Virtual Currency Transactions: Revised IRS FAQ and Enforcement Activities
Contributing Author: James C Young
Notice 2014-21 (2014-16 I.R.B. 938), the Internal Revenue Service provided basic answers to taxpayers’ questions about virtual currency (also known as cryptocurrency) in Notice 2014-21 (2014-16 I.R.B. Virtual currency can be used in certain environments like paper money and coin, but it is not legal tender in any country.
The IRS has stated that Bitcoin is not considered currency. Instead, virtual currency is considered property for U.S. Federal tax purposes. Transactions using virtual currency are subject to the same tax principles as property transactions. This means, among other things:
Virtual currency wages paid to employees are taxable and must be reported by the employer on Form W-2. They are subject to Federal income tax withholdings and payroll taxes.
Payments made using virtual currency to independent contractors or other service providers are subject to tax and generally fall under the self-employment tax rules. Payers have the same information reporting requirements that any other payer. If Bitcoin payments exceed $600 per annum, a Form 1099MISC must be issued.
The nature of the gain or loss resulting from the sale or exchange virtual currency varies depending on whether it is a capital asset held by the taxpayer.
Information reporting is required for virtual currency payments.
PwC provides a great primer on blockchain and crypto (with links to other reading material). A variety of articles have been written on the topic, including in the Wall Street Journal (June 2016, August 2017, September 2018, January 2019, September 2019 and September 2019), and Wolters Kluwer. In pursuing tax issues related to this, the AICPA has also been active (sending a request letter to IRS asking for a variety questions).
The IRS added virtual currency to its frequently asked questions in October 2019. The revised FAQs include the following:
(1) A taxpayer who sells virtual currency must account for capital gain or loss. (FAQ 4)
(2)Virtual currency is the equivalent of ordinary income. (FAQ
(3)A taxpayer who receives virtual currency in return for performing services must report income equal the fair market value (in U.S. Dollars) of the virtual currency when received. Virtual currency is received in a cryptocurrency transaction that takes place on the blockchain (an “on-chain transaction”) on the date and the time it is recorded on the distributed ledger. (FAQ 11)
(4) In an arm’s-length transaction, the basis of a taxpayer in virtual currency received for services is the fair value of the virtual currency at the time the virtual currency was received. (FAQ 12). The fair market value at the time of exchange is the basis of property that has been exchanged for virtual currencies. (FAQ 17)
(5) When exchanging property for virtual currencies, the gain/loss is the difference between the virtual currency’s fair market value when received and the adjusted basis of property exchanged. (FAQ 19)
(6) The fair market value for virtual currency obtained through cryptocurrency exchanges is the amount that the cryptocurrency exchange records for the transaction in U.S. Dollars. (FAQ 25)
(7) The fair market value for virtual currency obtained by peer-to-peer transactions (not through cryptocurrency exchanges) is the date and time that the transaction was recorded on a distributed ledger (on chain transaction) or the date and times that the transaction would have been recorded if it were an on-chain trade. (FAQ 26)
(8) Taxpayers can use a cryptocurrency explorer (a web browser used to track virtual currency transactions), to verify the fair market value (explorer value) of virtual currency. Taxpayers who do not use an explorer value must prove that the fair value they used for reporting their virtual currency transactions is accurate. (FAQ 26)
(9) Taxpayers with multiple units or virtual currency may decide which units were sold, exchanged, or disposed of. However, they must clearly identify the units involved in the transaction and provide evidence of the basis. (FAQ 36)
(10) A specific unit of virtual currency can easily be identified by documenting its unique digital ide