Internal Revenue Service Notice on Bitcoins and Other Virtual Currencies

27 Mar

Internal Revenue Service Notice 2014-21, March 25, 2014, describes how existing general tax principles apply to transactions using virtual currency. Virtual currency is described as a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. It operates like “real” currency but does not have legal tender status in any jurisdiction.

The Service answers frequently-asked questions on bitcoin status and solicits comments.  The Notice is uncontroversial, trendy and answering idiotic theories.

For federal tax purposes, virtual currency is treated as property. General tax principles are applicable. 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. The basis of the currency in the recipient’s hands is determined the same way.

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 which can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.

If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer, and ordinary gain or loss if the virtual currency is not a capital asset, e.g., inventory and other property held mainly for sale to trade customers.

Virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.

When a taxpayer successfully mines virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income. If a taxpayer’s mining constitutes a business, and the mining activity is not undertaken as an employee, the net earnings are subject to the self-employment tax. The fair market value of virtual currency paid as wages is subject to federal withholdings. A payment made using virtual currency is subject to information reporting to the
same extent as any other payment made in property.

A person who in the course of a trade makes a payment of $600 or more in a taxable year to an independent contractor for the performance of services is required to report that payment on Form 1099-MISC. A third party that contracts with a substantial number of unrelated merchants to settle payments between the merchants and their customers is a third party settlement organization (TPSO), required to report payments made to a merchant on a Form 1099-K, Payment Card and Third Party Network Transactions, if certain thresholds are met.

No clear answer was provided to the question whether taxpayers would be subject to penalties for having treated a virtual currency transaction in a manner that is inconsistent with the Notice, prior to March 25, 2014.

 

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