January 27, 2023

IRS Announces Form 1040 Changes for Digital Assets Question

For FY 2022, the IRS has announced changes to a question on Forms 1040, 1040-SR and 1040-NR relating to digital assets. These changes not only clarify the meaning of the term, but also better define when it applies.

Previously, the question required a “Yes” or “No” answer to the following:

“At any time in 2021, did you receive, sell, exchange, or otherwise dispose of financial interest in any virtual currency?”

For FY 2022, this question has been altered to:

“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)?”

This change affects both the definition of the relevant assets, as well as the actions taken with them over the course of the fiscal year which will trigger a “yes” answer to the question.

From a definition standpoint, the previous question (arguably) referred only to “virtual currencies,” specifically cryptocurrencies, such as Bitcoin, Ethereum, etc. However, the FY 2022 change to “digital asset” means that the scope of this question now includes NFTs, stablecoins and convertible virtual currency, at a minimum.

In addition, this change also clarifies what types of transactions are covered by the question. It’s important to note that this required yes/no question does NOT determine whether such a transaction is necessarily taxable, as other factors may apply; but it is nonetheless a required yes/no question on the form.

Generally speaking, even with the expanded definition of assets to which the question applies, taxpayers can click “no” to this question as long as they only held digital assets, transferred them to another wallet or account they control, or purchased additional relevant assets using either real currency, or by using electronic platforms likewise using real currency (such as PayPal, Venmo, etc.) The secondary change to the question – what defines a “transaction” – applies here. In particular, the addition of the new “otherwise dispose of” text specifically covers nearly all transfers of the assets to another person or entity.

Considering today’s ever-increasing emphasis on digital assets as a means of exchange and income, these clarifications are welcome to the taxpayer. However, they may raise additional concerns for individuals preparing a return, depending on the nature of their asset portfolio. Weiss & Company LLP remains focused on providing our clients with the highest level of support in the tax filing process. As always, should you have any questions about how this new definition affects your return, we encourage you to reach out to your tax professional.

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