Virtual Currency/ Bitcoin Taxation
Bitcoin and other virtual currency are treated as “property” for tax purposes. For purposes of this article, I will refer to “virtual currency” with the understanding that it potentially could include Bitcoin, Ethereum, Ripple, Bitcoin Cash, Cardano, NEM, Litecoin, Stellar, EOS, IOTA, Dash, NEO, TRON, Monero, Bitcoin Gold (to name only a few and not even considering what will arise in the very near future). This area of the tax law is changing daily, and thus this article is meant as a general guide only!
Investors in Virtual Currency
An investor in virtual currency typically treats the virtual currency as a “capital asset,” much like stocks, bonds, mutual funds, real estate, etc. As such, a taxpayer generally realizes a capital gain or loss on the sale or exchange of virtual currency. If the virtual currency investment is held one year or less, the gain or loss is treated as “short term.” The more favorable “long-term” capital gains provisions kick in once the holding period exceeds one year.
Valuation of Virtual Currency for U.S. Tax Purposes
For U.S. tax purposes, transactions using virtual currency must be reported in US dollars. Therefore, taxpayers will be required to determine the fair market value (FMV) of virtual currency in US 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 FMV value of the virtual currency is determined by converting the virtual currency into US dollars (or into another real currency which in turn can be converted into US dollars) at the exchange rate, in a reasonable manner that is consistently applied.
Payment for Goods/Services with Virtual Currency
You must include the virtual currency payments in income and convert the value of the virtual currency to US dollars. The conversion is based on the date that the virtual currency was received. It is reported as gross receipts as would any other payments for goods/services. In addition, sales tax issues may arise with the virtual currency transactions and payments for goods in the normal course of business. As such, it is important to review any state or local rules concerning virtual currency transactions.
Payments of Wages to Employees via Virtual Currency
Wages paid to employees using virtual currency are taxable to the employee, must be reported by the employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes. The value of the virtual currency must be reflected in US dollars on the Form W-2.
Payments to Independent Contractors via Virtual Currency
Payments using virtual currency made to independent contractors and other service providers are taxable and the 15.3% self-employment tax rules generally apply. Normally, payers must issue Form 1099-MISC.
A few common questions:
- Is virtual currency treated as a “currency” for purposes of determining whether a transaction results in foreign currency gain or loss under US federal tax laws?
No. Under currently applicable law, virtual currency is not treated as currency that could generate foreign currency gain or loss for US federal tax purposes.
- Is a payment made using virtual currency subject to filing a Form 1099?
Yes. A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
For example, a business that makes a payment using virtual currency with a value of $600 or more in any taxable year is required to report the payment to the IRS and to the worker via a Form 1099-MISC.
Payments of virtual currency required to be reported on Form 1099-MISC should be reported using the FMV of the virtual currency in US dollars as of the date of payment.
- Does a taxpayer who “mines” virtual currency realize gross income upon the receipt of the virtual currency resulting from those activities?
Yes. When a taxpayer successfully “mines” virtual currency (i.e. uses computer resources to validate virtual currency transactions and maintain the public virtual currency transaction ledger), the FMV of the virtual currency as of the date of receipt is includible in gross income.
- Is an individual who “mines” virtual currency as a trade or business subject to self-employment tax on the income derived from those activities?
Yes. If a taxpayer’s “mining” of virtual currency constitutes a trade or business, and the “mining” activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment (generally, gross income derived from carrying on a trade or business less any allowable deductions) resulting from those activities constitute self-employment income and are subject to the self-employment tax (at 15.3%).
For more information, please see https://www.irs.gov/newsroom/irs-virtual-currency-guidance