Update on Federal Tax Reporting of Virtual Currency and Related State Tax Issues

Tax Law

On August 18, 2020, the IRS released a draft Form 1040 for the 2020 tax year (the “2020 Form 1040”). The following question appears on the first page of the 2020 Form 1040: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” The same question (applicable to the 2019 tax year) appeared on Schedule 1 to Form 1040 for the 2019 tax year. To date, the IRS has not explained the reason for relocating its inquiry regarding virtual currency, but this appears to be part of a continuing effort to gather information about U.S. virtual currency and cryptocurrency users and, possibly, to assist taxpayers (who may not otherwise file Schedule 1 to Form 1040 because they do not have any other income or deductions) with their tax reporting obligations.

The IRS previously determined that virtual currency is treated as property, and the general tax rules applicable to property transactions also apply to transactions in, and transactions using, virtual currency. Some states have issued guidance on the sales tax treatment of digital currency. For example, California previously said that payment with Bitcoin does not alter the character of a transaction for sales tax purposes, and thus, a business that accepts Bitcoins must collect sales and use tax as it would for any other sale of tangible personal property (“TPP”) for consideration.

More recently, Kansas released Notice 20-04 dated November 2, 2020 (“Notice 20-04”). Notice 20-04 confirms (i) transaction fees for digital currency transactions are not subject to Kansas sales tax because such fees are not deemed a sale of TPP, (ii) a seller who receives payment in the form of digital currency for a sale of TPP is required to collect and remit sales tax based on the gross receipts it receives in the transaction measured by the value of the TPP on the date the virtual currency is paid to the retailer (i.e., digital payment as currency does not affect the taxability of the underlying sale) and (iii) the Kansas Department of Revenue will not accept digital currency in payment of a taxpayer’s sales tax obligations.

It will be interesting to see how states continue to respond to the tax issues related to virtual currency, and we will continue to monitor this evolving area of tax law.

How Manatt Can Help: Manatt’s tax practice is keeping abreast of the various developments in relation to the taxation of virtual currency. We are here to help clients navigate and understand this evolving area of tax law.

For More Information: Contact Jeffrey A. Mannisto at 310.312.4212 or JMannisto@manatt.com, or Jonathan C. Weiss at 310.312.4156 or JCWeiss@manatt.com.

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