IRS releases draft Form 1040 with new cryptocurrency question

The Internal Revenue Service has been posing questions on virtual currency on Form 1040 since 2020, hoping to understand and gather data around crypto transactions. These questions have mostly generated confusion without providing enough clarity to encourage large-scale compliance. The new question in the 2022 draft Form 1040 is likely no different, but could potentially offer more guidance than questions from earlier years simply because, for the first time, it refers taxpayers to the instructions.

The IRS began asking individual taxpayers on Form 1040 about their cryptocurrency transactions in 2020 with the question, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” This question was followed in the 2021 Form 1040 with "At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?" These were accompanied with a “yes” or “no” checkbox.

Taxpayers found these questions to be confusing.  There were several instances where it was unclear whether a taxpayer’s virtual currency activity constituted any of the transactions contemplated by the question or if the taxpayer’s digital assets were virtual currency for the purposes of the question.

For tax year 2022, in the draft Form 1040, the IRS appears to have changed the question again to potentially encompass other forms of digital assets (eg, NFTs and other nonfungible assets). The question states:  "At any time during 2022, did you: (a) receive (as a reward, award, or compensation); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)? (See instructions.)"

In a related change, the draft Form 1040 also expands the reporting of income not included on a Form W-2 in determining a taxpayer’s gross income indicating the IRS may intend to start understanding and tracking additional forms of compensation, potentially in the form of crypto, if crypto compensation could constitute “other earned income.”

In response to the change in question, the AICPA released a comment letter on August 26, 2022, requesting that the IRS and the Department of the Treasury (1) clarify the meaning of virtual currency; (2) do not ask about “digital assets” until this term has been defined in final regulations under Internal Revenue Code §6045; (3) modify the virtual currency question for simplicity and clarity; (4) include additional elements into the Form 1040 instructions for the virtual currency question; and (5) explain if a taxpayer needs to answer “yes” if a dependent had a virtual currency event but does not have a filing requirement.

While the 2022 instructions for Form 1040 have not been released yet, taxpayers and their advisors are anxious to understand the implications of the new question and see how the IRS provides further guidance, if any. Without further guidance, the question could lead to further confusion around filing tax returns and could dissuade certain taxpayers from reporting at all due to a lack of clarity.