Digital assets: 2022 individual tax compliance

Digital assets are becoming increasingly prevalent in financial markets. It is now estimated that over 40 million Americans, or 16% of the adult population, invest in, trade or otherwise transact using cryptocurrencies. Accordingly, the IRS is expanding its digital asset examination and enforcement efforts.

Underreporting of digital asset transactions

Currently, there is a considerable risk of tax evasion related to digital asset transactions. The decentralized and anonymous nature of digital assets, coupled with the absence of broker reporting requirements and limited understand of how the principles of taxation apply to digital assets among investors, has led to significant underreporting of taxable income.

The size of the tax gap created by the underreporting of digital asset transactions is hard to calculate. In 2020, only 2.3 million taxpayers answered that they received, sold, sent, exchanged or acquired any financial interest in a virtual currency. This represents less than 10% of the projected number of taxpayers who engaged in digital asset transactions in that year. A recent Barclays analysis found that investors are likely paying less than half of the taxes they owe on virtual currency trades. And, in 2021, former IRS Commissioner Chuck Rettig estimated tax evasion has reached $1 trillion annually, citing cryptocurrency transactions as a driving factor.

The 2021 Infrastructure Investment and Jobs Act created a new reporting requirement for digital assets, including cryptocurrencies. The legislation will require brokers to report digital asset transactions on a Form 1099. The law was set to go into effect Jan. 1, 2023; however, the implementation is currently delayed indefinitely, until the IRS is able to issue a set of final regulations.

2022 question on digital assets

This year, individual income tax filers must answer the following question on their return:

“At any time during 2022, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”

While this question is not new, the scope is significantly broader than in prior years, capturing a myriad of transactions and expanding to include all digital assets, not just virtual currency.

Taxpayers who meet any of the following criteria must answer “yes”: