(Bloomberg Law) – The IRS has given US cryptocurrency holders some more clarity on how to report digital assets on their 1040 income tax forms, a likely precursor to regulatory guidance.
In the 2022 draft tax form instructions released late Monday, the tax agency expanded the way taxpayers should list their crypto transactions, including switching the vocabulary from “virtual currency” to “digital assets.”
“They are a little more attuned to industry terminology and better at considering potential crypto transactions,” said Adnan Islam, tax partner at Marcum LLP.
The added clarity is welcome, tax experts said, but advice is still their top priority.
In August, the IRS expanded the crypto question on the 1040 tax form to specify that taxpayers should report whether they received crypto as a “reward, award, or compensation.”
The latest instructions change “virtual currency” to digital assets, a nod to the definition in Section 6045 in the amended Infrastructure Act of 2021, which expanded reporting requirements for cryptocurrencies. This change resolves the ambiguity over whether a non-fungible token or NFT is considered virtual currency. As updated, the agency explicitly states, digital assets include NFTs and virtual currencies.
The change in terminology bodes well that the agency is preparing more guidance, said Miles Fuller, head of government solutions at TaxBit and a former senior counsel in the office of chief counsel at the IRS.
“The IRS is stepping up its terminology by consolidating its terminology around this digital asset term that was in the law,” he said. “So that means that in the near future it is more likely than not that we will see these regs come out and the IRS continue to move forward with the implementation of some sort of regulatory regime. Probably sooner rather than later.”
While there is no penalty for not ticking “yes” on the 1040, a taxpayer who underreports their income could face penalties and interest on the unreported crypto income. The drafted forms will help taxpayers provide clarity to prevent that, tax experts said.
Financial interest is further defined in the updated draft instruction form, another area where the industry has requested guidance. “Financial interests,” it says, exist “if you are the registered owner of a digital asset or have an ownership interest in an account that contains one or more digital assets, including the rights and obligations to earn a financial interest, or you own a wallet containing digital assets.”
“They never really defined what that means,” Fuller said.
The definition of financial interest is in line with what tax professionals would expect, said Kevin Ainsworth, a partner at BDO. Ainsworth said he’d like to see more specific examples so taxpayers know if they need to tick the box on the form.
The draft form states that if a taxpayer received digital assets as a “result of mining, staking, and similar activities,” then they should check the “yes” box on the form. “Similar activities” could include decentralized finance activities or DeFi, such as B. Liquidity pools, said Lisa Zarlenga, a partner at Steptoe & Johnson LLP and a former tax advisor for the Treasury Department.
In a tax dispute, instruction forms are not authoritative guidance, so taxpayers may not be able to rely on them, she noted.
“In practice, if you think about it, most taxpayers rely on the instructions when filling out their tax forms,” Zarlenga said. “And so it seems kind of unfair that if they were going to rely on something these instructions say and then the IRS challenges it, they couldn’t point it out in court and say that’s something I trust.” had left.”
The digital asset question on the 1040 form “has nothing to do with tangible taxes” and is more disclosure-based, Fuller said, so it could potentially be used as a “mode of defense” against an argument.
Guidance or legislation — particularly in the areas of staking and mining, and how NFTs are treated — is what industry experts 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 would prefer leadership.
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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