IRS Says 1040 Cryptocurrency Question Is Meant to Be Broad

By: Nathan J. Richman

The income tax return question about cryptocurrency and digital assets is meant to capture more than just taxable transactions, according to IRS officials.

The question on the face of Form 1040 — the most recent draft replaced “virtual currency” with “digital asset” — isn’t meant to focus only on taxpayers’ taxable cryptocurrency transactions, but by checking “yes” they won’t trigger any sort of document matching program, Ronald Goldstein of the IRS Office of Associate Chief Counsel (Income Tax and Accounting) said November 2 at the American Institute of CPAs Fall Tax Division Meeting.

Checking yes doesn’t cause the IRS to assume that there should be some cryptocurrency income reported elsewhere on the return, according to Christopher Wrobel, also of the Office of Associate Chief Counsel (Income Tax and Accounting). The broad scope of the question is intentional, he added.

The AICPA recently suggested that the IRS explicitly limit the scope of the question on Form 1040 to only taxable transactions.

Goldstein said that taxpayers and their representatives shouldn’t be asking if they should check yes but why they can check no. The instructions say that merely holding cryptocurrency during a tax year is a reason to check no, he said.

The breadth of the question comes from the multiple functions it serves, including both IRS information-gathering and taxpayer education, according to Goldstein. Taxpayers with any uncertainty can just check yes with no downside and gain protection from IRS assertions that they negligently or fraudulently misreported, he said.

The area is novel enough that the IRS and Treasury don’t want taxpayers or professionals to leave the response to the Form 1040 question open to a later assertion that something wasn’t taxable and thus not reportable, Goldstein said. That said, the IRS won’t automatically cast a wary eye on taxpayers switching between no and yes in succeeding tax years, because there are situations like merely holding assets acquired in prior years that justify the change, he said.

The digital asset question and the accompanying instructions aren’t perfect and continue to evolve, Goldstein added.

Asked whether a taxpayer holding shares in an exchange-traded fund that includes digital assets should answer yes, Goldstein acknowledged that the result isn’t clear, so it’s probably safest to just check yes.

Goldstein acknowledged that Rev. Rul. 2019-24, 2019-44 IRB 1004, the IRS’s second piece of guidance on cryptocurrency, addressed only the results of hard forks. The revenue ruling mentioned airdrops as a possible way taxpayers receive new tokens after hard forks but doesn’t independently address what income results from airdrops, including marketing airdrops without any proximate hard forks, he said.