If you dabbled, or more, in innovative financial assets like crypto in 2022, then one of the most important lines on your 2022 tax return shows up early.
The section just below where you enter your (and, if married filing jointly, your spouse's) name, the Internal Revenue Service asks:
At any time during 2022, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)? (See instructions.)
Careful readers of tax forms will not that this year's 1010 query replaced the term "virtual currency" on the 2021 return with "digital asset."
In addition to showing up on the main Form 1040, this question also appears on Form 1040-SR used by taxpayers age 65 or older, and Form 1040-NR for nonresident alien filers.
Don't skip the query because you stuck to traditional currency and investments. The line has a box for both yes and no responses. "The question must be answered by all taxpayers, not just those who engaged in a transaction involving digital assets in 2022," says the IRS.
More explanation in the instructions: If you follow the form's instruction to see instructions, the guidelines to filling out your 1040 note that —
"Digital assets are any digital representations of value that are recorded on a cryptographically secured distributed ledger or any similar technology. For example, digital assets include non-fungible tokens (NFTs) and virtual currencies, such as cryptocurrencies and stablecoins. If a particular asset has the characteristics of a digital asset, it will be treated as a digital asset for federal income tax purposes."
When to say yes: If the digital assets explanation is still a little too vague — yes, I'm looking at you "characteristics of a digital asset" line — the 1040 instructions try to clear things up a bit.
They say you should check the "Yes" box if any time during 2022, you either —
- Received, as a reward, award, or payment for property or services, or
- Sold, exchanged, gifted, or otherwise disposed of a digital asset, or any financial interest in any digital asset.
The IRS also offers some examples of what would require affirmative acknowledgement from you regarding digital transactions. In addition to the various ways you can receive or dispose of digital assets specifically noted in the checkbox question, a "Yes" response is necessary if you —
- Received new digital assets as a result of mining, staking, and similar activities;
- Received digital assets as a result of a hard fork;
- 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;
- Transferred digital assets for free (without receiving any consideration) as a bona fide gift; or
- Completed any other disposal not listed of any other financial interest in a digital asset.
When to say no to this: Then there's the other possible checkbox answer.
If after reading this section's heading you're now hearing in your head the similarly-titled song from the Broadway hit Hamilton, come virtually sit next to me, my new musical friend. That invitation also applies if, again like me, you have no involvement with crypto.
We definitely can check "No" on the Form 1040 question.
In addition, the IRS says that a taxpayer who merely owned digital assets and held them in a wallet or account during 2022 and didn't engage in any transactions during the year also can check the "No" box.
The 1040 instructions say you also can check "No" box if your activities also were limited to —
- 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 such as PayPal and Venmo.
Reporting digital income: Of course, since the IRS does collect income tax, it has some reminders for taxpayers who were compensated with digital assets. They need to report those earnings so they can be counted in your tax calculations.
If you're an employee and were paid with digital assets, report the value of the assets received as wages on Form 1040, 1040-SR, or 1040-NR.
The same holds true for independent contractors paid with digital assets. Here, however, the digital asset payment value is reported on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship). Schedule C is also is the form to use if you sold, exchanged, or transferred digital assets to customers in connection with a trade or business.
Investors who had digital holdings as a capital asset — which is how the IRS views cryptocurrency, rather than any coin of any realm — and sold, exchanged, or transferred them during 2022 must detail that activity on Form 8949, Sales and other Dispositions of Capital Assets. There you'll figure your capital gain or loss on the transactions, then transfer that amount to Schedule D (Form 1040), Capital Gains and Losses, or Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, if the digital asset was a gift.
More questions, this time from taxpayers: Obviously, the IRS 1040 instructions can only answer a few of the crypto tax questions. If you have crypto, you also should have a tax professional to help you negotiate the checkbox, filing, and reporting requirements.
At the very least, you also should check out the IRS' Digital Assets and Frequently Asked Questions on Virtual Currency Transactions. Those special IRS.gov pages earn this weekend's dual Saturday Shout Out.
Evolution of crypto tracking: The IRS' growing interest in cryptocurrency and digital assets reflects the overall increase, despite some market hits, 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 Form 1040. The query has been tweaked a bit each year as the U.S. Treasury, financial communities, and citizens 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.
IRS crypto interest sparks audit fears: The government's growing interest in crypto also has sparked concerns about increased audits of those who have these assets.
The latest change to the 1040 question has some convinced that a "Yes" reply will automatically prompt a closer IRS examination of their return. One digital tax specialist says those audit fears likely are unfounded.
"At this time, tax experts say that the IRS is asking this question to better understand how many Americans are actively transacting in cryptocurrency. There’s no evidence that answering 'Yes' could potentially lead to an audit," wrote Miles Brooks, a Certified Public Accountant and Director of Tax Strategy at CoinLedger, in an article for the crypto tax software company.
That was sort-of confirmed by Ronald Goldstein of the IRS Office of Associate Chief Counsel (Income Tax and Accounting) when he spoke last November to the American Institute of CPA's Fall Tax Division Meeting. He told the group that checking "Yes" won't trigger any sort of document matching program.
But, again, do check the appropriate box for your crypto circumstances.
"On the other hand," noted Brooks, "answering 'No' to the question when the taxpayer has relevant crypto transactions for the year could be considered tax fraud and lead to criminal penalties."
The bottom line is simply to answer the question honestly. And be ready to back up your response if the IRS does ask about it.
You also might find these items of interest:
- IRS stepping up crypto info and tax collection
- IRS clarifies when a cryptocurrency transaction isn't a tax transaction
- Auditors group latest to call for more crypto oversight in wake of FTX fiasco