Should You Check the Virtual Currency Checkbox on Form 1040?

The current version of Form 1040 asks an important question: “At any time during 2021, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

Many taxpayers aren’t sure whether they should check yes or no. To help clear up this issue, here’s what you need to know about virtual currency—and what it means for your expat tax return.

What Is Virtual Currency?

Virtual currency is a type of currency that exists only in digital form. Like standard currency, virtual currency is meant to represent value. In certain contexts, virtual currency can even be used to trade for real-world goods and services, just like the US dollar.

The best-known types of virtual currency are cryptocurrencies such as Bitcoin and Ethereum.

While virtual currency has faced plenty of criticism over the years, there’s no denying that it has become a powerful force in the global economy.

How Does the IRS Tax Virtual Currency?

The IRS currently treats virtual currency as property for tax purposes. Depending on how you use your virtual currency, it could be classified as personal property, business property, or investment property—and taxed accordingly.

Let’s look at some common transactions and how they might be taxed.

1. Buying Virtual Currency

If you simply buy virtual currency using an alternate form of currency (such as the US dollar) and store it in a virtual “wallet” or account, then that is not a taxable transaction, and you are not required to report it. The same is true if you only transfer your virtual currency between multiple wallets or accounts that you own.

2. Mining Virtual Currency

“Mining” is a complicated process used to gain new virtual currencies. This process is especially associated with mining Bitcoin.

If you successfully mine a virtual currency, you must report it as income. To value this income, use the fair market value of that currency on the day you received it.

In addition to this, if you mined the virtual currency as part of your own trade or business, it will be considered business property. As such, your net earnings will be subject to the federal self-employment tax.

3. Paying for Goods and Services

If you use virtual currency to pay for goods or services, it is a taxable transaction and must be reported as a capital gain or loss. This applies even if you are exchanging one virtual currency for another.

The rules for this tax are very complex. To learn more, consult a qualified tax professional.

4. Selling Virtual Currency

As with any asset, when you cash out your virtual currency, you must report any gains or losses.

5. Receiving Virtual Currency as Payment

If you receive virtual currency as payment for goods or services, you must report it as income. This applies whether you are trading goods or being paid for work as an employee or independent contractor.

To value your payment, use the fair market value of that currency on the day you received it.

6. Paying Employees or Independent Contractors

If you use virtual currency to pay an employee’s wages or an independent contractor’s fee, it will be subject to the same tax and reporting as any other payment made using property.

• If you are paying an employee with virtual currency, the payment will be subject to the federal wage withholding tax as well as FICA and FUTA taxes.
• If you are paying an independent contractor, the payment will be subject to self-employment tax.

Once again, to value this transaction, use the fair market value of that currency on the day you paid it to an employee or contractor.

Should I Check the Virtual Currency Checkbox on Form 1040?

So—when should you check the virtual currency checkbox on your Form 1040? The quick answer is that you should check it if you’ve used virtual currency in a reportable transaction.
Reportable transactions include:

• Selling virtual currency
• Using virtual currency to pay for goods or services
• Receiving virtual currency as payment for goods or services
• Mining virtual currency
• Exchanging one virtual currency for another
• Receiving virtual currency for free (such as in an airdrop)

If you have taken part in any of these transactions, you should check “Yes” on the virtual currency checkbox on Form 1040.

Non-reportable transactions include:

• Buying virtual currency
• Holding virtual currency without disposing of it
• Transferring virtual currency between multiple wallets or accounts you own
• Gifting or donating virtual currency

If you have only taken part in transactions like these, you should check “No” on the virtual currency checkbox on Form 1040.

Note: This advice is generalized, and there’s a lot of nuance involved in virtual currency taxations. We recommend consulting a tax professional if you’ve engaged with virtual currency at all during the year. Failing to meet your reporting requirements could result in severe penalties.

Do I Have to Report Virtual Currency on My FBAR?

All US citizens with at least $10,000 in one or more non-US bank accounts must report it by filing a Foreign Bank Account Report (FBAR). Naturally, many Americans living abroad are required to file this form.

But what if you have $10,000 in virtual currency stored in a foreign account or exchange? Do you have to report that too? As it stands, the answer appears to be no. According to FinCEN Notice 2020-2, taxpayers are not required to report foreign wallets, exchanges, or accounts holding only virtual currency.

However, the same notice states that this rule may change in the future. Check back with us for further updates.

What If I Fail to Report My Virtual Currency Activity?

If you fail to accurately report your virtual currency activity when required, you could face a range of penalties, including an IRS audit, incurred interest, or tax penalties. If the failure is considered to be willful tax evasion or fraud, you could even be subject to criminal charges.

What Are Some Best Practices for Using Virtual Currency?

If you want to stay tax compliant with your virtual currency, the most important thing to do is maintain detailed records. This includes records of:

• When you received virtual currency
• How you received that virtual currency
• What the fair market value of that currency was on the day you received it
• What purpose you are holding that currency for (e.g., as an investment)

Above all, we recommend enlisting the help of a tax professional to advise you on how to remain tax compliant.

Get Reliable Help from an Expat Tax Specialist

We hope this guide has helped you understand virtual currency—and whether you should check the Form 1040 virtual currency checkbox. If you still have questions, we have the answers. In fact, we can even prepare and file an accurate tax return on your behalf so you don’t have to worry about making a mistake.