An Introduction to Digital Currency and NFT Tax

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How the IRS is Looking for its Share of Cryptocurrency and NFT Growth

Written by Lynn M. Mucenski-Keck, Principal

Let’s be honest. Most tax accountants would not be described as “hip” and many struggle to be considered “tech savvy”. Even so, some of their clients’ needs are forcing them into a new world surrounding the exchange of digital assets.

While many persons trading cryptocurrency or buying a non-fungible token (“NFT”) think they are just doing something new, fun, or just goofing around because they have cash to play with, what they don’t realize is that Uncle Sam is looking to collect their share. The number of questions being asked in this space have skyrocketed. Countless persons are looking for help and are shocked when they learn of their potential tax bills. The lack of understanding and proper planning in this space can result in a significant check being made out to the IRS.

If you are one of those persons that is thinking, not again, this is just a fad, it might be time to rethink that attitude. The Crypto market capitalization, calculated by multiplying price of the cryptocurrency with the number of coins in circulation, went over $1 trillion in 2021. A large portion of the market capitalization relates to the nonfungible token (“NFT”) market. NFT sales volume totaled $24.9 billion, of which $4.8 billion was related to NFT gaming. For perspective, Crypto market capitalization in 2020 was $758 billion and the total sales in the NFT market in 2020 was just $340 million.

But is the IRS really watching this? The short answer is yes. As early as 2016, the IRS utilized a “John Doe” summons to Coinbase, which is a secure online platform for buying, selling, transferring, and storing cryptocurrency. The summons requested transaction activity for Coinbase users from 2013 through 2015 who were US persons. Coinbase was required to provide user information who bought, sold, sent or received cryptocurrency of at least $20,000 in value in one year. Based off the information received, the IRS sent 10,000 compliance letters to taxpayers advising them of their failure to properly report cryptocurrency transactions. In 2021, the IRS issued John Doe Summons to Payward Ventures (aka Kraken) and Internet Financial (Circle) seeking similar information for taxable years 2016 through 2020. In March of 2021 the IRS launched Operation Hidden Treasure, an enforcement initiative for tax violations related to cryptocurrency. And maybe you haven’t notice, but there has been a question on the individual income tax return since 2019 regarding this topic, which for 2021 asks “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”. So if your client says the IRS will never track their virtual currency activity, think again.

Tax professionals are not only battling the murky guidance issued by the Internal Revenue Service in this space but also struggle to understand what all the terminology means when dealing with digital assets. It is the merging of two worlds: the young CPAs who are just starting to learn about tax law but are more likely to trade virtual currency and purchase NFT’s, coupled with the dinosaur CPA who thinks a hard fork is something you eat with. You get the point. The first step in minimizing unnecessary tax burdens in the digital asset space is...

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