Should You Check the Virtual Currency Checkbox on Form 1040?

The current version of Form 1040 asks an important question: “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)?” 

In previous years, this question was a little different. 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 form of digital currency that can be used to make purchases on the Internet. It can also be traded for other virtual currencies, as well as fiat currency which is the real-world paper currency we are all accustomed to using.

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. Whether you accept or pay with cryptocurrency, invest in it, are an experienced currency trader, or you receive a small amount as a gift, it’s important to understand the tax implications of your situation.

How Does the IRS Tax Virtual Currency?

The IRS currently treats virtual currency as property for tax purposes. General tax principles applicable to property transactions apply to transactions using virtual currency. 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 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.

If you sell, trade or dispose of cryptocurrency investments in any way that causes you to recognize a gain in taxable accounts, you must report that gain as taxable income. This does not apply if you trade cryptocurrency in a tax-deferred or tax-free account like an individual retirement account (IRA).

Note that converting one virtual currency for another is considered two transactions by the IRS: you have sold the first virtual currency, and you have bought a second virtual currency. 

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. If you earn cryptocurrency by mining it, the income is taxable and must be reported on Form 1099-NEC. You must report this even if you don’t receive a 1099 form as the IRS considers this taxable income and is likely subject to self-employment tax in addition to income tax. 

3. Being Paid for Goods and Services

If someone pays you cryptocurrency in exchange for goods or services, the payment counts as taxable income, just as if they’d paid you via cash, check, credit card, or digital wallet.  

For tax reporting purposes, you must include the dollar value of the cryptocurrency in U.S. dollars on the day it was received or determine your taxable income for the goods or services you provided. 

4. Selling Virtual Currency

When you sell or spend cryptocurrency you have a capital transaction resulting in a gain or loss just as you would if you sold shares of stock. When disposing of cryptocurrency, it’s necessary to report each sale on your tax return.

Keeping good records of what your actual cost was for each virtual currency is a crucial part of correctly reporting sales on your tax return. You are required to keep track of and accurately report all purchases and sales. This is ultimately your responsibility regardless of whether or not the virtual currency exchanges provide you with incorrect or incomplete information.  

5. Receiving Virtual Currency as Payment for Work Performed

If you receive virtual currency as payment for wages or salaries,, you must report it as income. This applies whether you are 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, you may have to report this payment on form 1099-NEC to the IRS and the independent contractor.

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

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

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 report your virtual currency activity when required, you could face a range of penalties, including an IRS audit, incurred interest, or tax penalties. But there are still several ways in which you could avoid incurring penalties. 

The first step is contacting the IRS and disclosing your failure to report income accurately. This might allow you to enter into an agreement with the IRS that may reduce or eliminate any penalties. If the IRS believes that you have intentionally avoided reporting virtual currency activity, they may impose additional penalties. This could include a higher accuracy-related penalty or even criminal prosecution.  

What Are Some Best Practices for Using Virtual Currency?

To ensure compliance with tax regulations when using virtual currency, it is crucial to maintain comprehensive records. The following information should be recorded:

• The date you received the virtual currency 
• How you receive the virtual currency (payment of wages, for selling goods, etc.) 
• The fair market value of the currency on the day you received it 
• The purpose for which you are holding the currency (e.g., investment or business use) 
• The date you sold or exchanged the virtual currency 
• The fair value of the currency on the date you sold or exchanged it 

It is highly recommended to seek the advice of a tax professional to assist with remaining tax compliant.

Virtual Currency Reporting Doesn’t Have to Be Complicated

We hope this guide has helped you understand virtual currency—and whether you should check the Form 1040 virtual currency checkbox. If you’re ready to be matched with a Greenback accountant, click the get started button below. For general questions on expat taxes or working with Greenback, contact our Customer Champions.