This blog was last updated on August 26, 2020
Last week, the IRS released an updated draft of the Form 1040 to be used by individual taxpayers when reporting income taxes for the 2020 calendar year. The new version contains the question about whether a taxpayer held an interest in virtual currency assets on the front page of the form.
Crypto investors and the IRS
The IRS has been trying to track down crypto investors who are not claiming income related to their trading activities for some time.The IRS reported only receivIng about 800 to 900 income tax returns claiming crypto gains from 2013 to 2015. In 2017, they issued a summons to Coinbase demanding taxpayer information for all of their clients, which resulted in the exchange turning over information for about 13,000 taxpayers. By the spring of 2018, U.S. headlines screamed of overnight millionaires as Bitcoin soared over 1,000% in value. Last summer, the IRS issued audit notices to over 10,000 crypto taxpayers that they believed were underreporting or misreporting income associated with virtual currency transactions.
And last fall, the IRS added a question about virtual currency assets to the 2019 version of Schedule 1 – Additional Income and Adjustments to Income.
So why the change to the 1040 this year?
Previously, the question “did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” was located on Schedule 1 – Additional Income and Adjustments to Income. This Schedule is used by taxpayers to report 1099 income outside of bank interest and dividends as well as to adjust income for certain eligible deductions (separate from itemized deductions or the standard deduction).
For 2019, a crypto investor would have needed to receive a Form 1099 from the exchange related to their crypto transactions and then would complete the Schedule 1 accordingly. However, since most exchanges do not report Form 1099 or they report the Form 1099-K which follows an extremely high federal reporting threshold, many crypto investors do not have a form that would require them to complete Schedule 1.
As a result, many crypto investors are not required to complete Schedule 1 and therefore, the IRS is not receiving the information it intended.
By placing the question on the front page of Form 1040 however, the IRS can get information from a larger group of taxpayers about their virtual currency activity.
Why not just require 1099 reporting?
For over 30 years, the IRS has used Forms 1099, W-2, 1098 and other information returns to substantiate income and deductions made by businesses and individual taxpayers alike. Given this well-established practice of enforcing tax compliance, tax professionals (and crypto investors) continue to be baffled by the lack of clear guidance from the IRS on withholding and 1099 reporting requirements related to crypto transactions.
If businesses were required to issue Form 1099 for crypto transactions like all other U.S. businesses do for taxable transactions they make, the IRS would not need to spend resources on issuing legal summons to exchanges, auditing pockets of taxpayers one-by-one to find evaders and asking broad questions that will likely not reveal meaningful or enforceable tax information.
