Individual taxpayers have probably noticed that they have been required to answer questions on Form 1040 about virtual currency transactions in recent years. The U.S. Congress has introduced, and in some cases passed, a variety of legislation addressing different aspects of cryptocurrency, although the federal government’s perspective of virtual commerce has not been timely nor in step with investors who actually acquire and use digital assets. The relatively modest amount of extant IRS guidance addresses cryptocurrency as property and reflects an attitude of suspicion towards the intentions of taxpayers who participate in the virtual exchange economy. Along these lines, the IRS Criminal Investigations (CI)_Cyber Crimes Unit pursues investigations related to cryptocurrency abuses—such as defrauding investors and laundering stolen cryptocurrency—among its targeted focuses. There is no question that such manipulations do occur, as evidenced by IRS CI seizing virtual currency valued at more than $3.5 billion in 2021 and already exceeding that in 2022 (FS-2022-19, March 2022, https://bit.ly/39EerYl).
The taxation issues surrounding virtual currency are something that many tax professionals will find both interesting and necessary to serve clients who participate in the crypto economy. This month’s column presents several resources that may provide some insight.
Internal Revenue Service
The IRS Virtual Currencies webpage (under “small business and self-employed”) provides access to some of the federal tax guidance on reporting virtual currency taxable transactions (https://www.irs.gov/businesses/small-businesses-self-employed/virtual-currencies). The page links to Notice 2014-21, Revenue Ruling 2019-24, and several IRS publications that may be pertinent to cryptocurrency transactions, such as Publication 525, “Taxable and Nontaxable Income.” The Frequently Asked Questions feature should not be overlooked; it may be the most useful tool on this web page.
IRS Notice 2014-21 (https://www.irs.gov/pub/irs-drop/n-14-21.pdf) generally addresses the IRS’s perspective on the use of virtual currency to pay for goods or services or to be held as an investment. The majority of the notice consists of FAQs that outline pertinent definitions and tax law applications. For example, Q-1 states that virtual currency is treated as property for tax purposes. Q-2 indicates that virtual currency is not treated the same as a foreign currency.
Revenue Ruling 2019-24 (https://www.irs.gov/pub/irs-drop/rr-19-24.pdf) applies IRC sections 61, 1011, and 451 to crypto-currency transactions. The FAQs (below) explain the terms “hard fork” and “airdrop”; briefly, a hard fork is a permanent split in the blockchain that creates a new branch of the currency. An airdrop occurs when new tokens are deposited into users’ wallets, which can result from hard forks, but can also be from other events. Further compounding the complexity, a recipient may or may not have dominion or control, which also affects whether gross income has been actually or constructively received.
The Frequently Asked Questions on the IRS Virtual Currencies webpage is a useful feature that expands upon the FAQs begun in Notice 2014-21 and covers many practical issues, beginning with what is virtual currency, how is cryptocurrency treated for tax purposes, and what is cryptocurrency, as well as questions about specific transactions (https:/www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions). The FAQs define virtual currency as a digital representation of value that functions as a unit of account, store of value, and medium of exchange. Cryptocurrency is a type of virtual currency that is digitally recorded on a distributive ledger. As per Notice 2014-21, virtual currency is treated as property and generally falls under the tax rules applicable to property transactions.
In addition to the resources linked on the IRS Virtual Currency web page, there are two other items that readers may find useful. First, the most recent Tax Time Guide information release (IR-2022-45, March 1, 2022, https://bit.ly/3b2gZQp) provides a handy list of taxable virtual currency transactions, such as the receipt of virtual currency as payment for goods or services provided, the receipt of new virtual currency as a result of mining and staking activities, and any disposition of a financial investment in virtual currency. A second resource addresses more complicated issues. Office of Chief Counsel Memorandum 202114020 (April 9, 2021) clarified the Revenue Ruling 2019-24 position concerning whether a taxpayer who received Bitcoin cash as a result of a well-publicized August 2017 Bitcoin hard forks had taxable gross income under IRC section 61; the decision came as a surprise to many taxpayers (https://bit.ly/3NXY9bM).
AICPA Virtual Currency Tax Guidance
The AICPA’s Virtual Currency Tax Guidance and Resources webpage (https://www.aicpa.org/resources/article/virtual-currency-tax-guidance-and-resources) provides access to a selection of AICPA and IRS materials. “Navigating the World of Crypto Tax Reporting” (https://bit.ly/3tHoEua) is a 12-page PDF prepared in partnership between CPA.com and Lukka, Inc. AICPA members can access it without charge after logging in, and the general public is granted a one-time access with registration. The booklet presents a handy glossary of crypto terminology, an overview of IRS guidelines, a discussion of tax reporting challenges, and an explanation of how CPAs can play a role—especially for reporting entities.
The AICPA offers two 20-minute podcasts, including “Dissecting the Latest in the World of Crypto Assets and Taxes (Oct 6, 2021, https://bit.ly/3tI8eBu). This presentation covers the basics of cryptocurrency and some of the terminology, taxation of cryptocurrency and IRS guidance, and recommendations for addressing IRS notices to clients regarding virtual activities. The podcast webpage includes links to several related resources. “Cryptocurrency: Discover Three Ways to Add Value for Your Clients” (May 2022, https://bit.ly/3QmvUoK) presents ideas for CPAs to assist clients who are interested in investing in virtual currency, along with tax planning and reporting considerations.
Other Cryptocurrency Taxation Resources
With little official guidance on the expected increase in third-party reporting requirements targeting tax evasion in the virtual economy, as well as learning some of the technical crypto terminology, readers may be interested in some helpful materials from commercial vendors.
Basics & Beyond, Inc., is a commercial provider of tax-related continuing professional education for CPAs. The company provides a monthly newsletter on its Tax News and Events blog (https://www.cpehours.com/blog/) that covers a variety of tax topics and sometimes offers additional tools and resources. “The Tax Considerations of Cryptocurrency: An Accountant’s Primer” (January 2022), covers much of the basic terminology and also lists some software options (https://bit.ly/3NY08wK). The must-see item, however, is the sample “Client Letter: 2023 IRS Cryptocurrency Reporting Requirements” in the April 2022 newsletter (https://www.cpehours.com/tax-newsletter-april-2022/).
Cryptocurrency software providers can be a good source for basic tax information, and a small selection is presented below.
Social Finance, Inc.’s “Crypto Tax Guide 2022: How to Report Crypto on Your Taxes” is available in webpage format and covers the topic from the transaction tax effects perspective (https://www.sofi.com/learn/content/crypto-tax-guide/). Verady, Inc’s Legible Platform “Best Practices for Crypto Tax Reporting – A Guide for Tax Professionals” (February 2022) can be viewed on its website (https://bit.ly/3u5FFyn) at or downloaded as a PDF. Cointracker’s website offers a “Cryptocurrency and Bitcoin Tax Guide (2022 Edition)” webpage (https://www.cointracker.io/blog/crypto-tax-guide) with extensive hyperlinks.
Finally, Global Legal Insights is a publisher of books addressing specific legal practice areas. It is currently offering a free online-only view of a book chapter, “Blockchain & Cryptocurrency Law and Regulation 2022: 14 U.S Federal Income Tax Implications of Issuing, Investing and Trading in Cryptocurrencies” which presents an understandable tax law discussion, including footnotes identifying the specific primary source law (https://bit.ly/3NW2WdP).