Texas residents are very much aware of the power of the Internal Revenue Service. As we approach the end of the year, many individuals and business owners will likely begin to think about how taxation will need to be addressed, and the most financially expedient way to do it with experienced support from a skilled advisor. For some, the process may get more complicated. There is a relatively new facet to income that is still in its infant stages: virtual currency. While Bitcoins may be a familiar term, there are actually other currencies available as well – with more being developed regularly.
The question that may come up is whether or not these currencies are taxable as income. According to Notice 2014-21, virtual currencies are a digital representation of value functioning as a unit of account or exchange medium. In some instances, it functions as U.S. coin and paper money does in our country. Virtual currency with equivalent value in real currency or substitutes for it is called convertible virtual currency. An example is the aforementioned Bitcoin, which can be traded digitally between users and can be purchased with real currencies or exchanged into it.
The IRS’s basic premise is the use of convertible virtual currency to pay for real goods or services has tax consequences. For federal tax purposes it is considered to be property. Thus, general tax principles applicable to property transactions apply to these. Any person or business receiving virtual currency in payment must declare it as gross income based on its fair market value on the date it was received. Standard gain and loss provisions apply as market value fluctuates.
Complications increase if a taxpayer accumulates virtual currency through the mining process. One can be an employee of someone else, an independent contractor or a business subject to self-employment tax. Virtual currency paid as wages is subject to employment taxes just as standard currency would be. Reporting and Form 1099 requirements are the same. Penalties and interest for failure to comply with tax laws will apply.
Virtual currencies exist in cyberspace. There is no need for bankers and middlemen. It’s likely, however, the continuing evolution of virtual money will go hand in hand with IRS involvement.
Source: IRS, “Notice 2014-21” Nov. 20, 2014