Recent COVID tax legislation has led to changes in the 1040 and 1040-SR instructions for the 2020 tax year. The new draft has recently been released by the IRS, incorporating the changes from the CAA, 2021. Among the changes is new information regarding the handling of virtual currency reporting and EIPs.
With both the CARES Act and the COVID-Related Tax Relief Act, direct payments were sent to a number of taxpayers, often referred to as Economic Impact Payments. These payments serve as an advance for the recovery rebate credit. The recent changes to the instructions reinforce the original instructions stating that these payments will not be taxable as federal income but will reduce the recovery rebate credit you may receive.
Another change to the instructions was the reporting of virtual currency. Virtual currency is defined as a digital representation of value that is not a representation of “real currency” but functions as a unit of account, a store of value, or a medium of exchange. Some types of virtual currencies are convertible, which will give them equivalent value in real currency.
In 2019 taxpayers saw the addition of a question on the 1040 Forms, asking if they have received, sold, exchanged, sent, or acquired a financial interest in virtual currency. Changes to the draft instructions released in October 2020 stated that the virtual currency reported would not need to include virtual currency in an account or wallet or transferred virtual currency transferred between them.
Instructions also state that the IRS will apply the term virtual currency to describe different types of convertible currency if they are used for exchange, such as cryptocurrency and digital currency, regardless of the label applied. If it has the characteristics of virtual currency, it will be treated as such. This definition matches the definition provided by the IRS in its FAQs regarding virtual currency transactions.
Other changes in the draft instructions include what type of transactions will be included. These transactions include, but are not limited to:
- Receiving or transferring virtual currency for free, including airdrops following a hard fork.
- Exchanging virtual; currency for goods or services.
- Purchasing or selling virtual currency.
- Exchanging virtual currency for other virtual currency or other property.
- Disposition or acquisition of financial interest in virtual currency.
Other changes to the draft instructions involve taxpayers filing Form 4952, which is the Investment Interest Expense Deduction. If a taxpayer has an amount on line 4e, which is the smaller of a net gain from the distribution of property that was held for investment, a net capital gain the taxpayer received from selling property for investment, or the amount that they have elected to include in their investment income, then the taxpayer will be required to complete a Schedule D Tax Worksheet. This can be found in the Schedule D instructions for Capital Gains and Losses and will be used to determine the taxpayer’s tax. This step must be completed even if the taxpayer wouldn’t need to file a Schedule D.