Personal finance

The IRS Wants to Know About Your Crypto Transactions This Tax Season

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The tax season is fast approaching — and the IRS has its eye on crypto investors.  

Form 1040, which U.S. taxpayers use to file an annual income tax return, has a question about "virtual currency" near the top of the first page.

Investors must report taxable 2021 transactions involving bitcoin, ethereum, dogecoin and other cryptocurrencies to the federal government.

Such transactions include getting compensation in crypto, rewards for crypto mining or free coins via "Airdrops" or "hard forks" (when a cryptocurrency splits into multiple branches and creates a new coin), according to Shehan Chandrasekera, an accountant and head of tax at CoinTracker.

Converting crypto to cash, buying goods or services with it and converting one coin to another also qualify, he said.

Asking about crypto transactions isn't new, but the IRS has placed more emphasis on such tax reporting in recent years.

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The move comes as the White House and Democratic legislators aim to crack down on tax cheats. The crypto economy contributes to the so-called tax gap via lax reporting requirements that help facilitate tax evasion, according to a U.S. Department of the Treasury report issued earlier this year.

A new $1.2 trillion bipartisan infrastructure law requires annual tax reporting by digital currency brokers starting in 2023.

It also comes as cryptocurrencies have become more popular among investors. Tesla CEO and crypto enthusiast Elon Musk said this week the automaker would accept dogecoin as payment for some of its merchandise.

"[The IRS] is trying to capture the tax revenue in that growing market," Chandrasekera said. "Every year, there's a new wave of people coming into crypto who think it's not taxed."

The IRS first explicitly asked taxpayers about their crypto dealings for 2019 taxes. However, it posed the question on a Schedule 1 form, which not all taxpayers use. (That form reports certain types of income, such as unemployment benefits or rental income, that doesn't appear on the main 1040.)

The following year, the IRS placed the crypto question front-and-center on the 1040 — where it remained for the 2021 tax year.

However, the 2021 question is worded differently than it was for 2020. It asks taxpayers: "At any time during 2021, did you receive, sell, exchange or otherwise dispose of any financial interest in any virtual currency?"

Last year's phrasing encompassed some non-taxable transactions, like simply holding crypto or sending holdings from one digital wallet to another, Chandrasekera said. The change in wording translates to a narrower set of transactions, he said.

"This year, the question only asks about things that could lead to taxable events," he said.

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