Virtual Currency & IRS Reality

Author: Scott B. Johnson

The Internal Revenue Service recently issued Notice 2014-21 to provide guidance for the tax treatment of virtual currency, such as Bitcoin. In the Notice, the IRS describes how existing general tax principles apply to transactions using virtual currency.

Among other points, the Notice states that (i) for federal tax purposes, virtual currency is treated as property, and general tax principles applicable to property transactions apply to transactions using virtual currency; (ii) a taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received; (iii) the fair market value of virtual currency paid as wages is subject to federal income tax withholding, Federal Insurance Contributions Act tax, and Federal Unemployment Tax Act tax and must be reported on Form W-2; (iv) the fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax; (v) a person who in the course of a trade or business makes a payment of $600 or more (whether in cash or virtual currency) in a taxable year to an independent contractor for the performance of services is required to report that payment to the IRS and to the payee on Form 1099-MISC; and (vi) a taxpayer will generally realize capital gain or loss on the sale or exchange of virtual currency if it is a capital asset in the hands of the taxpayer; otherwise, a taxpayer will generally realize ordinary gain or loss on the sale or exchange of virtual currency if, for example, the currency is similar to inventory or other property held for sale in a trade or business.

Taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency that, in turn, can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.

The full text of Notice 2014-21 is available here.

Taxpayers who accept virtual currency as payment for goods or services, who use virtual currency to pay for goods or services, or who sell or exchange virtual currency, should be aware of the tax consequences and obligations associated with such payments, sales and exchanges.

To read our comments in the March 28, 2014, Financial Services Law newsletter on this issue, click here.