How to Answer the ‘Virtual Currency' Question on Your Tax Return

• There's a key question about cryptocurrency on the front page of your tax return this season.
• You need to answer yes if you sold, exchanged, mined or made purchases with digital currency.
• If you don't report taxable transactions and face an IRS audit, you may incur interest, penalties or even criminal charges, experts say.

If you're one of the millions of Americans who own cryptocurrency, there's a key question to answer this tax season.

Over the past couple of years, the IRS has stepped up crypto reporting with a yes-or-no question about "virtual currency" on the front page of your tax return. 

The question reads: "At any time during 2021, did you receive, sell, exchange or otherwise dispose of any virtual currency?"

While buying and holding crypto doesn't require a yes, you need to check that box if you sold, exchanged, mined digital assets or used it for purchases, according to the IRS.

However, there may be issues if you have taxable activity and answer no, experts say.

"That's where the hammer comes down because they can say that you lied on a government document under penalties of perjury," said Ryan Losi, a Richmond, Virginia-based CPA and executive vice president of accounting firm PIASCIK. 

How crypto taxes work

Cryptocurrency may be subject to capital gains when exchanged or sold at a profit. Swapping digital coins, cashing out for U.S. dollars or even making a purchase may be taxable events, Losi explained.

The gain or loss is the difference between your purchase price, known as basis, and the value when selling or exchanging, and your tax rates depend on the length of ownership.

If you held digital assets for more than one year, you might qualify for long-term capital gains rates of 0%, 15% or 20%, depending on your taxable income.

However, many crypto investors sell or exchange more frequently, according to a CNBC survey, triggering short-term capital gains, levied at regular income tax rates, up to 37% for top earners.

What's worse, figuring out your basis to calculate your crypto tax bill may not be easy with limited reporting from digital currency exchanges.

Not reporting taxable activity

If you don't report taxable crypto activity and face an IRS audit, you may incur interest, penalties or even criminal charges.

It may be considered tax evasion or fraud, said David Canedo, a Milwaukee-based CPA and tax specialist product manager at Accointing, a crypto tracking and tax reporting tool.

While the chances of IRS scrutiny are lower with limited staffing, the agency may pursue larger amounts of money, he said. 

For example, there's a big difference between buying bitcoin in 2012 and cashing out millions of dollars in 2021 versus small trades for $100 profit, Canedo said. But you still have to disclose everything regardless. 

"You're playing with fire if you don't report it," he said.

Although the IRS has a three-year lookback for errors, there is no statute of limitations for fraud, Canedo said.

Another risk is whistleblowers, who can report missing activity to the IRS for a percentage of penalties collected, Losi from PIASCIK said.

"The No. 1 way the IRS finds out about tax cheats is a former business partner or former spouse," he said.