Bitcoin and other cryptocurrencies stacked together
Tax & AccountingMarch 09, 2022

Taxation of Cryptocurrency and Non-fungible Tokens

The IRS has taken the position that virtual currency is treated as property for income tax purposes, not a legal currency. The result is that, while use of U.S. dollars to purchase goods or services is generally a non-taxable transaction, use of virtual currency to purchase goods or services may be taxable, similar to a barter transaction. The IRS supported its position by stating that cryptocurrency is not recognized as a legal currency. However, since that statement, El Salvador has recognized a cryptocurrency as a legal currency. This development so far has not altered the IRS position. The development of stable coins tied to a legal currency, most commonly U.S. dollars, also raises questions about the currency distinction.

There remain a number of uncertainties as to how cryptocurrency is treated under various tax provisions. It is uncertain whether cryptocurrency qualifies as a security or a commodity which might allow the trading of cryptocurrency to be treated as a trade or business.

The growth in the popularity of non-fungible tokens has also raised questions as to their tax treatment. Non-fungible tokens are recorded on a ledger similar to cryptocurrency, but the IRS has not officially stated a position on the tax treatment of non-fungible tokens. Many commentators feel that the safest approach is to treat non-fungible tokens in a manner similar to cryptocurrency.

The bipartisan infrastructure legislation enacted in November, 2021 included a provision requiring broker reporting of virtual currency transactions. There are, however, concerns that the definition of “broker” in the legislation is overly broad and may be read to include persons involved with cryptocurrency who do not have the necessary information to comply with the reporting requirements. The new reporting would not be required until 2023, giving Congress some additional time to revisit the broker reporting requirements. The Organization for Economic Cooperation and Development is also working on a broker reporting requirement.

Similar to the situation on the 2020 tax return, the 2021 Form 1040 includes a slightly revised question as to whether the taxpayer received, sold, or exchanged any virtual currency during the year. The IRS added the question on the return due to suspicions that many cryptocurrency transactions are not being reported on tax returns. The broker reporting requirement is designed to help close the reporting gap. The IRS has also been issuing subpoenas to cryptocurrency exchanges to identify taxpayers engaged in cryptocurrency transactions. If the Form 1040 question is answered in the affirmative, the IRS will be looking for the reporting of gain from cryptocurrency transactions. If the Form 1040 question is answered in the negative and the IRS obtains evidence of the taxpayer engaging in cryptocurrency transactions, the taxpayer could be subject to criminal as well as civil penalties.

Virtual currency cases are also starting to make it to the courts, where taxpayers challenge whether particular types of cryptocurrency transactions, such as staking, should be treated as taxable transactions.

The taxation of virtual currency is likely to continue to evolve as the industry continues to evolve. The U.S. is undertaking a study of the merits of making a virtual currency a form of legal tender. Growing acceptance of virtual currency in general business transactions indicates that virtual currency in some form is likely here to stay.

Mark Luscombe
Principal Federal Tax Analyst
Mark Luscombe, a CPA and attorney, is the principal federal tax analyst for Wolters Kluwer Tax & Accounting. He is the current chair of the Important Developments Subcommittee of the Partnership Committee of the American Bar Association Tax Section and speaks on a wide range of tax topics. He authors monthly columns in Accounting Today and TAXES magazine. Prior to joining Wolters Kluwer, he was in private practice with several Chicago-area law firms where he specialized in taxation.
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