Internal Revenue Service (IRS) Issues Guidance for Bitcoin, Other Virtual Currencies in Time for Tax Season
Bitcoin and other virtual currencies must be treated as property for U.S. federal tax purposes, the Internal Revenue Service has determined in guidance released on March 25, 2014. IRS Notice 2014-21.
The IRS apparently relied on the premise that virtual currencies do not have legal tender status in any jurisdiction. Signaling that its position on the tax treatment of virtual currencies is not set, however, the IRS included in its guidance a request for public comments “regarding other types or aspects of virtual currency transactions that should be addressed in future guidance.”
The exchange of property is a reportable event. Transactions using virtual currency, therefore, fall under general tax principles that apply to property transactions. Among other things, this means that:
Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.
The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
Automated accounting solutions are in the works to help users of virtual currencies track their transactions to satisfy these recordkeeping requirements. (The Bitcoin Taxman Cometh: Calculating How Much Crypto-Investors Owe IRS Could Be Easy, Forbes, Mar. 25, 2014; New IRS Bitcoin Rules Pose a Problem Only an Army of Startups Can Solve, Wired, Mar. 25, 2014.)
Complying with the IRS guidance may be burdensome for users of bitcoins or other virtual currencies. However, even the security failure of bitcoin exchange Mt. Gox has not dampened supporters’ enthusiasm for the virtual currency. Bitcoin ATMs are popping up in the United States and abroad and companies are finding innovative ways to accept virtual currencies as payment. (A Better Way to Buy Bitcoin?, The New Yorker, Mar. 25, 2014; How To Use Bitcoin To Shop At Amazon, Home Depot, CVS And More, Forbes, Feb. 17, 2014.) Perhaps the most intriguing development on the horizon is the race to open regulated investment funds and exchanges in the United States. (SecondMarket Seeks to Open Bitcoin Fund to Ordinary Investors, The Wall Street Journal (registration required), Mar. 19, 2014.) Bitcoin might soon see an enormous influx of capital, which enthusiasts hope will lead to more innovations, making virtual currencies more prevalent and practical for everyday use.