IRS Adds New Guidance But Form 1040 Cryptocurrency Question Is Still Causing Confusion

The IRS really wants to know about your cryptocurrency. For tax year 2020 the IRS moved the cryptocurrency question from Schedule 1 of the Form 1040, where it was in 2019, to the much more prominent position of Page 1 of the Form 1040 itself. The question is the second piece of information requested, right after the taxpayer’s name and address. The question reads as follows: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” The draft instructions for Form 1040 indicated that if you purchased cryptocurrency you should answer yes to the question. The final Form 1040 instructions, however, removed the examples that indicated taxpayers who purchased cryptocurrency should answer yes to the question. The question itself remained unchanged.

On March 2, 2021 the IRS issued new guidance (by updating Question 5 of its Frequently Asked Questions or FAQ) that states “If your only transactions involving virtual currency during 2020 were purchases of virtual currency with real currency, you are not required to answer yes to the Form 1040 question.”  FAQs are not considered authority when taking a position on a tax return and FAQs change frequently. Relying on FAQs for bulletproof guidance is risky. At a minimum, tax professionals recommend the best practice of printing a dated copy of the relevant FAQ into the client’s tax file. If you do your own taxes, keep a hard or electronic copy with your other tax documents (W2s, etc.).

The updated guidance is causing consternation among taxpayers and tax professionals because it has changed from the original guidance and because it is confusing. People (including many tax practitioners) are wondering why taxpayers are allowed to answer no to the question when, if they purchased cryptocurrency with real currency during the year, they clearly received or acquired a financial interest in cryptocurrency during the year.

The confusion comes from the combination of a wordy and somewhat ambiguous question combined with changes to the guidance. I don’t think many taxpayers pay attention to draft instructions but tax practitioners do. Consequently, the disappearance of the “answer yes if you purchased cryptocurrency” examples in the 1040 instructions combined with the recently updated FAQ is creating confusion that at times seems to border on panic. In general tax professionals are a cautious bunch who prefer bright line answers. This is the kind of situation that makes their eyes twitch.

Nevertheless, it is important to consider both the current authority surrounding cryptocurrency transactions, which admittedly amounts to “not much” and what the IRS is trying to accomplish with this question. They are trying to determine if the taxpayer had any taxable transactions related to cryptocurrency. Buy and hold is not a taxable transaction.