The Internal Revenue Service recently reminded taxpayers that they must again answer a digital asset question and report all digital asset-related income when they file their 2022 federal income tax return, as they did for fiscal year 2021.
The term “digital assets” has replaced “virtual currencies,” a term used in previous years.
The question, which appears at the top of Forms 1040, Individual Income Tax Return; 1040-SR, U.S. Tax Return for Seniors; and 1040-NR, U.S. Nonresident Alien Income Tax Return, was revised this year to update terminology.
In addition, the instructions for answering the question were expanded and clarified to help taxpayers answer it correctly. All taxpayers must answer the question regardless of whether they engaged in any transactions involving digital assets.
For the 2022 tax year it asks: “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)?”
What is a digital asset?
A digital asset is a digital representation of value which is recorded on a cryptographically secured, distributed ledger. Common digital assets include:
- Convertible virtual currency and cryptocurrency
- Non-fungible tokens (NFTs)
Everyone must answer the question
Everyone who files Form 1040, Form 1040-SR or Form 1040-NR must check one box, answering either “Yes” or “No” to the digital asset question. The question must be answered by all taxpayers, not just those who engaged in a transaction involving digital assets in 2022.
When to check ‘Yes’
Normally, 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.
How to report digital asset income
Besides checking the “Yes” box, taxpayers must report all income related to their digital asset transactions. For example, an investor who held a digital asset as a capital asset and sold, exchanged or transferred it during 2022 must use Form 8949, Sales and other Dispositions of Capital Assets, to figure their capital gain or loss on the transaction and then report it on Schedule D (Form 1040), Capital Gains and Losses, or Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, in the case of gift.
If an employee was paid with digital assets, they must report the value of assets received as wages. Similarly, if they worked as an independent contractor and were paid with digital assets, they must report that income on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship). Schedule C is also used by anyone who sold, exchanged or transferred digital assets to customers in connection with a trade or business.
When to check ‘No’
Normally, a taxpayer who merely owned digital assets during 2022 can check the “No” box as long as they did not engage in any transactions involving digital assets during the year. They can also check the “No” box if their activities were limited to one or more of the following:
- 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.