The most current guidance on IRS virtual currency is found in Internal Revenue Bulletin: 2014-16.
IRS Guidance on Virtual Currency:
Excerpts from Internal Revenue Bulletin: 2014-16
IRS knows that “virtual currency” can be used to acquire goods and services, or as an investment. Defines virtual currency as a digital representation of value used as a medium of exchange, or to store value and has some functions like “real” currency of the U.S. or many foreign jurisdictions. It can function like legal tender, but does not enjoy the legal status as “legal tender” in any jurisdiction.
Convertible virtual currency, BitCoin for example, has an equivalent value in real currency and functions as a substitute for real currency and can be digitally exchanged between buyers and sellers, purchased via or exchanged into, U.S. dollars and many other foreign currencies.
The purchase, sale or exchange or use of virtual currency to pay for goods or services has tax consequences that may result in tax being owed. The common U.S. federal tax consequences related to virtual currencies are described below.
- Virtual currency is currently not treated as currency such that would generate foreign currency gain or loss for U.S. federal tax purposes.
- A taxpayer who receives virtual currency where goods or services are sold must include the fair market value of the virtual currency, in U.S. dollars at the date of receipt.
- The basis of virtual currency is the fair market value in U.S. dollars at the date of payment or receipt.
- Where virtual currency is listed on an exchange that reflects market supply and demand, its FMV is determined by converting to U.S. dollars at the applicable exchange rate, in a reasonable and consistent manner.
- Where the FMV of the property received in an exchange involving virtual currency exceeds the taxpayer’s adjusted basis in the virtual currency, the taxpayer has incurred a taxable capital gain. In contrast, a capital loss occurs where the FMV of the property received is less than the adjusted basis of the virtual currency.
- The character of the gain or loss generally turns on if the virtual currency is a capital asset in the hands of the individual taxpayer. A taxpayer realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in their hands. Virtual currency held as inventory in a trade or business is not a capital asset.
- Where a taxpayer “mines” virtual currency, the fair market value of the virtual currency at the time of receipt is includible in gross income. Where the mining of virtual currency constitutes a trade or business and is not conducted as an employee, the gross income less allowable deductions constitutes self-employment income subject to the self-employment tax.
- The FMV of virtual currency received as payment for services performed as an independent contractor constitutes self-employment income and is subject to the self-employment tax.
- The fair market value of virtual currency paid as wages is subject to self-employment tax and federal income tax withholding, and must be reported on Form W–2
- All payments made using virtual currency are subject to identical information reporting as any other payment that is made in property. For example, payment made from a trade or business using virtual currency with a FMV in excess of $600 to a non-exempt U.S. recipient during a taxable year are required to reported to the IRS and to the payee via the appropriate form 1099. Examples reportable payments include rent, salaries, wages, premiums, annuities, and compensation.
- Payments made via virtual currency to foreign payees are also subject to backup withholding as are other payments made in property. Taxpayer identification number (TIN) must be obtained from the payee where appropriate. Moreover, the payor must do backup withholding where a TIN is not obtained of where the payor receives notification from the IRS that backup withholding is required.
Excerpts from IRS notice 2014 – 21
This notice describes how existing general tax principles apply to transactions using virtual currency. Bitcoin is one example of a convertible virtual currency. For a more comprehensive description of convertible virtual currencies FinCEN (FIN-2013-G001, March 18, 2013). https://www.fincen.gov/sites/default/files/shared/FIN-2013-G001.pdf
- In general, a business or organization interacting with a substantial number of unrelated merchants to settle payments between the various merchants and their individual customers is deemed a third-party settlement organization and is required to report the total payments made to an individual merchant during a calendar tax year on a Form 1099-K.
- Taxpayers utilizing virtual currency will be subject to penalties for failure to comply with tax laws as with other types of mediums of exchange. For instance, underpayments related to virtual currency transactions are subject to accuracy-related penalties as dictated by section 6662. Failures correctly report virtual currency transactions where required are subject to information reporting penalties found under section 6721and 6722. Penalty relief may be available who can establish that a virtual currency reporting error is due to reasonable cause.
The current uncertainty when dealing with virtual currency is best illustrated by the following link to an AICPA request to the IRS for further guidance in this area: