Baffled by Bitcoin? In the dark over Litecoin but find Ethereum engaging?
No matter what your attitude toward the use of virtual currency, the Internal Revenue Service wants you to know that there’s really only one thing to keep in mind as far as income taxes are concerned: virtual currency transactions are taxable by law just like transactions in any other property.
To be sure, this isn’t news. Complete guidance is contained in IRS Notice 2014-21.
Virtual currency, as generally defined, is a digital representation of value that functions in the same manner as a country’s traditional currency. There are currently more than 1,500 known virtual currencies. Because transactions in virtual currencies can be difficult to trace and have an inherently “pseudo-anonymous” aspect (in the words of the IRS), some taxpayers may be tempted to hide taxable income.
Notice 2014-21 provides 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. Among other things, this means that:
- A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
- 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-MISC.
- 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.
- Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card, and Third Party Network Transactions.
- 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.
The IRS makes it clear that taxpayers who don’t report virtual currency transactions in a straightforward manner can be audited and could be liable for penalties and interest where applicable.
“In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions” the IRS states. “Criminal charges could include tax evasion and filing a false tax return.”