As we previously reported, the IRS recently updated Form 14457 (Voluntary Disclosure Practice Preclearance Request and Application) to include a section requiring disclosure of virtual currency. Virtual currency is a digital representation of value stored in electronic form and usable as a medium for exchange. Virtual currency can sometimes operate as a payment method akin to traditional currency, though it lacks legal tender status. Certain virtual currencies, such as the popular Bitcoin, have equivalent values in real currency and can be purchased or exchanged for U.S. dollars. For tax purposes, virtual currency is treated as property and general tax principles apply. As a result, the purchase, use, and even holding of virtual currency as an investment has tax implications and may create a liability. On the newly updated Form 14457, applicants must disclose all noncompliant virtual currency that they own or that is under their control.
Taxpayers can avoid noncompliance by timely reporting their virtual currency transactions during the 2021 tax year on Form 1040, Form 1040-SR, or Form 1040-NR. Each form asks, “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” All taxpayers – regardless of whether they have engaged in a virtual currency transaction – must answer this question “Yes” or “No.” Examples of common transactions that require the answer “Yes” include:
- The receipt of virtual currency as payment for goods or services, as a result of mining and staking activities, or as a result of a hard fork in virtual currency (a taxpayer receives gross income under Internal Revenue Code § 61 if and when the taxpayer obtains “dominion and control” after a “hard fork” which results in a taxpayer receiving a new cryptocurrency formed as a second generation from cryptocurrency they currently own).
- A trade of virtual currency in exchange for property, goods, services, or another form of virtual currency.
- Any sale of, or disposition of a financial interest in, virtual currency.
If a taxpayer received virtual currency as income, the value of that virtual currency must be reported as such. A taxpayer who answers “Yes” must also use Form 8949 to calculate any capital gain or loss and report it on their Schedule D.
Conversely, a taxpayer should answer “No” to the virtual currency question on Form 1040 if they did not own any virtual currency during 2021, or if they owned virtual currency but merely held it in their own account, transferred it between personally-held accounts, or bought it using real currency. For more information from the IRS about the tax consequences of holding or trading virtual currency, click here. For guidance on how to report virtual currency transactions on your 2021 tax returns, click here or contact Kostelanetz & Fink, LLP for assistance.