In 2014, the IRS issued guidance explaining that virtual currency is treated as property for income tax purposes. It stated that tax principles applicable to transactions involving other types of property apply to virtual currency. In the last two years, the IRS has replaced the term “virtual currencies” with the term “digital assets.
Taxpayers are obligated to answer a question on their 2022 federal return regarding digital assets and report all digital asset-related income.
The question appears in the following forms:
- Form 1040, Individual Income Tax Return;
- Form 1040-SR, U.S. Tax Return for Seniors; and
- Form 1040-NR, U.S. Nonresident Alien Income Tax Return, revised to update the new terminology.
This year, the IRS updated the instructions for these forms. Provisions were added to help clarify the question and help taxpayers answer it correctly. All taxpayers must answer the question even if they did not engage in any digital asset transactions.
This year’s forms for 2022 ask:
“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)?”
What is a Digital Asset?
The IRS uses a broad definition of “digital assets.”
“Any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified . . .”
The following are some examples of digital assets:
- Convertible virtual currency and cryptocurrency
- Stablecoins
- Non-fungible tokens (NFTs)
Digital assets are not real or “flat” currency because they do not serve as coin or paper money of any country and are not digitally issued by a government’s central bank. They do have an equivalent value in real currency and can substitute for real currency.
Digital assets are sometimes referred to as convertible virtual currency. A cryptocurrency is an example of a convertible virtual currency that you can use to pay for goods and services. You can also use it to trade for other digital assets, or you can exchange it for or into real currencies or digital assets.
Typically, a taxpayer must check the “Yes” box if they:
- 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;
- Received digital assets as payment for property or services that they provided;
- Transferred digital assets for free as a bona fide gift;
- Received digital assets as a reward or award;
- Received new digital assets from mining, staking, and similar activities;
- Received digital assets from a hard fork (a branching of a cryptocurrency’s blockchain that splits a single cryptocurrency into two);
- Otherwise disposed of any other financial interest in a digital asset.
You can check the “No” box if you did not engage in any transactions involving digital assets during 2022. You can also check the “No” box if their activities were limited to one or more of the following:
- Holding digital assets in a wallet or account;
- Transferring digital assets from one owned or controlled wallet or account to another wallet or account owned or controlled; or
- Purchasing digital assets using U.S. or other real currency, including electronic platforms such as PayPal and Venmo.
How to Report Income from Digital Assets
To properly report income digital assets, check the “Yes” box and file the appropriate form. For example, if you sold or transferred a digital asset as a capital asset, you would use Form 8949, Sales and other Dispositions of Capital Assets, to calculate your capital gain or loss on the transaction and then report it on Schedule D (Form 1040), Capital Gains and Losses, or Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, in the case of a gift.
Employees and independent contractors paid with digital assets must report the value of assets received as wages and compensation respectively. They must report this income on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship).
Talk to a Qualified Tax Professional!
If you live in New York or the Tri-State area and have any questions about any tax-related issue, including digital assets, call 212-490-0704 today for a FREE consultation. You can also learn more online here – THE TAX EXPERTS. We can help you maximize your tax savings for 2022, as well as help you plan now to save on your 2023 tax bill!
