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IRS Stance on Crypto Spurs Confusion, Relief in Tax Profession

March 4, 2021, 6:56 PM

A recent Internal Revenue Service FAQ about reporting cryptocurrency activity on tax forms has sowed confusion and frustration among tax professionals.

Individuals who have purchased cryptocurrency with dollars should answer “no” to a tax return question aimed at cryptocurrency tax dodging, the IRS said in an answer posted online this week. But that position contradicts what the agency has told Americans for more than a year, ever since it updated the Form 1040 asking whether at any point in the previous year, “did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

The IRS often uses FAQs to quickly clarify issues online. But tax professionals have long argued that the use of FAQs creates problems, because the answers can’t be relied on in legal disputes or to stave off penalties. The agency can also change the answers without notice. The newest cryptocurrency question comes at an especially challenging time—midway into tax-filing season.

People sign off on their tax returns under penalty of perjury. But it’s unclear what penalties would apply if someone simply bought cryptocurrency and answered “no,” as penalties are based on tax liability, and such people wouldn’t owe taxes on their holdings, said Lisa Zarlenga, a partner at Steptoe & Johnson LLP, and other tax professionals. This new FAQ response is likely the IRS’s attempt to avoid sending letters to people with nothing taxable to report from their cryptocurrency holdings, they said.

The FAQ may also apply to a narrow group of taxpayers: Few people simply purchase cryptocurrencies and hold onto them without further activity, tax professionals said.

Joshua Azran, co-founder of the tax and accounting firm AzranHawkins, said he thought most people would still select “yes” on their tax forms, rather than risk facing consequences if the IRS later discovered they should have reported some activity. The FAQ ultimately raises more questions than it answers, he said.

“I think it’s better than nothing,” but much more guidance is needed, he said.

Confusion Remains

Tax professionals said the FAQ was nonetheless helpful in plugging gaps in IRS guidance. Many warned last year that the existence of the question on the Form 1040 was bound to create confusion and worries.

Zac McClure, co-founder of TokenTax, said the FAQ was welcome because there had been stress and anxiety about how to answer the question correctly. And while it would have been better to have had the notice a month ago, it’s “better now than never,” he said.

The fact that the IRS asks on tax returns about the acquisition of cryptocurrency is still confusing, said Shehan Chandrasekera, a CPA and head of tax strategy at CoinTracker. Simply acquiring cryptocurrency shouldn’t trigger a tax, because like stocks or other assets, tax only kicks in after a sale or transfer.

Erin Collins, the National Taxpayer Advocate, said in a March 3 blog post that the IRS posted the FAQ response to clarify the use of the term “acquire” on the Form 1040, following pressure from her office. She said the agency wasn’t looking for information from taxpayers who don’t have taxable transactions. The instructions on the form were written to define what a “transaction” is. The FAQs, she said, were meant to clarify that distinction.

She said her office continues to push the agency to reword the question and the form instructions for the 2021 version.

To contact the reporters on this story: David Hood at dhood@bloomberglaw.com; Lydia O'Neal in Washington at loneal@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com

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