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Bitcoin wallet

Cryptocurrency continues to make inroads into our daily lives, including our taxes.

On Sept. 1, Colorado officially became the first U.S. state to allow its residents to pay their state taxes in bitcoin.

It's a pretty safe assumption that those Centennial State residents who pay state taxes with bitcoin also will be forthcoming at the federal level when it comes to their digital assets.

But for those who are less transparent, the Internal Revenue Service is stepping up its efforts to know about and collect on crypto transactions.

Legal action against hidden crypto: Last week, the IRS obtained a so-called John Doe summons requiring M.Y. Safra Bank to produce information about U.S. taxpayers who may have failed to report to the IRS, and pay taxes on, cryptocurrency transactions. 

A John Doe summons is an investigative tool used to determine the identity of unknown individuals who the IRS has reason to believe have been violating tax law. The summons requires a third party — such as a crypto exchange, bank, or credit card company, or, as in this case, a bank — to provide certain information to the IRS.

In this latest John Doe search, the IRS is seeking information about customers of SFOX, a cryptocurrency prime broker, who used banking services that M.Y. Safra Bank offered to SFOX customers engaged in cryptocurrency transactions.

New crypto broker reporting, 1099 form: The IRS should find its search for crypto tax evaders a bit easier next year. That's when a new third-party reporting system for cryptocurrency transactions will begin.

The tax code definition of broker was broadened under the Infrastructure Investment and Jobs Act that was signed into law late last year. It now is anyone "regularly providing any service effectuating transfers of digital assets on behalf of another" for consideration.

This law change will require those brokers to report information on cryptocurrency transactions on a new Form 1099-DA. The appended letters are for digital assets; the form is still in the works. But like its brethren 1099 forms, the 1099-DA will report the crypto info to both the IRS and the individuals making the transfers.

Broader 1040 crypto query: The 1099-DA isn't the only IRS form that will be tracking crypto.

This summer, the IRS released a draft version of the basic individual income tax return Form 1040. The return tweaks for the upcoming filing season include a change in the wording of the agency's question concerning cryptocurrency.

It now will read, as highlighted in the excerpt below, "At any time during 2022, did you (a) receive (as a reward, award, or compensation); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?"

Form 1040 draft 2022 tax year_crypto question
See more tax forms and more about them at Talking Tax Forms.

The 2022 change is an expansion of the 2021 crypto question, which read, "At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?"

This planned elaboration on crypto holdings looks to be a way for the IRS to bring other forms of digital assets, such as nonfungible assets, or NFTs, into its previous cryptocurrency information collection effort.

The reason for the increased IRS interest is obvious. Despite the disruption this year in the cryptocurrency world, nearly half of bitcoin alone is, by some reports, being at a profit. Where transactions are made on those crypto assets, the IRS wants to ensure it gets its rightful tax cut.

And although IRS Criminal Investigation's Cyber Crime unit seized $3.5 billion worth of cryptocurrencies used for illegal purposes, Uncle Sam would rather collect on crypto the traditional, voluntary tax payment way.

The IRS is hoping its new forms and information collection will make that possible.

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