Now that it’s time to file your freelance taxes, you may have questions about how to report your cryptocurrency (now referred to as “digital assets'' instead of virtual currencies by the IRS). Why is it so important to report your activity with digital assets carefully, especially this year?
The penalties for failure to report cryptocurrency activity could be substantial. IRS can impose a penalty up to $250 per customer, up to a maximum $3 million penalty, for failure to timely file a correct Form 1099 with the IRS under IRC 6721 and a penalty up to $250 per customer, up to a maximum $3 million penalty, for failure to timely furnish a correct Form 1099 to the customer under IRC 6722. These penalties may be reduced if such failures are corrected in a timely fashion.
To help you understand the impact of digital assets on your tax return, here are answers to some frequently asked questions about reporting them in compliance with the latest digital asset tax laws:
What is a digital asset in the eyes of the IRS?
According to the IRS, “A digital asset is a digital representation of value which is recorded on a cryptographically secured, distributed ledger. Common digital assets include:
- Convertible virtual currency and cryptocurrency
- Non-fungible tokens (NFTs)”
All cryptocurrency exchanges are also now considered “brokers” similar to traditional investment brokers and digital assets are considered the same as securities, similar to stocks, bonds, and certain types of commodities in the eyes of the IRS. Therefore, the tax treatment of digital assets is essentially the same as before: you must pay taxes on capital gains.
Does everyone have to report their digital asset activity on their tax return?
Yes, even if you didn’t have any digital asset transactions, you must answer the digital asset question at the top of your Form 1040 and report all digital asset-related income when you file your 2022 federal income tax return.
For the 2022 tax year the digital asset question that you must answer is: "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)?"
When do I check ‘Yes’ in answer to the digital asset question on my tax return?
The IRS states that you must check the " Yes" box if you:
- Received digital assets as payment for property or services provided;
- Transferred digital assets for free (without receiving any consideration) as a bona fide gift;
- Received digital assets resulting from a reward or award;
- Received new digital assets resulting from mining, staking and similar activities;
- Received digital assets resulting from a hard fork (a branching of a cryptocurrency's blockchain that splits a single cryptocurrency into two);
- Disposed of digital assets in exchange for property or services;
- Disposed of a digital asset in exchange or trade for another digital asset;
- Sold a digital asset; or
- Otherwise disposed of any other financial interest in a digital asset.
How do I report digital asset income?
Besides checking the “Yes” box, all income related to any digital asset transactions must be reported. For example: If you held a digital asset as a capital asset and sold, exchanged or transferred it during 2022 you must use Form 8949, Sales and other Dispositions of Capital Assets, to calculate any capital gain or loss on the transaction and then report it on Schedule D (Form 1040), Capital Gains and Losses, or Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, in the case of a gift.
If you paid an employee with digital assets, you must report the value of those assets received as wages. If you worked as an independent contractor and were paid with digital assets,or you did this for a contractor you hired, you must report income on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship). Schedule C must also be used if you sold, exchanged or transferred digital assets to clients in connection with a trade or business transaction.
When should I answer ‘No’ to the digital asset question on my federal freelance tax return?
If your only exposure to digital assets during 2022 was the ownership of them and not conducting any transactions, you can check the "No" box on Form 1040 the same is true, according to the IRS, if your digital asset activity was limited to:
- Holding digital assets in a wallet or account;
- Transferring digital assets from one wallet or account they own or control to another wallet or account they own or control; or
- Purchasing digital assets using U.S. or other real currency, including through electronic platforms such as PayPal and Venmo.
What other reporting standards relate to digital assets for 2022 freelance tax returns?
In 2022 new cryptocurrency legislation was passed as part of the IIJA, a sure sign that regulating digital currencies from a tax perspective is a priority for the government.
This means that it is more important than ever to keep your digital asset activity well-documented and to work with reputable dealers and platforms. Keep these developments in this area in mind as you file your return.
Reporting requirements are now more stringent for cryptocurrency exchanges which must now report information to both the IRS and to their customers. As we touched on at the beginning of this article, while there are no reporting requirements for digital asset exchanges for the 2022 tax year, some exchanges may send you tax forms such as Form 1099-MISC, which only covers the payouts received, not capital gains related to your crypto activity.
The new law states that the following information is now required to be reported to the IRS and to customers: (1) name, address, and phone number of each customer; (2) the gross proceeds from any sale of digital assets; and (3) capital gains or losses and whether such capital gains or losses were short-term (held for one year or less) or long-term (held for more than one year).
The legislation does not state what IRS forms cryptocurrency exchanges must send to their customers, but Form 1099-B (“Proceeds from Broker”), would seem reasonable.
Another important development in the IIJA is that digital assets valued at $10,000 or more are now treated as “cash” received for any person engaging in a trade or business
The law states that, “Any person engaging in a trade or business that receives more than $10,000 in cash must file IRS Form 8300 (''Report of Cash Payments Over $10,000 Received in a Trade or Business”).” With this form you are required to report: (1) the name, address, and TIN of the person from whom “cash” was received; (2) the amount of “cash” received; and (3) the date and nature of the transaction.
These new reporting requirements take effect January 1, 2023. This means that exchanges are not required to send you Form 1099-B until 2024 (for 2023 taxes).
Keep close tabs on your digital asset transactions to avoid tax time trouble.
Get started now preparing to file your freelance tax return, especially if you have cryptocurrency transactions to include. Making sure you have all necessary documentation of your activities will make it much easier to efficiently complete your taxes and set you up for success next year when the tax reporting requirements are even more stringent.
Jonathan Medows is a NYC-based CPA who specializes in taxes for consultants across the country. His website has a resource section with how-to articles and information for freelancers. https://www.cpaforfreelancers.com/