IRS may put cryptocurrency question at the top of 1040 to catch cheaters

The Internal Revenue Service is considering adding a question to Form 1040—America’s primary income tax form—asking tax filers if they dealt in virtual currency in 2020. It would be the agency’s latest attempt to crack down on underreporting of cryptocurrency profits.

If an American buys bitcoin, ether, or another cryptocurrency and then sells it later at a profit, she or he will typically owe capital gains tax on the difference. But blockchains do not have the tax reporting infrastructure that has become standard for conventional financial institutions. So the IRS doesn’t have an easy way to figure out who has received a cryptocurrency windfall. In the early years of the bitcoin boom, many taxpayers failed to report large bitcoin-related profits.

In recent years, the IRS has increased pressure on cryptocurrency traders to comply with tax laws. A 2014 bulletin laid out the basic rules for paying taxes on virtual currency price gains. In 2016, the IRS sought transaction data about thousands of users of Coinbase, a popular US-based cryptocurrency exchange. Coinbase complied with the request in 2018 after some legal wrangling.

But chasing down individual cryptocurrency investors after the fact is a lot of work for the IRS. The agency would much prefer American taxpayers voluntarily comply with the law. And that’s where the new question on Form 1040 would come in.

In the past, it was easy for taxpayers to leave out cryptocurrency earnings and then claim ignorance if the IRS catches them. It was hard 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 it was in a part of the return that not every taxpayer had to fill out.

On the 2020 version of the 1040, the cryptocurrency question could be the very first one taxpayers answer after giving their name and other identifying information. A draft of the 1040 posted to the IRS website asks taxpayers: “at any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

If taxpayers check “yes,” the agency can double-check that virtual currency transactions were reported correctly. If taxpayers check “no,” they could be prosecuted for tax evasion if the IRS later discovers they were lying. The prominent placement of the question will make it harder for a taxpayer to convince a jury that a failure to report cryptocurrency profits was an honest mistake.

Ed Zollars, a CPA with Kaplan Financial Education, told The Wall Street Journal that this strategy helped the IRS crack down on the use of offshore bank accounts a decade ago. Adding an explicit question about offshore bank accounts to tax forms increased compliance with reporting rules and has added billions of dollars to the federal treasury.