Taxation of Virtual Currency Transactions – Basics

IRS Notice 2014-21 spells out the basic concepts of how transactions in virtual currencies are taxed. I boiled them down for you and here’s what’s left.

For IRS purposes, virtual currency is not treated as currency (legal tender). It is “property” and all the general tax principles applicable to property transactions apply to transactions using virtual currency. Because the virtual currency is treated as property a taxpayer who receives virtual currency as payment for goods or services must include the fair market value of the virtual currency in computing their gross income, measured in U.S. dollars, as of the date that the virtual currency was received.

The “basis” (cost for purposes of determining gain or loss on the sale of property) of virtual currency that a taxpayer receives as payment for goods or services is the fair market value of the virtual currency in U.S. dollars as of the date of 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, in a reasonable manner that is consistently applied. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. Whether sale of the virtual currency generates capital gain/loss or ordinary income/loss depends on a multitude of factors, which are the same for virtual currencies as they are for any other property.

When a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income and in net earnings from self-employment and are subject to the self-employment tax.

The fair market value of virtual currency paid as wages is subject to federal income tax withholding, social security and medicare taxes, and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2. Similarly, the fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax and the regular information reporting rules for 1099s.

– Mark S Gleason, CPA

www.mattson-cpa.com

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