You have probably heard the term Bitcoin and all the media buzz about this new technological evolution of currency, but you may not understand the clamor. Supporters of Bitcoin, particularly the millennial generation that is accustomed to electronic transactions, will tell you it’s a different, some would say better, type of currency, and it’s unique in that it has no physical form, just a digital one. Cryptocurrency, also referred to as virtual currency, is just what it sounds like: digital money, but with one basic difference from the dollars and coins residing in your pocket. While the value of Cryptocurrency may go up or down, that value exists solely with the people that create it and those that accept it as a replacement to the more recognized forms of payment.
Bitcoin is one of the most popular forms of virtual currency, and the only one most people recognize. But it would probably surprise you to know that there are more than 1,000 other cryptocurrencies in circulation.
Taxation in General
In United States, the IRS says that Bitcoin is to be treated as property for federal tax purposes. This means that the same general tax principles that apply to property transactions will apply to any transaction involving cryptocurrencies. Under these principles, taxpayers receiving Bitcoin in exchange for providing goods or services will recognize income equal to the fair market value of the Bitcoin received on the date of receipt. With the volatility of Bitcoin over the last few years, and particularly the last few months, this could indicate a very wide range of values.
Taxpayers must document the cyrptocurrency’s fair market value (in dollars, if a U.S. taxpayer) at the time of receipt, as this value establishes both the taxpayer’s income on the transaction as well as the taxpayer’s basis in the cryptocurrency that will be used to determine the taxpayer’s future gain or loss when the virtual currency is disposed or used.
If a taxpayer mines Bitcoin or other virtual currency as a trade or business, and the mining is not done as an employee, the net earnings from this mining will be subject to self-employment tax. And, any independent contractor who is paid in virtual currency for their services will be subject to self-employment tax on the cryptocurrency’s fair market value as well. In addition, if a company pays its employees’ wages in virtual currency, the fair market value of said wages will be subject to the usual federal income tax withholding, and will need to be reported on their W-2. Note that all of those U.S. taxes due will be paid in U.S. dollars—the IRS does not accept Bitcoin or other cryptocurrencies.
Since cryptocurrencies are not classified as currency for U.S. tax purposes, international taxation can add another layer of complexity.
Bitcoin is still a fairly new technology, which means tax treatment of virtual currency transactions is still being developed. However, with the increase in use and established values, it is likely to gain more interest from the IRS. We will have more articles exploring the various aspects of taxation when using Bitcoin or other cryptocurrencies, as well.
Article by Andrea Mouw, J.D., Principal, EideBailly, An independent member firm of HLB International.