IRS Commissioner Charles Rettig, testifying before Congress in April 2021, estimated the gap between taxes owed and taxes collected in the United States to be close to $1 trillion. While there is some debate as to how much lax reporting on cryptocurrency transactions contributes to this so-called “tax gap,” with a market capitalization hovering at the time of writing around $2 trillion, cryptocurrency investments have increasingly become an object of regulatory scrutiny.
Virtual currency disclosure on Form 1040
Beginning with Notice 2014-21, the IRS has consistently taken the view that cryptocurrencies are property for U.S. federal income tax purposes. Absent any specific statutory or regulatory exception, U.S. individual taxpayers are generally required to report gains realized on the sale of property (including cryptocurrency) and pay tax on these gains. To remind taxpayers of this requirement, Form 1040 now specifically asks taxpayers whether they have received, sold, exchanged or otherwise disposed of any financial interest in any virtual currency. (The instructions define “virtual currency” for this purpose as a digital representation of value other than a representation of a “real” (i.e., fiat) currency that functions as a unit of account, a store of value, or a medium of exchange. Cryptocurrencies are included in this definition). The question on Form 1040 requires an affirmative answer of “yes” or “no” from all taxpayers.
A version of the virtual currency question was included on Schedule 1 of Form 1040 when it was introduced in 2019 but, beginning with the 2020 tax year, the question has had a more prominent position on page 1 (and, at that time, asked: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”). The wording of the question has been modified for the 2021 tax year to remove the word “send” and replace…
