IRS offers guidance on how to answer the tax return digital assets question

January 22, 2024

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IRS offers guidance on how to answer the tax return digital asset question

On Jan. 11, the first day of trading after the Securities and Exchange Commission approved exchange-traded funds (ETFs) tied to bitcoin, companies offering such products saw $4.6 billion in transactions.

The investors who were first to board the bitcoin ETF train will have to deal with the associated tax route next filing season.

This year, however, the Internal Revenue Service is reminding taxpayers that, in most cases, they need to report their cryptocurrency transactions and, where applicable, pay any income tax due from those digital assets.

And all filers get notice of that tax responsibility early in the filing process.

Crypto question on more 2023 tax forms: As has been the case for several years, filers of Forms 1040, the main individual income tax return; 1040-SR, the form filed by age 65 or older taxpayers; or 1040-NR, the form for U.S. nonresident alien taxpayers will see a crypto question.

This year, the crypto question has also been added to four other forms. It now must be answered by filers of —

Form 1041, U.S. Income Tax Return for Estates and Trusts;
Form 1065, U.S. Return of Partnership Income;
Form 1120, U.S. Corporation Income Tax Return; and
Form 1120-S, U.S. Income Tax Return for an S Corporation.

Below is a screen capture of the crypto question as it appears on Form 1040.

Form 1040 TY2023 Digital Assets question starred

See more tax forms and more about them at Tax Forms 2024.

The query is tweaked on the other forms for corporate, partnership, or estate and trust taxpayers, to reflect those filers using it, but all ask the same basic question:

At any time during 2023, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?

Answers required of all filers: Everyone who files any of these seven forms must check one box answering either "Yes" or "No" to the digital asset question.

To help you answer, the IRS offers this description —

A digital asset is a digital representation of value that is recorded on a cryptographically secured, distributed ledger or any similar technology.

The IRS also notes for reference some common digital assets. They include —

Convertible virtual currency and cryptocurrency;
Stablecoins; and
on-fungible tokens (NFTs).

When "No" is the correct answer: Normally, if you merely owned digital assets during 2023, you can check the "No" box as long as they did not engage in any transactions involving the assets during the year.

You can also check the "No" box if your activities were limited to one or more of the following —

Holding digital assets in a wallet or account;
Transferring digital assets from one wallet or account they own or control to another wallet or account they own or control; or
Purchasing digital assets using U.S. or other real currency, including through electronic platforms.

If you're able to answer no, check the "No" box. Don't just ignore the question. The IRS emphasizes that it requires the answer from all taxpayers, not just by those who engaged in a transaction.

Failing to answer, regardless of whether your response, means your return is incomplete. And that could slow the processing of your return.

If you're getting a refund, delayed processing will mean it will take longer for the IRS to send you your tax cash.

When to check the "Yes" box: Then there are the moves that the IRS considers digital transactions.

The IRS says that you generally must check the "Yes" box if you —

Received digital assets as payment for property or services provided;
Received digital assets resulting from a reward or award;
Received new digital assets resulting from mining, staking, and similar activities;
Received digital assets resulting from a hard fork (a branching of a cryptocurrency's blockchain that splits a single cryptocurrency into two);
Disposed of digital assets in exchange for property or services;
Disposed of a digital asset in exchange or trade for another digital asset;
Sold a digital asset; or
Otherwise disposed of any other financial interest in a digital asset.

These transactions may or may not produce taxable income. Regardless, still answer the question "Yes" if applicable.

Report your digital asset income: If you checked the "Yes" box, you might also have received income associated with the digital asset. You now must report it on your tax return.

The IRS provided the following examples of income-producing digital transactions and how to report the amounts.

If you held a digital asset and then sold, exchanged, or transferred it, you must file Form 8949, Sales and other Dispositions of Capital Assets, to figure the digital asset's capital gain or loss on the transaction. Then report the Form 8849 amount on Schedule D (Form 1040), Capital Gains and Losses.
If you disposed of any digital asset by gift, you may be required to file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
If you are an employee and were paid with digital assets, the value of the assets received must be reported as wages on your appropriate 1040 form.
If a taxpayer worked as an independent contractor and was paid with digital assets, they must report that income on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship). Schedule C is also used by anyone who sold, exchanged or transferred digital assets to customers in connection with a trade or business.

More crypto questions and answers: If you have questions about your digital asset tax responsibilities, talk with your tax adviser. Your tax professional can help you negotiate the checkbox, filing, and reporting requirements.

Before that discussion, you can find more on crypto taxes in the Form 1040 instructions, as well as at IRS.gov' special pages on Digital Assets and Frequently Asked Questions on Virtual Currency Transactions.

Evolving digital asset tax tracking: The IRS' growing interest in cryptocurrency and digital assets reflects the overall interest and increase in the holdings.

The IRS in 2019 sent letters to more than 10,000 bitcoin et al investors to educate them about their tax responsibilities, encourage them to report their transactions, and, of course, get payment where due. That outreach worked out pretty well.

It followed up the next year, with the first question about crypto holdings and transactions appearing on the tax year 2020 Form 1040. That query was relatively easy to overlook, so the query has been tweaked a bit each year as the U.S. Treasury, financial communities, and taxpayers get more involved and comfortable with the assets.

And the Infrastructure Investment and Jobs Act of 2021 (IIJA) requires cryptocurrency exchanges share information with the IRS.

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