Article Highlights:
- Taxation of transactions in virtual currency
- Wages paid in virtual currency
- Payments to contractors in virtual currency
- Virtual currency as capital asset
- Virtual currency as inventory or property for sale
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency of any country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance. However virtual currency does not have legal tender status in any jurisdiction.
Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. It can be digitally traded between users and purchased for, or exchanged into, U.S. dollars, euros, and other real or virtual currencies.
Virtual currency is treated as property, not currency, 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 taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the virtual currency’s fair market value.
- 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.
- When a virtual currency is sold, it is treated as property.
- If the property is a capital asset like stocks or bonds or other investment property, gains or losses are realized as capital gains or losses.
- If the property is inventory or other property mainly for sale to customers in a trade or business, then ordinary gains or losses are generally incurred.
Virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers must determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, reasonably and consistently.
If you have transactions using virtual currency and have questions on how that might affect your taxes, please give this office a call.