With 2022 giving us the collapse of TerraUSD and Luna, the FTX fiasco, and price drops in every major cryptocurrency, it is no wonder the year has been defined as a long “crypto winter.” While this past year may have been a bear market for the cryptocurrency industry, the Internal Revenue Service (IRS) has certainly not been hibernating. Over the last month, the IRS has made a few key announcements related to digital asset transactions that have significant implications for the 2022 tax year. We will take a deep dive into these updates below.
Announcement 2023-2: Transitional Guidance for Broker Reporting on Digital Assets
Under the Infrastructure Investment and Jobs Act (IIJA), signed into law in November 2021, Sections 6045 and 6045A were modified to clarify and expand information reporting on digital assets by brokers. The purpose was to improve tax administration and tax compliance with respect to trading and investing in digital assets. As a result, crypto exchanges would now be required to issue Form 1099-Bs, the Proceeds from Broker and Barter Exchange Transactions, to taxpayers to report gains/losses on sales, similar to the requirements of traditional brokerages.
However, on December 23, 2022, the IRS announced that brokers would not be required to report additional information with respect to 6045 and 6045A until final regulations have been issued. Until the Treasury Department and IRS issue these new final regulations, a broker may report gross proceeds and basis as required under existing law. It is important to note that this guidance only applies to Form 1099-B informational returns filed or furnished by brokers. Taxpayers are still required to report any income they receive from digital asset transactions.
CCA 202302011: Applicability of IRC 165 to Cryptocurrency That Has Declined in Value
In the Chief Counsel memorandum, the IRS Chief Counsel addresses whether a taxpayer has sustained a loss under Section 165 of the tax code due to worthlessness or abandonment of cryptocurrency. The memorandum includes a hypothetical situation in which a taxpayer purchases a cryptocurrency at one dollar per unit on an exchange, only to see the value substantially decrease to less than one cent per unit at the end of 2022. In this fact pattern, the taxpayer continued to maintain dominion and control over the cryptocurrency and it continued to be traded on at least one exchange.
The memorandum explains that Section 165 provides a deduction when there is evidence of closed and completed transactions, fixed/identifiable events, and actual losses during the taxable year. In this instance, the taxpayer had not abandoned or otherwise disposed of the cryptocurrency, causing it to still hold value. Therefore, the taxpayer has not sustained a loss under Section 165 since “virtually worthless” is not the same as “worthless.”
An interesting footnote within the memorandum points out that as of January 1, 2023, fifteen cryptocurrencies valued at less than one cent per unit were actively traded with market caps ranging from approximately $77 million to over $4.4 billion. This occurred along with a 24-hour trading volume ranging from $833,000 to $92 million. Perhaps the service is anticipating taxpayers claiming Section 165 losses related to cryptocurrency holdings and is preemptively signaling its position to cryptocurrency investors.
CCA 202302012: Qualified Appraisal Requirement for Charitable Contribution of Cryptocurrency
In this Chief Counsel memorandum, a hypothetical situation is presented where an individual taxpayer acquired cryptocurrency on an exchange and subsequently transferred the asset to a charitable organization. On their self-prepared federal income tax return for the year of donation, the taxpayer claimed a $10,000 charitable deduction based on a value listed on the cryptocurrency exchange at the date and time of the donation. Generally, a qualified appraisal is required for any contribution of property in which a deduction of more than $5,000 is claimed. However, there is an exception for publicly traded securities.
In this hypothetical fact pattern, the taxpayer did not obtain, or attempt to obtain, a qualified appraisal for the donation, and argued that (as is the case with publicly traded securities) no appraisal is required because the cryptocurrency had a readily ascertainable value based on the value published by the cryptocurrency exchange.
While the cryptocurrency in question certainly had “security-like” features, the memorandum defines a “security” for these purposes. A security is a share of stock in a corporation, a right to subscribe for or receive a share of stock in a corporation, a bond, debenture, note, or certificate. Additionally, a security is defined as other evidence of indebtedness issued by a corporation, government, or political subdivision thereof, with interest coupons or in registered form. In this case, the cryptocurrency in question is none of the items listed above, therefore it does not satisfy the definition of security and a qualified appraisal is required.
Conclusion
Applying the U.S. tax code to the nuances of cryptocurrency and other digital assets is far from an easy task. While ambiguity may create tax planning opportunities for taxpayers, it is evident that the IRS is doing its best to play catch up and clarify their position as to how current law should apply to cryptocurrency. Luckily, your advisors at Wolf & Company are monitoring this space closely and are here to help.
