In the overwhelming age of online shopping, digital streaming services, and the “dark web,” a new form of “currency” has emerged – virtual currency. Although there are various iterations of this new way to purchase goods and services, by far, the most well-known is bitcoin. Whenever bitcoin is bought, sold or traded, there are tax impacts, which require reporting and recordkeeping. In fact, the key to using bitcoin is maintaining records, which are substantially similar to stock.
For tax purposes, the Internal Revenue Service ruled that bitcoins and other “convertible virtual currencies” are “treated as property” and not treated as currency. This concise guidance has implications for the taxation of bitcoin and what information is necessary to ensure that taxes are accurately calculated and reported. See, Notice 2014-21; Financial Crimes Enforcement Network (FinCen), Guidance on the Application of FinCen’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (Fin-2003-G001, March 18, 2013). To summarize the main points:
• Virtual currencies are property for tax purposes;
• Taxpayers will report and pay capital gain or loss upon disposition of the virtual currency;
• Compensation earned in virtual currency is taxable income;
• Spending virtual currency is structurally two transactions: spending the dollar equivalent amount and disposing of the virtual currency; and
• Business transactions in bitcoin are subject to all the normal rules for sales tax, withholding, and information reporting.
Therefore, for Federal tax purposes, since virtual currency is treated as property, general tax principals applicable to property transactions apply to bitcoin transactions. 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 received, and report the same on their tax return.
When the taxpayer disposes of the bitcoin, this is also a taxable transaction treated as the sale or exchange of a capital asset. Thus, income is realized to the extent of any gain on the property/bitcoin. The taxpayer measures gain in the usual manner, that is, the difference between the cost basis and the amount realized (purchase price or value of compensation – sales price or value of property received). This gain is reported using Form 1040, Schedule D and Form 8949 or Form 4797.
If you or a client is either compensated in virtual currency or is contemplating investing in the same, it is wise to consult a tax professional to ensure compliance with all revenue laws.