The IRS has released much-awaited guidance, in the form of frequently asked questions (FAQs), on convertible virtual currency For federal tax purposes, convertible virtual currency is treated as property and not as currency.
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account or a store of value. It constitutes a medium of exchange that operates like currency in some environments but does not have all the attributes of real currency, such as the status of legal tender. Virtual currency that has an equivalent value in real currency is referred to as convertible virtual currency. One example of a convertible virtual currency is bitcoin.
Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars and other real currencies.
Under Notice 2014-21, convertible virtual currencies are not currencies that can generate foreign currency gain or loss. General tax principles applicable to property transactions apply to transactions using convertible virtual currency, the IRS explained. A taxpayer who receives convertible virtual currency in payment for goods or services is required to include the fair market value (FMV) of the virtual currency as of the date the virtual currency was received. The basis in virtual currency is its FMV on the date of receipt, determined by converting the virtual currency into U.S. dollars (or another real currency that can be converted into U.S. dollars) at the applicable exchange rate in a reasonable manner that is consistently applied.
The IRS will treat convertible virtual currency paid by an employer for service rendered as wages for employment tax purposes. The FMV of virtual currency paid as wages is subject to payroll taxes and income tax withholding and must be reported on Form W-2, Wage and Tax Statement. Similarly, the FMV of virtual currency received for services performed as an independent contractor is self-employment income subject to self-employment tax.
Information reporting may be required for a payment made using virtual currency to the same extent as any other payment made in property, the IRS explained. This encompasses, if applicable, reporting on Form 1099-MISC, Miscellaneous Income, and Form 1099-K, Payment Card and Third Party Network Transactions.
The process of creating virtual currency (in many cases) is known as “mining.” Cryptographic software protocols generate the currency and validate transactions. The IRS explained that when a taxpayer successfully mines virtual currency, the FMV of the virtual currency as of the date of receipt is includible in gross income. If an individual’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 resulting from those activities are self-employment income.
If you have questions regarding this matter or how it applies to your specific situation, please do not hesitate to contact us.