IRS makes change to crypto reporting

In the latest draft of IRS Form 1040, the agency has made a slight but essential change to the wording of the question related to virtual currency.

On the 2019 and 2020 tax returns, the following question appeared: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
The question led many people to wonder whether the IRS was trying to create a database of cryptocurrency investors, even if they had not sold their interests. It was also so broad that taxpayers and advisors found it tough to answer.

The new draft question seems to hint that the IRS is focused on taxable transactions. The new question is: “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in VC?”

The two most notable changes are the removal of the word “send,” which appeared in the 2020 version. Also, the agency has replaced “acquire any financial interest” with “dispose of any financial interest.”

Crypto tax compliance

The IRS has been cracking down on noncompliance with tax reporting requirements related to cryptocurrency investments.

The agency has been receiving far fewer tax returns reporting crypto investments than there are taxpayers invested in bitcoin and other virtual currencies. The original question was added to Scheduled 1 of the 2019 return in an attempt to boost compliance.

The IRS soon realized that Schedule 1, which is used to report business income, rental property income, and other things such as moving expenses and self-employment taxes, isn’t filed by many taxpayers. For example, a W-2 wage earner who invested in bitcoin wouldn’t be required to file Schedule 1 and would be missed.

Then, for the 2020 return, the IRS moved the question to the top of Form 1040, which every taxpayer has to file. As a result, the IRS got a somewhat more complete answer to its question.

Tough to answer

Taxpayers and their advisors found the original question challenging to answer.

For one thing, the IRS hadn’t provided guidance on what each element of the question covers. For example, what counts as a “financial Interest” in cryptocurrency? Taxpayers wondered if owning an interest in a company that mines cryptocurrency would qualify.
The major impact of the changed language is that it seems that taxpayers would no longer have to say “Yes” if they sent cryptocurrency between wallets or exchanges or simply bought some.
The 2021 draft Form 1040 is likely to be revised before being finalized and it remains to be seen whether clearer guidance on answering this question will be provided.