Bitcoin & Other Virtual Currencies on your U.S. Tax Return
Ines Zemelman, EAJun-10-2017
Welcome to the gold rush of 2017, where the new gold is no longer a physical product, but virtual currency (cryptocurrency). All the rage in silicon valley, the subject of many confused google searches and medium blog posts of why you should be investing, bitcoin and other virtual currencies are taking the financial world by storm. We won’t attempt to educate you on the specifics of virtual currency, and we certainly will not be providing financial investment advice. What we will do, however, is explain to you the U.S tax reporting requirements from transactions in Bitcoin and other virtual currencies.
What is a virtual currency
“The new money” - Bitcoin and other virtual currencies are a method to exchange money or assets between parties. A “Digital representation of value” - although there is no legal tender status in any jurisdiction (they are not backed by a principal authority or governing body), they operate just like paper money (on the internet) and growing number of vendors are beginning to accept it as payment (although still nascent). Bitcoins are ‘mined’ by powerful computers.
Is this FAQ applicable for all virtual currencies?
Note - this is only for bitcoin. With the growth of other virtual currencies (Ethereum, Antshares, etc) - this is a constantly evolving field. The IRS specifically notes that “no inference should be drawn with respect to virtual currencies not outlined” - but in absence of information it is really the only logical conclusion (think ‘transitive property’ from middle school).
How is the virtual currency treated on my U.S. tax return?
The IRS treats virtual currency as property. As such, general tax principles applicable to property transactions apply to transactions using virtual currency. Think capital gains: taxation rules are the same that for capital gains from stock transactions. Also note that 3.8% Net Investment Income tax (NIIT) may apply.
But virtual currencies are currencies, do I have to figure out currency gain/loss?
No - despite the name, virtual currency is not treated as a currency that could generate ordinary gain or loss.
If I receive virtual currency as payment instead of USD, do I have to report it?
Yes - most definitely so. If you receive virtual currency (i.e. Bitcoin) as payment for goods or services, the fair market value of the virtual currency must be added to your gross income. The fair market value must be determined on the date that the virtual currency was received.
How do I know the Fair Market Value (FMV)?
Bitcoin and other virtual currencies are listed on exchanges and the exchange rate is determined by the market. If the exchange is USD listed, then you have your price right there. If listed in another currency, then convert the non-USD currency into USD. Much like other currency translations, the exchange rate needs to be ‘reasonable’ and ‘consistently applied’. Ie - if you use the closing price of bitcoin on one day to determine the USD value of goods received, you should not use the opening price on the next transaction.
What if I used bitcoin to purchase other property - can there be a gain or loss upon the exchange?
Yes. For example, you purchased 50 bitcoins for $1000 on Jan 1 2017 - ie your basis was $50,000. On Jun 20, 2017, that bitcoin is now worth $135,000 (50 * $2,700), and you purchase a home for 135,000 - paid with a transfer of bitcoin.
This is the same thing as selling the bitcoin for $135,000 - you have a capital gain of 85,000 (135,000-50,000) that you must pay tax on.
What if the Fair Market Value of bitcoin dropped by the time when I used it purchase other property - can there be a gain or loss upon the exchange?
Yes, loss will be recognized in the same manner as capital loss from selling stocks. It may be long- or short term depending on whether the currency was held for one year or less. Unused portion of the capital loss may be carried over to the following years.
If I am a broker and hold bitcoins to sell to customers, how is this treated? Does the IRS view my sales of bitcoins the same as they would of a general speculator?
All traders of bitcoins buy and sell, but not all are made equal in the eyes of the IRS.
Just like stocks, your “intent” matters and not every sale of virtual currency is a capital gain/loss.
Virtual currency held for selling to customers is not a capital asset (as it would be if you were Joe Shmoe trading bitcoins in hopes of profiting) - these bitcoins would be treated by the IRS as business inventory, therefore the gain would be taxed as ordinary income and not capital gains.
If in the course of business you lose money, the loss may be recognized in full in the year of the transaction, without limitations existing for recognition of capital loss ($1,500 per year per person, with ability to carry forward). Net investment tax will not apply.
I “Mine” bitcoins. How is this accounted for with the IRS?
If you are looking to learn about the specifics of bitcoins, what they are, and where they come from, you should probably not be looking on a tax website, so please excuse the ‘dumbed down’ explanation. Bitcoins are ‘mined’ with computers - computer resources are used to validate bitcoin transactions. Now, the person who ‘mined’ these bitcoins is now in receipt of bitcoins and must declare them on their tax return. The bitcoins should reflect the fair market value of the virtual currency as of the date of receipt and be included in gross income of the taxpayer.
Is ‘Mining’ bitcoins self-employment?
If the ‘mining’ is your main trade or business and you are not undertaking the activity as an employee for another person or entity, then yes this is self-employment. The net earnings from self-employment (ie - your revenue less your allowable deductions (costs)) resulting from those activities constitute self-employment income and are subject to self-employment tax (SECA).
If you work for a company that hires you to mine bitcoins, and receipt of bitcoins is not in your name, but for the company, then you are an employee and not subject to SECA tax. This is especially relevant for Americans abroad - please see our guides for Digital Nomads and Self-Employed Expats
If I am paid in bitcoin for my services, does that determine if I am self-employed or employed?
Absolutely not. The determinant for self-employment vs employment is not based upon the currency that you are paid in, but upon the terms surrounding your services (see example above for mining bitcoins)
If you are a contractor, this is self-employment whether you are paid in USD, bitcoins, or pet sheep. Similarly, If you are employed by a company, and you perform services on their behalf as an employee, the currency of remuneration is immaterial to the determination of whether your wages are subject to SECA.
Are payments made by virtual currency subject to reporting?
Payments from bitcoin and other virtual currencies are subject to reporting in the same manner as any other payment made in property.
For example, if in the normal course of business, you were to pay $600 or more to an independent contractor (not an employee), this payment is required to be reported to the IRS and the payee on form 1099 MISC?) If you paid $600 worth of bitcoin to a roofing contractor as compensation for fixing your roof (as of this writing, this amount in .222 bitcoins at a price of $2,700), you would be required to issue a 1099-MISC.
*Note - this rule has little application in real life. Although the rules stipulate she should, we doubt Kate Smith is issuing 1099’s to her roofers and plumbers for normal work. This is more for businesses which can deduct these expenses.
I am paid in bitcoin, is this subject to withholding for tax purposes?
You are subject to the same withholding principles as you would be for other payments made in property.
I sell items on the internet and the payments are settled via bitcoin - what are my reporting requirements?
With the sharing economy, online sales are soaring.
If you (merchant) sold tickets on Stubhub (3rd party settlement organization - TPSO) to customers, Stubhub is required to report the payments made to you on form 1099-K if both of these two bullets are true for the calendar year:
Number of transactions settled for you (merchant) exceeds 200, and
Gross payments made to you exceeds $20,000
As above, since you are settling in virtual currency which is highly volatile, the fair market value on the date of payment is crucial.
The same principle would apply if you rent your home on AirBnB, or sell product on EBay.