Taxation of Virtual Currency

Published on Tuesday, January 26, 2021

As virtual currency gains increasing acceptance by the public, it is important to consider the tax implications for those that invest and engage in various transactions with the digital currency.

What is virtual currency?

Virtual currency is a digital representation of value. Although virtual currency is exchangeable in the same manner as real currency, for example the dollar, it is not recognized as legal tender in the United States. Some virtual currencies including Bitcoin and Ethereum are convertible virtual currency, meaning they may be exchanged for an equivalent value of dollars, euros, or other types of real currency.

Tax treatment of virtual currency

In 2014, the IRS issued IRS Notice 2014-21, in which it elected to treat virtual currency as property rather than currency. As a result, virtual currency is given the same tax treatment as other property transactions. Income or loss generated from virtual currency transactions may be either ordinary or capital depending on the nature of the transaction.

• Virtual currency received as payment for goods or services is included in US dollars as income on the date of receipt at the fair market value of the currency received.
• Payment received from an employer is subject to withholding for income taxes, FICA, and FUTA in the same manner as wages paid to an employee and the fair market value is included on Form W-2. Similarly, virtual currency received by a self-employed individual is also subject to self-employment taxes.
• Just as with cash payments, payments of virtual currency in amounts greater than $600 also require the filing of Form 1099. Fair market value of the currency at the date of payment is the appropriate reportable amount.
• Virtual currency held for investment is treated in the same manner as investment in other securities. The sale of virtual currency will be short-term capital gain or loss if held for less than one year and long-term capital gain or loss if held for greater than one year.

Cost Basis

As with other property transactions, it is important to track basis involving virtual currency transactions because basis will be an offset to the amount of reportable gain or loss resulting from a transaction.

Receiving Payment in virtual currency

Basis is equal to the fair market value of the virtual currency on the date it was received as income.

Making Payment in virtual currency

If the market value of the currency at the date of payment exceeds the payor’s basis in the currency, a gain is realized. A loss will result if the payor’s basis in the currency at the date of payment exceeds the currency’s market value at the date of payment.

Example

A car mechanic is paid in virtual currency with a value of $1,000 for repairing a customer’s car. The car mechanic will report income of $1,000 and now has basis in the virtual currency of $1,000. A month later, the car mechanic pays a supplier in virtual currency when it is now worth $1,500. The car mechanic will have a short-term gain of $500, the amount that the value of the virtual currency exceeded his basis.

Compliance

To better enforce compliance with the reporting of virtual currency transactions, the IRS now requires all taxpayers to answer whether they have received, sold, or exchanged virtual currency on page one of the 2020 Form 1040.

Like stocks and other investments, capital gain and loss resulting from the sale of virtual currency is reported on Form 8949 and summarized on Schedule D, Capital Gains and Losses. Ordinary income resulting from the sale of virtual currency will be reported, as applicable, on the Form 1040 or Schedule 1, Additional Income and Adjustments to Income.

As always, we aim to be a resource for you. If you would like further advice on virtual currency transactions, please reach out to us with your questions.

Josh Fishburn