The Internal Revenue Service is considering adding a question to Form 1040 – America's primary income tax form – asking taxpayers if they looked at virtual currency in 2020. This would be the agency's most recent attempt to combat underreporting of cryptocurrency profits.
When an American buys bitcoin, ether, or some other cryptocurrency and later sells them for a profit, he or she usually owes capital gains tax on the difference. However, blockchains do not have the tax reporting infrastructure that has become standard for traditional financial institutions. So the IRS has no easy way to find out who got a cryptocurrency windfall. In the early years of the Bitcoin boom, many taxpayers were unable to report large profits related to Bitcoin.
In recent years, the IRS has increased the pressure on cryptocurrency traders to comply with tax laws. A 2014 bulletin laid down the basic rules for paying taxes on prizes in virtual currencies. In 2016, the IRS searched for transactional data on thousands of users of Coinbase, a popular cryptocurrency exchange in the US. Coinbase complied with the request in 2018 after a few legal battles.
However, tracking individual cryptocurrency investors after the fact is a lot of work for the IRS. The agency would very much prefer American taxpayers to voluntarily comply with the law. And this is where the new question on Form 1040 would come into play.
In the past, it was easy for taxpayers to cut out cryptocurrency revenue and then claim ignorance when the IRS catches them. It has been difficult for the IRS to prove that this was deliberate tax evasion rather than an honest oversight.
Last year, the Wall Street Journal reports, the IRS added a question about cryptocurrency to tax forms. But not every taxpayer had to fill out part of the tax return.
In the 2020 version of the 1040, the cryptocurrency question could be the very first taxpayers answer after providing their name and other identifying information. A draft of the 1040 posted on the IRS website asks taxpayers, "Have you received, sold, sent, exchanged, or otherwise acquired financial interests in any virtual currency at any time during 2020?"
If taxpayers check yes, the agency can verify that virtual currency transactions have been reported correctly. If taxpayers tick "No" they could be prosecuted for tax evasion if the IRS later determines they lied. The prominent placement of the question will make it more difficult for a taxpayer to convince a jury that failing to report cryptocurrency gains was an honest mistake.
Ed Zollars, CPA at Kaplan Financial Education, told the Wall Street Journal that this strategy helped the IRS curb the use of offshore bank accounts a decade ago. Adding an explicit question about offshore bank accounts to tax forms has improved reporting compliance and added billions of dollars to the federal treasury.