July 1, 2021
By Brad Polizzano, J.D., LL.M., New York City, and Mark Heroux, J.D., Chicago
Editor: Valrie Chambers, CPA, Ph.D.
The IRS and other agencies continue to expand efforts to enforce reporting compliance for taxpayers who transact in virtual currency. This discussion summarizes key recent developments to assist clients with proper reporting on 2020 tax returns and other filings.
2020 Form 1040
The 2020 Form 1040, U.S. Individual Income Tax Return, asks the following question on page 1: "At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?" The question appears underneath the name and address fields.
On the 2019 Form 1040, this same question (except for the year) appeared on Schedule 1, Additional Income and Adjustments to Income. The IRS moved the question to page 1 of Form 1040, presumably to require taxpayers who do not otherwise complete Schedule 1to address the question for the 2020 tax year.
This revision is a strong signal that the IRS considers virtual currency in the mainstream and is serious about enforcing reporting compliance. Note that the IRS continues to use the phrase "virtual currency" rather than cryptocurrency or cryptoasset.
The IRS defines "virtual currency" as 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, and/or a medium of exchange (Rev. Ruls. 2014-21 and 2019-24).
For purposes of reporting on Form 1040, 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 what the IRS defines as an airdrop;
- An exchange of virtual currency for goods or services;
- A sale of virtual currency;
- An exchange of virtual currency for other property, including for another virtual currency; and
- A disposition of a financial interest in virtual currency.
A transaction involving virtual currency does not include the holding of virtual currency in a wallet or account, or the transfer of virtual currency from one wallet or account to another wallet or account under the same ownership or control.
Furthermore, if during 2020 a taxpayer purchased virtual currency with real currency and had no other virtual currency transactions during the year, then, according to the IRS, the taxpayer does not have to answer yes to the question on the 2020 Form 1040 (IRS webpage, "Frequently Asked Questions on Virtual Currency Transactions," Q&A5 (March 2, 2021), available at www.irs.gov). This position seems inconsistent with the plain language in the question "did you . . . otherwise acquire any financial interest in any virtual currency?" A conservative position would be to check yes for the acquisition of any virtual currency. IRS FAQs do not constitute law.
In December 2020, Treasury's Financial Crimes Enforcement Network (FinCEN) announced in Notice 2020-2 its plans to propose amendments to regulations under the Bank Secrecy Act. FinCEN intends to include a foreign account holding virtual currency as a type of account reportable on an FBAR (FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR)).
At this time, FinCEN has not yet issued those proposed regulations. It is unclear whether the proposed regulations would be effective for 2020. It is also unclear whether the definition will include virtual currency held in "cold storage" wallets under self-control on a hard drive, as well as assets held on a virtual currency exchange located outside the United States. Also unclear is how the value of the accounts should be measured for FBAR reporting purposes, as the assets are not held in U.S. dollars.
Reporting requirements for banks and money services businesses
On Dec. 18, 2020, FinCEN proposed regulations that would expand the application of U.S. anti-money laundering rules to virtual currency. If finalized, the regulations would impose reporting and recordkeeping requirements on banks and money services businesses (MSBs), including many virtual asset service providers, that facilitate transactions in convertible virtual currencies and legal tender digital assets with self-hosted wallets and hosted wallets held in jurisdictions that FinCEN identifies as of primary money laundering concern.
More specifically, the two main components of the proposed regulations require banks and MSBs to (1) report convertible virtual currency (CVC) or digital assets with legal tender status (LTDA) exceeding $10,000; and (2) keep records of a customer's CVC or LTDA transactions and counterparties, including verifying the identity of their customers, if a counterparty uses an unhosted wallet or otherwise covered wallet and the transaction exceeds $3,000.
More to come
The messaging from the federal government is clear: Reporting rules for virtual currency will be many, will change, and will require practitioners to stay ahead of the curve to properly advise their clients.
Valrie Chambers, CPA, Ph.D., is an associate professor of accounting at Stetson University in Celebration, Fla. Mark Heroux, J.D., is a tax principal and leader of the Tax Advocacy and Controversy Services practice at Baker Tilly in Chicago, and Brad Polizzano, J.D., LL.M., is a senior manager at Baker Tilly in New York City. Mr. Heroux is a member of the AICPA Tax Practice & Procedures Committee. For more information on this article, contact firstname.lastname@example.org.