Tax Reporting of Digital Asset Activity
With digital assets becoming more popular as a form of investing and holding property, the IRS is getting serious about enforcing the law that taxes income and gains from such property just like any other form of investment. In a recent release, the IRS reminded us all that we are required in general to report all earned income on their tax return, including income earned from digital asset transactions.
So serious, in fact, that almost every income tax return (including business entities) contains a "Yes" or "No" question regarding transactions involving digital assets. More on that later.
To remind you, a digital asset is a digital representation of value that is recorded on a cryptographically secured, distributed ledger. Common digital assets include:
- Convertible virtual currency and cryptocurrency
- Stablecoins
- Non-fungible tokens (NFTs)
The question referred to above must be answered by all taxpayers, not just by those who engaged in a transaction involving digital assets. In answering the question, a taxpayer must check the "Yes" box if they:
- Received digital assets as payment for property or services provided;
- Transferred digital assets for free (without receiving any consideration) as a bona fide gift;
- Received digital assets resulting from a reward or award;
- Received new digital assets resulting from mining, staking and similar activities;
- Received digital assets resulting from a hard fork (a branching of a cryptocurrency's blockchain that splits a single cryptocurrency into two);
- Disposed of digital assets in exchange for property or services;
- Disposed of a digital asset in exchange or trade for another digital asset;
- Sold a digital asset; or
- Otherwise disposed of any other financial interest in a digital asset.
In addition to checking the "Yes" box, taxpayers must report all income related to their digital asset transactions. For instance, an investor who held a digital asset as a capital asset and sold, exchanged or transferred it during 2023 must report the transaction on IRS Schedule D and related forms.
Other possible reporting situations include the receipt of digital assets as payment for work performed. An employee in such a case would be required to report this as taxable wages. Likewise, a business must report such receipts in gross income.
Transferring digital assets to another as a gift could require the filing of a gift tax return (Form 709) depending on the value of the gift when combined with all other gifts made to the recipient.
The following actions or transactions in 2023, alone, generally don't require you to check "Yes":
- Holding digital assets in a wallet or account;
- Transferring digital assets from one wallet or account they own or control to another wallet or account they own or control; or
- Purchasing digital assets using U.S. or other real currency, including through electronic platforms such as PayPal and Venmo.
A final word of caution – you may be tempted to just ignore the question and not answer it. Answering the question is not optional, according to the IRS. It is mandatory. Not answering it is a sure-fire way to throw up a red flag about your tax return. That's just not a good idea.
