Written by: Marisa C. Harvey, CPA, Kaylee H. Wold, CPA
The popularity of digital assets is growing immensely, and many individuals are beginning to invest in virtual currencies, including cryptocurrencies, to reap the benefits of this emerging sector. The regulatory environment surrounding these assets is constantly evolving, and individuals who invest in cryptocurrencies should be aware of recent updates to tax guidance. We recently attended two events—the American Institute of Certified Public Accountants’ (AICPA) Preparing for the 2020 Crypto Tax Reporting & Compliance Season and the Massachusetts Society of Certified Public Accountants’ (MSCPA) Virtual Federal Tax Camp—that discussed these amendments and how they impact individuals and their tax requirements.
The Internal Revenue Service (IRS) is increasing its regulation of cryptocurrency transactions to ensure they’re correctly reported for tax purposes, so it’s extremely important to give your tax preparer the proper information needed to comply with the new requirements. Drawing on the new information showcased at these events, we’ve highlighted the most important tax legislation updates that are crucial for the compliance of individuals investing in cryptocurrencies.
Tax & Cryptocurrency: What You Need to Know
- There’s now a question on the U.S. Individual Income Tax Return 2020 Form 1040 asking whether a taxpayer invests in virtual currency
The IRS is becoming more stringent when it comes to reporting. On page one of the U.S. Individual Income Tax Return 2020 Form 1040, there’s now a question that states, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
It’s important to reach out to your tax preparer to let them know that you invested in cryptocurrency during 2020 so they can help you gather the right information needed for your tax return. The earlier you can alert your tax preparer to virtual currency activities, the better.
- Some virtual currency exchanges won’t issue a Form 1099-B
A Form 1099-B is a tax form that gives individuals information on capital gain and loss transactions. Most individuals rely on a Form 1099-B to provide all the details about their sales of investments, so they’re not in the habit of providing their tax preparer with details outside of what’s shown on the document.
However, many virtual currency exchanges won’t issue a Form 1099-B because taxpayer accounts or cryptocurrency wallets are anonymous, so senders and receivers aren’t publicly identifiable, making it difficult for the exchange to track who the currency went to. Some exchanges may provide a 1099-K, which only shows the gross payouts from transactions and doesn’t include basis or purchase and sale dates.
If the cryptocurrency exchange does not issue a Form 1099-B, the burden would then lie on the taxpayer to keep track of, record, and communicate what happens in their virtual transactions. In this circumstance, individuals would need to record all transaction information, and then communicate that information to their tax preparers so they can file their taxes accurately.
- If you’ve sold a virtual currency, give your tax professionals the details needed to calculate gain or loss as soon as possible after year end
Some major exchanges only allow an individual to download three months of transaction data. If you’ve been investing in cryptocurrencies for longer than three months, you may need to keep your own record of your transactions.
In the past, some exchanges have been hacked, which has caused them to restrict access to all transaction data while they remediated the situation. If you can’t access your information through the exchange, you need to have your own record of it.
- Taxable/Deductible Events & Non-Taxable Events
Various events involved in cryptocurrency are taxed differently (i.e. mining is taxed differently than the sale of currency). Individuals should make their tax preparer aware if they had various events so their preparer can help assemble the necessary information for each transaction.
|Taxable/Deductible Events||Non-Taxable Events|
- If a dependent child invests in cryptocurrency and they don’t file their own tax return, all information regarding this investment needs to be reported on the parents’ tax return, including the general question about virtual currency investments on page one of Form 1040
- Consider how you’re determining cost basis
There are several methods available to calculate your tax basis in your cryptocurrency investments, such as Specific Identification, Last In First Out (LIFO), and First In First Out (FIFO). Sometimes it isn’t possible to switch methods from one year to the next. Consult your tax preparer if you have questions about which method to use.
- The IRS is targeting noncompliance for cryptocurrency transactions
The IRS has been targeting individuals who haven’t been reporting their virtual currency investments and transactions. Make sure you’re aware of these potential risks and supply your tax preparer with all necessary documentation to ensure compliance.
The IRS also expanded its FAQs for virtual currency transactions to help any individuals seeking guidance.
Individuals investing in virtual currencies have more responsibility than ever to ensure they’re reporting these transactions accurately and thoroughly. It’s essential that individuals keep through records of all details regarding their virtual transactions, and supply their tax preparer with the necessary information to avoid noncompliance.