I previously wrote an article on the taxation of cryptocurrency. It details the tax ramifications and tax treatment of cryptocurrency property owned by a taxpayer. While the tax rules pertaining to cryptocurrency have not changed, compliance enforcement pertaining to complete and accurate reporting of virtual currency transactions is expected to increase at the IRS.
As taxpayers completed their 2020 IRS Form 1040, they may have noticed a new question on page 1. It reads:
At any time during 2020, did you receive, sell, exchange, or otherwise acquire any financial interest in virtual currency?
This question is not exactly new, but rather, it was moved from its former place on Schedule 1 of the 2019 Form 1040, to be displayed with new prominence on the 2020 Form 1040 immediately below the taxpayer’s name and address. Clearly this was an intentional reconfiguration by the IRS to stress the importance of cryptocurrency disclosure.
Given its new place on the Form 1040, every single taxpayer, regardless of their return’s complexity or the taxpayer’s status, must now make an affirmative disclosure to the IRS about their virtual currency ownership, or lack thereof. The IRS has previously stated its concerns that taxpayers have been failing to report cryptocurrency transactions, essentially underreporting potentially billions of dollars of taxable income. Now all taxpayers are in a position where they have no choice but to disclose their virtual currency activity.
The IRS is also aware that most cryptocurrency exchanges do not engage in third-party reporting. Thus, the IRS and the taxpayer do not typically receive IRS Form 1099-Bs (or an equivalent) that reports virtual currency transactions for a given tax year. Nevertheless, the taxpayer remains responsible for properly tracking, voluntarily reporting, and paying associated taxes with their cryptocurrency transactions. With the new placement of the cryptocurrency question on the Form 1040, failure to be forthright and honest is expected to have severe consequences. The Biden administration has unequivocally stated that it intends to empower and embolden the IRS by allocating additional funding for agents, audits, and compliance enforcement initiatives. Undoubtedly, cryptocurrency transactions will be prominent, ongoing IRS targets.
If a taxpayer indeed owns cryptocurrency but fails to honestly answer the cryptocurrency disclosure question, the IRS believes it will have a strong civil fraud claim against the taxpayer, in addition to the other fines and penalties it routinely levies on tax deficiencies. Ignorance of the law is not an excuse and defending this scenario under audit will be very difficult for taxpayers that get caught in this cryptocurrency trap.
Despite the initial 2020 filing season being well underway (2020 Form 1040s that were not on extension were due by May 17, 2021), it may still be possible to amend prior returns or pursue other good faith efforts with the IRS to clean up unreported cryptocurrency transactions, while possibly mitigating associated penalties or potential criminal investigations. Taxpayers who extended their 2020 Form 1040 and have not yet filed should ensure they honestly answer the cryptocurrency disclosure question and properly report any taxable transactions. Taxpayers who may be struggling with this issue should contact a McCarthy Lebit tax attorney for a consultation and to discuss their options. Consultations are confidential and protected.
