Tax Treatment of Virtual Currencies

As many of you know who follow this tax blog I enjoy dabbling in the uncharted waters of the US Tax Code. It helps keep me fresh. One of the many areas that this includes is the tax treatment of virtual currencies.

With the most recent run up in the price of Bitcoins there were a handful of very fortunate people that quite literally amassed multi-generational wealth over just a few short weeks cashing out their Bitcoins all the way to $1,000 per coin. You know who you are. May God bless you on your journey that you use this new found wealth for good.

Fortunately in your favor the IRS produced Notice 2014-21 explaining how existing general tax principles apply to transactions using virtual currencies, including Bitcoin. The following are some interesting points worth attention that I pulled from the Notice:

Q – What type of gain or loss does a taxpayer realize on the sale or exchange of virtual currency?

A – The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. 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. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset. See IRS Publication 544 for more information about capital assets and the character of gain or loss.

What this means from my perspective generally speaking is that if you get paid in virtual currency you will need to record the value of the virtual currency on the date it is received as though it were a capital asset.  Then when you go to convert the virtual currency you will be subject to a capital gain or (loss) depending on the value of the virtual currency at the time of the conversion.

Basically if you are going to accept payment in Virtual Currency you better keep detailed records of the value of the currency by day end closing prices each day the currency is received.

Q. Are there IRS information reporting requirements for a person who settles payments made in virtual currency on behalf of merchants that accept virtual currency from their customers?

A. Yes, if certain requirements are met. In general, 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). A TPSO is required to report payments made to a merchant on a Form 1099-K, Payment Card and Third Party Network Transactions, if, for the calendar year, both (1) the number of transactions settled for the merchant exceeds 200, and (2) the gross amount of payments made to the merchant exceeds $20,000.

When completing Boxes 1, 3, and 5a-1 on the Form 1099-K, transactions where the TPSO settles payments made with virtual currency are aggregated with transactions where the TPSO settles payments made with real currency to determine the total amounts to be reported in those boxes. When determining whether the transactions are reportable, the value of the virtual currency is the fair market value of the virtual currency in U.S. dollars on the date of payment.

See the Third Party Reporting Center for more Information.

So don’t think that you can hid these gross receipts simply because they are virtually received.