A Few Gotchas: The 2020 IRS Virtual Currency Question

IRS virtual currency check-the-box for 2020

In our first ever Crypto Bullseye Blog where I talked about the virtual currency gotcha question for 2019. 

Guess what? The saga continues for 2020 and there are a few more twists to this ongoing tale. 

The "virtual currency question" has turned into a darker shade of gray. Read on...

In Part 1 of the this Blog we said the virtual currency question was introduced in 2019 BUT placed on Schedule 1.

This is a form that ONLY some people need to file so it could slip through the crack and become a gotcha because it must be answered under the penalty of perjury. 

The GOOD news...

As you can see from the screenshot above, the question was moved prominently to Form 1040, Page 1, so its impossible to leave out the question because EVERYONE files Page 1. 

***NOTE: I understand there many people think there is NO good news in having to answer that question at all. The point here is I'm making sure you don't step into quicksand.***

The BAD news...

You can still forget to answer (although unlikely with software) or answer incorrectly, the real GOTCHA.

Here is the question again for 2020 just underneath the name and address section:

At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency? Yes or No

• The 2020 DRAFT Form 1040 INSTRUCTIONS (See page 16 for DRAFT virtual currency instructions)
• The 2020 Form 1040 (screenshot above)

The Pitfalls:

The IRS added new language to the draft instructions attempting to make the answer clear, HOWEVER many tax practitioners think it creates more questions (gray areas) than it answers.

Example #1:

• "Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes."

Ok. So what are the characteristics? Is it one characteristic or ALL characteristics?

Example #2:

• "Virtual currency is a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, or a medium of exchange."

Ok. So does this mean stablecons are not considered virtual currency? If not you could check the box NO (if you only transacted in stablecoins) yet still have to report gains and losses from stablecoins.

Does this mean a stablecoin with a hard peg to USD etc.?: What about soft peg stablecoins, synthetic stablecoins and derivative stablecoins (a basket of "fiats") and so on. 

Does this mean only Central Bank Digital Currencies (CBDC)?

Example #3:

A transaction involving virtual currency includes, but is not limited to:

• The receipt or transfer of virtual currency for free (without providing any consideration) including from an airdrop or hard fork
• An exchange of virtual currency for goods or services
• A purchase or sale of virtual currency
• An exchange of virtual currency for other property, including for another virtual currency
• An acquisition or disposition of a financial interest in virtual currency

Ok. Whew. I don't know where to start on this list. We could probably do another blog for each bullet in the list. I'll pick a couple. 

What happens when a taxpayer gets an ETH token airdrop, for example, you know the kind you don't even know about? (A brick shows up inside your wall while you are sleeping)  

What does "financial interest" mean? A taxpayer could have an interest in a partnership transacting in crypto and they have no knowledge of it. (assuming they use no other crypto) This creates a good faith gotcha.

Takeaways: 

• The downside to spinning wheels trying to figure out how to answer NO is not worth it especially if you play with crypto. 
• If you buy, sell, trade, get paid in or pay others in crypto then you have to check yes. 
• For 2020, if you only BUY crypto and do NOT sell you have to check YES. That was not clear for 2019.
• If you only BUY which requires you to check yes then you don't report sales on Schedule D (and Form 8949) The IRS may think you failed to report sales and come knocking which is an unfortunate gotcha. 
• Some folks may transact with something other than virtual currency (which has the characteristics of virtual currency as noted above) ie. digital airline miles, any other digital credits, tokens etc. that a bitcoiner would say is not crypto, but the IRS expects a YES answer for. Good luck to these folks who act in good faith. 
• In incorrectly answered question subjects you to the penalty of perjury and that is not a good situation 
• Tax returns are amended all the time for various reasons so amending is routine matter

Good luck and remember your goal is a always a Crypto Bullseye™

Yours in Crypto, 

Kirk Phillips, CPA, CMA, CFE, CBP

DISCLAIMER: The information in this newsletter can not be construed as tax advice because tax advice can only be dispensed with an official engagement letter.