You’re not alone if you entered tax season wondering what could you use as a write-off or if there’s any part of your income that perhaps the IRS doesn’t need to know about. A recent study suggests that 6% of American taxpayers might have “cheated” on their taxes in one way or another.
If you have had any dealings with cryptocurrency over the last year, you might be wondering if you need to tell the IRS about it. It’s natural to wonder, do I need to report crypto income? Will the IRS ever know?
In fact, it appears the IRS is on to the world of digital currencies. Recent changes to their forms suggest the IRS voluntary disclosure form is all about crypto. They want their fair share of the trillion-dollar market connected to crypto.
So, what is the impact of this new voluntary disclosure form on taxpayers who use digital currency? Read on to learn more about cryptocurrency’s impact on taxes and how the IRS is getting serious about collecting those taxes.
Cryptocurrency: How It Moved to Center Stage
It appears to all who are noticing that the IRS has taken notice of cryptocurrency, but they’ve also gotten serious about collecting from the revenue it generates.
But how did crypto get to where it is today? It started just over a decade ago as something techies played around with. Now the digital marketplace, including cryptocurrency, is worth trillions of dollars.
While there are many different kinds of cryptocurrency on the market, Bitcoin’s the most common and well-known. These virtual currencies are secured by cryptography.
They are unique because they are part of decentralized blockchain technology, making them impossible to counterfeit. Crypto refers to the encryption algorithms and cryptographic techniques that keep it safe and tamper-proof for users.
Cryptocurrency can be mined from the computer by solving intricate puzzles in the blockchain. Once solved, you’re rewarded with digital currency.
You can also buy digital currency from cryptocurrency exchanges.
It might have started with some techies playing on a computer, but now it’s a whole industry.
Cryptocurrency Getting Attention From the IRS
While it may have started with some online antics and some dedicated techies, It’s not that anymore. The IRS has not only taken notice of cryptocurrency; it’s now become a focus area for them.
The IRS fully recognizes the opportunity to collect tax dollars from a market that’s now worth so much.
The IRS has made it clear how they expect those who’ve had exchanges in digital currency to report it.
From the basic 1040 document that nearly every taxpayer uses to the newly revised Form 14457, the IRS is taking notice of this market and is adjusting accordingly.
The crypto voluntary disclosure changes make clear the IRS is serious about collecting tax dollars on digital currencies. They also intend to pursue those who don’t comply with disclosing their digital currency transactions.
1. How Is Digital Currency Taxed?
The tricky thing about digital currency is the challenge it creates to track and monitor it for anyone besides the owner. Part of the allure of crypto is how it remains untrackable to others.
This creates some challenges for the IRS. While you can use cryptocurrency to make purchases, the IRS doesn’t treat it like they would money. Part of that reason lies in their inability to monitor it.
The IRS doesn’t tax you for having cryptocurrency. They don’t tax you for seeking it out and building a stockpile. Instead, the IRS treats digital currency like they would property.
When you sell, trade, or dispose of cryptocurrency, the IRS wants to know about it.
Then it gets treated like any other assets you have.
If you mine crypto or even buy crypto, the IRS doesn’t care; and you don’t need to report it. When you start using it in your transactions, the IRS wants to know about it.
2. Form 1040
One of the first ways any taxpayer will know the IRS has taken a keen interest in cryptocurrency is when they see their 1040, 1040-SR, or 1040-NR forms.
Each of these forms lists the following question from the IRS, “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”
It’s one of the first things you’ll see when you start this form, and they want a clear yes or no from every taxpayer.
Remember, simply owning any form of cryptocurrency isn’t of interest to the IRS. The keywords in their question involved some type of transaction. Did you receive, sell, exchange, or dispose of?
Simply owning digital currency means you can answer no. However, if you’re involved in any transactional activities with your digital currency, the IRS expects you to answer yes.
You can even move your currency from wallet to wallet, and it’s okay to say no.
So, when should you answer yes to the crypto question?
- Received digital currency as payment for goods and services
- Received digital currency for free that doesn’t qualify as a gift
- Received new digital currency because of mining and staking activities
- Exchange of digital currency for goods, services, or property
- Traded in the digital currency where you were given more of it
- Sold digital currency
If you’re unclear if you should answer yes or no, you should check with your tax specialist.
3. Form 8949
If you’ve answered yes to the Form 1040 question, you will need to report to the IRS about your cryptocurrency. To do this, you will use Form 8949.
Your crypto interests could have brought you gains, losses, or both. Form 8949 is the form used by the IRS to report capital gains.
If your cryptocurrency transactions brought you profits, the IRS will expect you to pay capital gains on those profits. Form 8949 is what you’ll use to report those.
On the flip side, if you experienced losses, you can use those as a deduction.
In the early days of cryptocurrency, even transactions with cryptocurrency were challenging to trace. Now though, that is often not the case. Many larger firms attempt to maintain legitimacy and report those transactions to the IRS using Form 1099.
If the IRS gets sent tax information on Form 1099 for you and you haven’t reported it, you have a big problem.
4. Form 14457
The IRS Voluntary Disclosure Practice Preclearance Request and Application is IRS Form 14457.
The IRS understands people make mistakes in their taxes. They might miss something or even forget it’s something they should disclose.
Form 14457 allows taxpayers to disclose to the IRS something they should have declared but hadn’t in their previous tax forms.
You’ll notice the form title has the words preclearance request. This form comes in two parts. You must first apply to the IRS for preclearance to make you eligible to use Form 14457.
Seeking preclearance is Part I of the form. Once you’ve been granted preclearance, then you can submit Part II of the form to the IRS with the voluntary disclosure information.
The IRS does make a point of noting that just because you submit Part I of this form doesn’t mean you will automatically be approved to complete Part II. You should not submit Part II without preclearance.
5. Changes to Form 14457
Some tax specialists have questioned the voluntary disclosure IRS procedures. More on this shortly.
The changes to Form 14457, including crypto reporting revisions, addressed some of those concerns. The revisions to this form also showed the IRS’s intention to come after those with crypto claims that aren’t disclosed.
As recently as February 2022, the IRS announced changes to this form focusing on the expanded section related to reporting virtual currency.
This form basically allows a taxpayer who could potentially face prosecution for willfully not reporting something on their taxes to voluntarily disclose the information to stay out of more trouble.
Some of the changes to this form include:
- Expanded section for reporting virtual currency
- Identified penalty structure for employment tax and estate and gift issues
- A check-box for inability to pay in full if needed
While this form can be used for other voluntary disclosures beyond cryptocurrency, currently, tax specialists and those in the crypto world are taking note of the significance of the extended reporting section.
6. IRS Expectations
The fact that Form 14457, up to now, has commonly been used by those who wish to voluntarily disclose to the IRS because they risk criminal exposure also speaks to the cryptocurrency.
The IRS, including the expanded section on this form for reporting cryptocurrency, should tell those who have something to report that it’s time to come clean.
It elevates the significance of reporting those digital currency transactions, because they have so directly announced these changes and highlighted the information about cryptocurrency in all of their releases.
It should now be evident that the IRS intends to come after those who choose not to comply.
Questions about Voluntary Disclosure
Prior to the revisions of Form 14457, many tax experts questioned the fairness of the IRS asking individuals to identify themselves through voluntary disclosure.
In 2021, the National Taxpayer Advocate Annual Report was delivered to Congress. This report questions the legitimacy of asking taxpayers to come forward. The report questioned whether they would then be at risk with the IRS.
Another group, the Taxpayer Advocate Service (TAS), also questioned and voiced concerns about whether it was wise for taxpayers who dealt in digital currency to disclose information. Did the voluntary disclosure put the taxpayer at increased risk for criminal prosecution from the IRS?
Many experts believe the revisions addressed in Form 14457 address the concerns that were raised regarding voluntary disclosure.
Penalties for Noncompliance
You don’t have to know much about the IRS to understand that if they think you owe them money, they want it.
The IRS voluntary disclosure program in Form 14457 is a statement by the IRS that those using any form of cryptocurrency had better say so.
By adding the very straightforward question to Form 1040, the IRS has identified its focus on digital currency. Some experts also believe it’s significant that are using Form 14457 as a last-ditch opportunity to voluntarily disclose the digital currency.
This form has been used by the IRS to help other tax evaders avoid potential criminal prosecution through voluntary disclosure.
By addressing concerns with their previous program and increasing their questions about cryptocurrency, the IRS is making clear to those dealing in digital currency that should be telling the IRS or risk the full penalties capable from the IRS.
Getting Help With Your Digital Currency Tax Questions
When to make a voluntary disclosure about crypto can be slightly confusing. You don’t want to make a mistake, especially if you’ve dealt with a firm that will issue Form 1099 to the IRS.
If you own or have done transactions with any form of digital currency, you should consult with a tax specialist.
Let a tax lawyer help you wade through the expectations of the IRS regarding cryptocurrency.
You don’t want to make a mistake and not disclose it. If you’ve already filed your taxes, you may need to use the voluntary disclosure form to avoid further trouble with the IRS.
IRS Voluntary Disclosure Guidelines for Cryptocurrency
It’s clear that disclosing cryptocurrency income is now front and center with the IRS, and they expect anyone who has had a transaction related to digital currency to disclose it.
The IRS voluntary disclosure announcement connected to Form 14457 is noteworthy.
Do you need help with your taxes and cryptocurrency? Our tax attorneys can help get all your questions answered. We’ll help you figure out what you need to report to the IRS.
Contact us today so we can help you with your tax issues.