Digital Assets Taxation
The Internal Revenue Service (IRS) has updated its approach to the taxation of digital assets. The change has involved the use of the term “digital assets” instead of “virtual currencies.” The IRS has also clarified and expanded the instructions for the digital asset question that appears on Forms 1040, 1040-SR, and 1040-NR. The question requires taxpayers to report all income related to their digital asset transactions.
What are Digital Assets?
Digital assets refer to digital representations of value that are recorded on a secure, distributed ledger. They include convertible virtual currency, cryptocurrency, stablecoins, and non-fungible tokens (NFTs).
Who Must Answer the Digital Asset Question?
All taxpayers who file Forms 1040, 1040-SR, or 1040-NR must answer the digital asset question. This requirement applies regardless of whether the taxpayer engaged in any transactions involving digital assets in the year.
When to Check “Yes” on the Digital Asset Question
A taxpayer must check “Yes” if they:
- Received digital assets as payment for property or services;
- Transferred digital assets as a gift;
- Received digital assets resulting from a reward or award;
- Received new digital assets from mining, staking, and similar activities;
- Received digital assets resulting from a hard fork;
- Disposed of digital assets in exchange for property or services;
- Disposed of a digital asset in exchange or trade for another digital asset;
- Sold a digital asset;
- Otherwise disposed of any other financial interest in a digital asset.
How to Report Digital Asset Income
Besides checking “Yes” on the digital asset question, taxpayers must report all income related to their digital asset transactions. For example, an investor who held a digital asset as a capital asset and sold, exchanged, or transferred it during the year must use Form 8949 to calculate their capital gain or loss on the transaction and then report it on Schedule D (Form 1040) or Form 709 (in the case of gift).
Employees who were paid with digital assets must report the value of the assets received as wages. Similarly, independent contractors who were paid with digital assets must report that income on Schedule C (Form 1040). Schedule C is also used by anyone who sold, exchanged, or transferred digital assets to customers in connection with a trade or business.
When to Check “No” on the Digital Asset Question
A taxpayer who merely owned digital assets during the year can check “No” as long as they did not engage in any transactions involving digital assets during the year. They can also check “No” if their activities were limited to:
Holding digital assets in a wallet or account;
Transferring digital assets from one wallet or account to another;
Purchasing digital assets using real currency, including through electronic platforms such as PayPal and Venmo.
The IRS has updated its approach to the taxation of digital assets and has clarified the instructions for the digital asset question. Taxpayers must report all income related to their digital asset transactions and answer the question accurately. Failure to do so can result in penalties and fines. Taxpayers who have questions or need assistance should consult a tax professional.