The Internal Revenue Service (IRS) announced that its Free File tax software was available for taxpayers starting January 13. The Free File program allows taxpayers to enter their data and file their tax returns online for free. Free File returns will be filed starting on the opening day of tax season, January 23.

Free File is in its 21st season. The seven partners of Free File are commercial software companies. They offer complimentary online software to taxpayers with 2022 incomes of $73,000 or less. Taxpayers with incomes over $73,000 may use a separate filing system, the IRS Free File Fillable Forms (FFFF).

The seven Free File providers each create their own eligibility rules. Several providers offer their software for taxpayers with incomes under $73,000, while others have lower income cut-offs. Active-duty military members with adjusted gross income in 2022 of $73,000 or less are permitted to use any of the seven companies.

To use the Free File software, taxpayers should go to IRS.gov/FreeFile. Select the Free Guided Tax Preparation and a Free File Online Lookup Tool to help you select the best program. You can use the Browse All Offers function to look at the different offers. You select one of the seven providers and click through to the provider's website. You will then be able to complete your tax return online. Taxpayers without a computer may complete their tax return on a mobile phone or tablet.

The seven Free File providers are 1040Now, ezTaxReturn.com, FileYourTaxes.com, On-Line Taxes, Tax Act, FreeTaxUSA and TaxSlayer. For forms in Spanish, taxpayers can use ezTaxReturn.com.

Editor's Note: Free File is a valuable service for many taxpayers. It will be used this year by millions of Americans. The IRS continues to receive requests from Members of Congress to develop its own tax software. However, the IRS has been reluctant to replace the Free File program with its own product. Because many other countries provide a government product, this may occur at some time in the future.

Crypto Gift Appraisals Required

An IRS Chief Counsel advice memorandum (ILM 202302012) was released on January 13 and requires charitable gifts of cryptocurrency over $5,000 to comply with the qualified appraisal rules.

The Chief Counsel Advice is guidance for IRS staff on key issues. A hypothetical was set forth where Taxpayer A acquired cryptocurrency and gifted it to charity. The cryptocurrency was held as an investment for more than one year and could qualify as a gift of a capital asset that is deductible at fair market value. Taxpayer A completes Part I, Section B of Form 8283 and reports a charitable deduction of $10,000. The $10,000 deduction was based on the exchange value of cryptocurrency based upon the date and time of the donation. Taxpayer A did not obtain a qualified appraisal and claims that Cryptocurrency B has a readily ascertainable value based upon the published value on the cryptocurrency exchange.

Cryptocurrency is deemed by the IRS to be property under Notice 2014-21, 2014-16 IRB 938 and Rev. Rul. 2019-24, 2019-44 IRB 1004. It is a type of virtual currency using cryptography to secure the transaction. Transactions are recorded on a distributed ledger termed a blockchain. Cryptocurrency units are generally designated as coins or tokens.

Taxpayers who own cryptocurrency may transfer the coins or tokens to a qualified exempt charity and claim an income tax deduction. Sec. 170(f)(8) and (f)(11) note that if the noncash asset is valued at over $5,000, the taxpayer must obtain a qualified appraisal. Sec. 170(f)(11)(D)(i) states the qualified appraisal must comply with the regulations and also be made by a qualified appraiser. The qualified appraiser must have an appraisal designation or otherwise have met minimum education and experience requirements and regularly perform appraisals. Because there are no formal educational institutions that train cryptocurrency appraisers, the appraiser must qualify under the "education and experience" standard.

Qualified appraisals are not required for readily valued property. This could include cash or publicly traded securities (such as a stock, bond, debenture, note or other certificate). However, the IRS notes that the "publicly traded securities" definition under Sec. 165(g)(2) does not apply to cryptocurrency. Because cryptocurrency is not a publicly traded security, a qualified appraisal is required.

Taxpayer A also notes that Sec. 170(f)(11)(A)(ii)(II) states an appraisal may be not required if there is "reasonable cause and not to willful neglect." However, the IRS determined that the claimed transfer based on the exchange valuation does not qualify for this exception. The IRS stated, "claims that Cryptocurrency B has a readily ascertainable value because it is listed on a cryptocurrency exchange does not establish reasonable cause for failing to obtain, or attempting to obtain, a qualified appraisal."

Therefore, gifts of cryptocurrency valued at over $5,000 require an appraisal by a qualified appraiser.

Editor's Note: Members of Congress have suggested that the IRS should allow gifts of cryptocurrency to be valued using a recognized exchange. The cryptocurrency legislation introduced by Senator Cynthia Lummis (R-WY) and Senator Kirsten Gillibrand (D-NY) included a requirement that the IRS must allow a method for valuation using a cryptocurrency exchange. A June 2021 letter from a bipartisan group of House Members from the House, including some from the Ways and Means Committee, stated the IRS should "eliminate the appraisal requirement in the case of virtual currencies with easy to establish exchange or index prices." The IRS has hesitated to take action. With a $1 trillion decrease in 2022 cryptocurrencies value, there are far fewer charitable gifts than in prior years. The failure of several exchanges and the turmoil in the cryptocurrency industry make it more challenging for the IRS to define an acceptable method for deciding which exchanges are permissible. Hopefully, at some point the cryptocurrency market will stabilize and the IRS will develop a methodology for determining value using one or more exchanges. Until then, the IRS is affirming its clear position that cryptocurrency gifts over $5,000 require a qualified appraisal.

Crypto Loss Not Recognized

In ILM 202302011, the IRS Chief Counsel issued advice on a cryptocurrency that had essentially lost all value.

A hypothetical described the facts as Taxpayer A purchased Cryptocurrency B for one dollar per unit. Cryptocurrency B declined in value and was priced on the cryptocurrency exchange at less than one cent on December 31, 2022. Taxpayer A still owned the Cryptocurrency B, but it was essentially zero value and no longer salable because no buyers would purchase it. Taxpayer A claimed Cryptocurrency B was now either worthless or abandoned and reported a deduction on his or her 2022 tax return under Sec. 165.

Digital assets are governed by Notice 2014-21, 2014-16 IRB 938 and Rev. Rul. 2019-24, 2019-44 IRB 1004. The virtual currency is generally referred to as a coin or a token. An investor who holds the asset for more than one year may report capital gain if it increases in value. If it is not held as a capital asset, there could be ordinary gain or loss.

Sec. 165(a) provides a deduction for losses sustained during the year, if it is the result of an identifiable event. If a capital asset becomes worthless, the loss is treated as a loss of a capital asset. This could apply to a public security, but Cryptocurrency B is not a stock, a bond, a debenture, a note or a certificate.

During tax years before 2026, Section 67(g) miscellaneous itemized deductions are not allowable. Therefore, Sec. 165(a) losses are not deductible as miscellaneous itemized deduction. In some cases, capital losses may be used to offset other capital gains.

While Cryptocurrency B has declined in value, Taxpayer A did not sell, exchange or otherwise dispose of the units. The IRS noted, "A decrease in value must be accompanied by some affirmative step that fixes the amount of the loss, such as abandonment, sale, or exchange."

Taxpayer A may claim that there is effectively an abandonment. The taxpayer may note there is a "subjective determination of worthlessness in a given year, coupled with a showing that, in such year of the asset in question is in fact essentially valueless."

However, the IRS determined that Taxpayer A did not take any specific action to abandon the cryptocurrency. Abandonment requires a specific act by the taxpayer. Because Taxpayer A maintained ownership of Cryptocurrency B through the end of 2022, there is no permissible deduction.

Editor's Note: With the loss of the cryptocurrency market capitalization during 2022, there are a large number of cryptocurrencies that have been reduced to no value on applicable exchanges. Because there are no buyers for these cryptocurrencies, it is uncertain how the taxpayer should show abandonment. The IRS did not give any specific guidance to taxpayers on how to demonstrate abandonment and qualify for a loss.

Applicable Federal Rate of 4.6% for February -- Rev. Rul. 2023-3; 2023-6 IRB 1 (16 January 2022)

The IRS has announced the Applicable Federal Rate (AFR) for February of 2023. The AFR under Section 7520 for the month of February is 4.6%. The rates for January of 4.6% or December of 5.2% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2023, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return.