Virtual currency may have an equivalent value in real currency. This type of virtual currency is referred to as "convertible" virtual currency. "Bitcoin" is an example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars and other real or virtual currencies.
The growth in virtual currency has brought tax questions. In 2014, the IRS announced that virtual currency is treated as property for U.S. federal tax purposes. General tax principles that apply to property transactions apply to transactions using virtual currency. The IRS explained that:
- Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
- Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.
- The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
- A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
Last year, a government watchdog, the Treasury Inspector General for Tax Administration (TIGTA), recommended that the IRS revisit virtual currency. TITGA noted the growing use of virtual currency. "However, some virtual currencies are also popular because the identity of the parties involved is generally anonymous, leading to a greater possibility of their use in illegal transactions," TIGTA cautioned.
In June, several lawmakers asked the IRS to describe the agency's virtual currency strategy. The lawmakers also asked the agency what outreach and education it has done for stakeholders. In their letter, the lawmakers directed the IRS to reply to their questions. As of the date this article was prepared, the lawmakers have not released the agency's response, if there was a reply.
If you have any questions about the federal tax treatment of virtual currency, please contact our office.