The IRS’s newly released draft instructions for Form 1040 add a line to the description of the now-prominent question about a taxpayer’s cryptocurrency to clarify what sorts of transactions the agency wants reported.
The draft instructions, dated October 23, move the virtual currency clarifications up to the sections governing the main body of Form 1040, following the repositioning of the reporting checkbox from Schedule 1.
Aside from some revisions related to the question's prominence, the main change in the instructions is the addition of this statement: “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 you own or control to another that you own or control.”
According to James Creech of the Law Offices of James Creech, “The clarification as to if transferring currency in between wallets you control requires a ‘yes’ response is a welcome one.” He said the broad wording of the 2019 version of the cryptocurrency question created problems for both the IRS and taxpayers. “Stating that taxpayers are not required to answer yes for transfers between wallets they control is a good start to solving these problems,” he told Tax Notes on October 26.
Zhanna A. Ziering of Caplin & Drysdale Chtd. pointed out the benefit of having something excluded from the definition, compared with the prior version, which only gave examples of what was included. Whether to report based on a taxpayer’s transfers between their own accounts or wallets had been one question people were asking, she said.
Taxpayers and practitioners have been concerned that the form’s simple yes-or-no question — “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” — could cover a surprisingly broad array of situations, particularly taxpayers that don’t actually have any cryptocurrency-related income to report.
The FAQs that the IRS published in October 2019 make clear that the agency doesn’t consider a taxpayer’s transfer of cryptocurrency between multiple wallets or accounts to be a taxable event.
Creech said taxpayers have been anxious that when they have to answer yes to the Form 1040 question even though they have no virtual currency income, their tax returns could appear incomplete, at least on the surface. Taxpayers still have to worry about checking the box when they buy cryptocurrency for long-term investment, “but as I said, it is a good start,” he added.
Looking for Focus
Like the 2019 instructions, the draft for the 2020 tax year states that reportable cryptocurrency transactions include free receipt or transfers of virtual currencies, although there is a slight revision to the hard fork reference. Creech said the 2020 draft question and instructions still don’t address what happens to a taxpayer unaware of a hard fork.
Ziering said that while the clarification in the draft instructions is a step in the right direction, taxpayers and practitioners need more. “The instructions should be crystal clear” and specifically describe what transactions to report, rather than rely on inclusion or exclusion guideposts, she said.
Ziering said that while the IRS might respond by pointing to the rapid change in this area, that shouldn’t be a problem because the agency could update the cryptocurrency instructions each year. “Both the taxpayers and the IRS at this point would benefit more from clarity and precision, rather than wiggle room,” she said.
The COVID-19 pandemic could further raise the importance of addressing cryptocurrency questions — reporting, in particular — as more people move away from higher-contact forms of payment like cash, Ziering said.