You may have heard of the impact virtual currency has recently had on the market and on how goods and services are sold or bought (does the name Bitcoin ring any bells?). Making its way into the world of taxpayers and businesses, virtual currency—frequently called cryptocurrency—has become a commonly utilized means of exchanging or purchasing currency. These “crypto” currencies operate on technology known as blockchain or distributed ledger technology (DLT). DLT allows for the immutable storage of ledger-type information on a network of computers. While an interesting concept on its own, even more so is the question: how is virtual currency taxed?
Taxes on Virtual Currency Explained
Virtual currency earned as payment for goods or services must be included in a taxpayer’s gross income at its fair market value determined on the date of payment. Virtual currency is referred to as convertible virtual currency when it represents an equivalent value in real currency and is quantifiable in U.S. dollars. It is classified as property when measured for federal tax purposes. In this regard, it can be considered personal, business, or investment property.
The same tax laws that apply to real currency also apply to virtual currency, and tax regulations for property transactions must be adequately followed when dealing in virtual currency. Taxpayers are responsible for filing taxes on virtual earnings, and consequences do apply when failing to comply.
IRS-issued Guidance
The Internal Revenue Service (IRS) issued guidance in 2014 concerning the sale and exchange of virtual currency, which states that the IRS is “aware that ‘virtual currency’ may be used to pay for goods or services, or held for investment.” They additionally define virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” The entirety of this guidance addresses reporting requirements in a series of frequently asked questions.
Are There Virtual Tax Evaders?
There is no loophole for escaping the IRS, and taxpayers receiving virtual currency will suffer penalties for tax misconduct just the same as anyone else. This is not to say that criminal activity surrounding virtual currency does not still exist. In 2016, the Treasury Inspector General for Tax Administration advised the IRS to more closely monitor taxpayers, who utilized virtual currency, to make sure they were not evading taxes. As a result, the IRS investigated a virtual currency exchanger in California for tax misconduct. This continues to be a concern for the IRS, as they work to hinder tax transgressions.
Conclusion
If you’re considering investing in virtual currency or are already using virtual currency and you want to learn more, contact our Sikich tax experts or our blockchain technology professionals.
Summary
- IRS definition of Virtual Currency: “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.”
- Virtual currency earned as payment for goods or services must be included in a taxpayer’s gross income at its fair market value determined on the date of payment.
- Convertible virtual currency: When virtual currency represents an equivalent value in real currency and is quantifiable in U.S. dollars.
- Virtual currency is considered personal, business, or investment property when measured for federal tax purposes.
- Taxpayers are responsible for filing taxes on virtual earnings.
- In 2016, the Treasury Inspector General for Tax Administration advised the IRS to more closely monitor taxpayers, who utilized virtual currency.
