If you are a trader of Bitcoin or use “virtual currencies” as payment, the Internal Revenue Service wants you to know that you are not immune to the bite of the income tax. The IRS has published a Notice providing guidance to owners of virtual currencies about their potential tax liabilities.
For federal tax purposes, virtual currency is treated as property and not as currency. As a result, each exchange of virtual currency results in a transaction that should require reporting on a federal income tax return. A taxpayer who receives virtual currency in exchange for goods or services must, when computing gross income, include the fair market value of the virtual currency on the date the currency was received. When the taxpayer disposes of the virtual currency, if the fair market value of property received in exchange exceeds the adjusted basis in the currency, the taxpayer has a taxable gain. The taxpayer has a loss if the fair market value on the date of exchange is less than the adjusted basis in the currency. A taxpayer will recognize capital gain/loss on an exchange if the currency is a capital asset of the taxpayer and ordinary gain/loss otherwise. For example, if someone receives 3 Bitcoin as salary when its fair market value is $5,000, the taxpayer must include $15,000 in gross income in the year received. The taxpayer’s adjusted basis in each Bitcoin is $5,000. If the same taxpayer buys a vehicle with these 3 Bitcoin when their value is $9,000 each, taxable gain of $12,000 ($4,000 gain per Bitcoin times 3) would be recognized. The same taxable gain would occur if the individual sold the Bitcoins for $9,000 each instead of using them as currency, and bought the same vehicle with cash.
There are tax consequences in other aspects of the virtual currency world. An individual who “mines” virtual currency must include in gross income the fair market value of the currency in U.S. dollars on the date of receipt. Further, an individual who mines virtual currency as a trade or business will also be subject to self-employment taxes. Virtual currency transactions are subject to the same backup withholding requirements as other property transactions are. Taxpayers who have income attributed to virtual currencies are subject to IRS penalties for failure to comply with the tax laws, like taxpayers whose income is received in U.S. dollars.
Do you have a question concerning a virtual currency transaction? Contact Peter E. Iorio to discuss whether there are tax liabilities that should be reported on your federal income tax returns.