currency, such as donating them to charity. The IRS has given no guidance on this subject, but presumably, this means donating crypto.
The charity donation itself can be deductible as a charitable contribution if you itemize and no tax on the gain.
When should you answer No?
If you only had transactions involving cryptocurrency that were one of the three listed below, respond “no” to the virtual currency question.
- Bought crypto using paper money: You can answer “No” to this question, if your sole cryptocurrency-related business was the purchase of crypto with your real currency. Thus, you could purchase $1 million worth of crypto and respond no if you didn’t sell crypto throughout the year. This might seem odd because a person who purchases virtual currency obviously will experience a financial loss in exchange for it. The IRS only care if it lends to transactions that creates taxable income. If you buy crypto with real cash and hang onto it, you do not pay taxes, just like if you hold stock or gold and hang onto it.
- Crypto was gifted to you: If you received cryptocurrency as a true gift, answer no. You will not recognize income until you’ve sold, exchanged, or disposed of that cryptocurrency. Note a true gift occurs when someone gives you crypto for nothing of value in return.
- You move cryptocurrency from one wallet to another: If you move virtual currency from your wallet, address, or account to another wallet, address, or statement that also belongs to you, the transfer is tax-free. Do not Check the “yes” box to add this information to the tax return.
Strategies for wrong answers
It’s possible that people filled the Form-1040 crypto question incorrectly. For example, it is not
uncommon for some individuals who bought bitcoins and held on to them for the whole year may have answered “yes” to that crypto question. If that’s the case, do you have to amend your return? Depending on your circumstances, it’s up to you.
You said “yes” instead of “No”: Did you answer yes to the crypto question when you should have answered no?” You don’t have to take any action. The IRS is only interested in identifying information about taxable crypto transactions.
You said “no” instead of “yes”: If you answered “no” and you should have answered “yes”, you are required to pay tax on some or all of the virtual currency you traded that earned you any income. You will need to file an amended return, if the due date for your return has not passed you may file a superseding return instead.
If you don’t do this, you might get a letter from the IRS asking you to file an amended return and pay any taxes due. The IRS started sending such letters in 2019.
Points to remember
The main points for you to remember are:
- Form 1040 requires all U.S. taxpayers to clarify whether they have any cryptocurrency.
- The IRS is only concerned with income (or losses) from virtual currency transactions, this must be reported on the taxpayer’s return.
- If you purchase or sell goods or services with crypto, raise your crypto through mining or staking activities, exchange it for cold hard currency or another cryptocurrency, or receive brand new crypto from a hard fork, answer ‘yes”.
- If you only purchased crypto, received it as a gift, or transferred it from one wallet to another, answer “no”.
- If you don’t respond to the correct virtual currency question on your tax return, file an amended return if you had taxable virtual currency transactions you did not report.