"There’s gold up in them/their hills." The allure of digital assets is like the gold rushes of old. They can produce a high rate of returns in a short amount of time. Before you know it, there is much pandemonium and things get out of control.
While it has seemed to fizzle lately, the dust has to settle, and eventually you will need to deal with the tax implications of digital assets. You might have questions whether to invest or not invest.
Let’s take a look at what digital assets are and how to plan for them.
Types of Digital Assets
The most common example of digital assets is cryptocurrency. It is no wonder that the percentage of American adults who have owned cryptocurrency as of 2022 is about 21%, according to Bankrate.com in 2023.
In financial terms, digital assets are fiat currency. It is currency that is not tied to a physical commodity like gold or silver.
Therefore, they are treated as property for tax purposes. You are most likely familiar with the purchasing and selling of securities. You may want to consider that first before getting into cryptocurrency.
How The IRS Is Taxing Digital Assets
The definition of digital assets is to be any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology, according to the IRS. They also changed the name to digital assets from the previous term of virtual currencies.
The IRS issued a news release on Jan. 24, 2023 to remind taxpayers to answer the digital assets question on their 2022 Form 1040 US Individual Income Tax Return.
The question was at any time during 2022, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?
If you sold, exchanged or transferred digital assets it will need to be reported as gains and losses on your tax returns.
History of Digital Assets and Taxes
The IRS as far back as March 2014 issued a notice stating that virtual currencies are treated as property not currency. In 2019 they issued revenue ruling on hard forks and air drops as well as a question about cryptocurrencies on tax forms.
Starting with the 2020 Form 1040 US Individual Income Tax Return, the question was did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency? Taxpayers were required to answer the question which was the first attempt by the IRS to tax digital assets.
Legislation on How to Further Tax Digital Assets
The Infrastructure Investment and Jobs Act of 2021 was signed on Nov. 15, 2021. One of the items in the act requires yearly tax reporting from digital currency brokers starting in January 2023. It should be similar to sales of securities in the stock market.
The tax reporting will have the sale and cost of the digital assets on IRS Form 1099-B. Many broker dealers issue consolidated Forms 1099, which will include the Form 1099-B Gains and Losses along with Form 1099-INT Interest Income and Form 1099-DIV Dividend Income.
What Happens When You Don’t Report
By not reporting the gains and losses, you will likely receive an IRS notice and will need to pay penalties and interest for unreported income. If you sold digital assets in past years, the IRS can go back as far as three years on Form 1040 US Individual Income Tax Return if you don’t report gains and losses from digital assets.
Scams to Get You to Buy Cryptocurrency
Cryptocurrency is like the Wild West regarding investments. There are many scams that arise when it comes to cryptocurrency. It has become so out of hand that the IRS is warning taxpayers of the scams. The IRS does not call or email you and try to get your personal or financial information.
The most common way they communicate is by mail. If you are not sure about the letter you can call the IRS. Fraudsters may also give you an ultimatum to pay right away or to buy gift cards. The IRS encourages people to report scammers by completing a form and returning it by mail.
How Cryptocurrency Has Worked Around the World
Countries in the European Union along with Canada and Australia allow Bitcoin to be used. Although it is not the same across the board, it is good to know how each country taxes Bitcoin.
In many African countries and China cryptocurrency is banned. Factors such as volatility and destabilization make cryptocurrency illegal in some international countries.
The Future of Digital Assets
With the collapse of FTX in November 2022, cryptocurrency remains unchartered waters. Many investors are weary that there will not be enough investor protection in the event of another cryptocurrency collapse.
The International Organization of Securities Commissions, a global financial organization, has a proposal for global cryptocurrency regulation.
While that may take a long time to be implemented, you will still need to know; particularly those of you who are near or at retirement age. Having a clear understanding will be key in your decision to plan for digital assets.
Gary Mills
Rene Carlos is an Enrolled Agent (EA) with nearly 20 years of experience in the tax and accounting industry, and business coaching. He, and his wife, Julia, own Summit Tax & Accounting Advisors in Orange County, California. He specializes in corporate tax preparation and accounting for small businesses and business coaching leadership development.
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