Tax Law

IRS Notice Provides Bitcoin Transaction Tax Guidance

In March, the IRS issued Notice 2014-21, 2014 IRB LEXIS 238 (March 25, 2014), providing guidance, in the form of FAQs, on the application of general tax principles to transactions involving virtual currency, such as bitcoins.

Q&A 1 of the notice provides the general rule that for federal taxation purposes virtual currency is treated as property, and many of the questions and answers in the notice reflect this basic rule. [IRS Virtual Currency Guidance: Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply, IR 2014-36 (March 26, 2014)]. As to the nature of virtual currency, the notice explains that: “Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” [Notice 2014-21].

As to bitcoin, specifically, the notice states that bitcoin is an example of a “convertible virtual currency”, and the notice explains that “convertible virtual currency” is “[v]irtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency . . .” [Notice 2014-21]. The notice points to the Financial Crimes Enforcement Network’s Guidance on the Application of FinCen’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (FIN-2013-G001, March 18, 2013) for further guidance on convertible virtual currencies.

As referenced above, the notice provides that: “For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.” [Notice 2014-21].

The notice provides that for U.S. federal tax purposes, virtual currency is not a currency that will be treated as currency that could generate foreign currency gain or loss. [Notice 2014-21].

In addition, the notice provides that a taxpayer who receives virtual currency as payment for goods or services must include the fair market value of the currency in computing the taxpayer’s gross income. [Notice 2014-21].

The notice further provides that the basis of virtual currency that a taxpayer receives as payment for goods and services is the fair market value of the virtual currency at the time it is received by the taxpayer. [Notice 2014-21].

As to determining the fair market value of virtual currency, the notice states that: “If a virtual currency is listed on an exchange and the exchange rate is established by fair 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 in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.” [Notice 2014-21].

The notice also provides guidance on the type of gain or loss a taxpayer realizes on the sale or exchange of virtual currency. The notice advises that a taxpayer will realize capital gain or loss on the sale or exchange of virtual currency “is a capital asset in the hands of the taxpayer” and that a taxpayer will realized ordinary gain or loss on the sale or exchange of virtual currency “that is not a capital asset in the hands of the taxpayer.” [Notice 2014-21].

The notice also provides guidance on the activity referred to a virtual currency “mining”. [Notice 2014-21]. As an example of mining activities, the notice cites to a taxpayer using “computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger.” [Notice 2014-21].

The notice provides that the fair market value of virtual currency obtained by a taxpayer by mining must be included in the taxpayer’s gross income. [Notice 2014-21].

With respect to information reporting, the notice states: “A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.” [Notice 2014-21].

The notice also advises that payments made using virtual currency are subject to federal backup withholding “to the same extent as other payments made in property.” [Notice 2014-21].

The notice also indicates that taxpayers may be subject to penalties resulting from treating virtual currency transactions in a manner inconsistent with the notice prior to the date of issuance of the notice, March 25, 2014. [Notice 2014-21].

Further information from the Service and Treasury Department on transactions involving virtual currency can be anticipated, as the notice requests comments from the public with respect to “other types or aspects of virtual currency transactions that should be addressed in future guidance”, as stated in the notice. [Notice 2014-21].

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