Crypto Investors Get Answers in US Tax Form Instructions

The IRS has given US cryptocurrency holders a bit more clarity on how to report digital assets on their 1040 income tax forms, a likely precursor to regulatory guidelines.

In draft 2022 tax form instructions released late Monday, the Internal Revenue Service expanded how taxpayers must list their crypto transactions, including shifting verbiage from “virtual currency” to “digital assets.” .

“They are a bit more attuned to industry terminology and are more inclusive of potential crypto transactions,” said Adnan Islam, tax partner at Marcum LLP.

The extra clarity is welcome, tax professionals said, but getting advice remains their first request.

In August, the IRS expanded the crypto question on tax form 1040 to specify that taxpayers must report whether they received crypto as a “reward, reward, or compensation.”

The latest instructions change “virtual currency” to digital assets,” a nod to the definition in Section 6045 as amended in the 2021 Infrastructure Bill that expanded crypto-reporting requirements. change. This change resolves the ambiguity as to whether a non-fungible token, or NFT, is considered virtual currency. In the updated form, the agency explicitly states that 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, head of government solutions at TaxBit and former senior counsel for the Office of Chief Counsel for the IRS.

“The IRS is stepping up to merge their terminology around this term digital asset that was in the statute,” he said. “So that means more likely than not in the near future we’re going to see these regulations come out and the IRS continue to move forward with some sort of implementation of a regulatory regime. Probably sooner rather than later.

While there is no penalty for not checking “yes” on Form 1040, a taxpayer who underreports income could be subject to penalties and interest on unreported crypto income. The elaborate forms help taxpayers get clarification to avoid this, tax experts said.

Financial interest is further defined in the updated draft instruction form, another area where industry was seeking guidance. “Financial interests”, he says, are present “if you are the registered owner of a digital asset, or if you hold an interest in an account that holds one or more digital assets, including the rights and obligations of acquire a financial interest, or you own a portfolio containing digital assets.

“They never really defined what that meant,” Fuller said.

The definition of financial interest is what tax practitioners expected, said Kevin Ainsworth, partner at BDO. Ainsworth said he would like to see more specific examples, so taxpayers know whether to tick the box on the form.

The draft form clarifies that if a taxpayer has received digital assets as a result of “mining, staking, and similar activities,” they must check the “yes” box on the form. “Similar activities” could include decentralized finance, or DeFi, activities such as liquidity pools, said Lisa Zarlenga, a partner at Steptoe & Johnson LLP and a former tax legislative adviser to the Treasury.

In tax litigation, instruction forms are not binding guidelines, so taxpayers may not be able to rely on them, she noted.

“When you think about it, in practice, most everyday taxpayers rely on instructions when filling out their tax forms,” ​​Zarlenga said. “And so it seems a little unfair that if they relied on something that those instructions said, and the IRS then disputed it, they couldn’t report it in court and say it’s something on which I leaned on.”

The digital asset question on Form 1040 “has nothing to do with substantial tax,” and it’s more disclosure-based, Fuller said, so it could potentially be used as a “sort of defence” to an argument.

Guidance or laws, particularly in the areas of staking and mining, and dealing with NFTs, are what industry professionals say they want most.

Trying to make sense of instructions and changes to forms is “like reading tea leaves,” Zarlenga said. She said she would prefer to be guided.