The Internal Revenue Service (“IRS”) recently announced its awareness of virtual currency (such as bitcoin) and wanted taxpayers to know the tax consequences of using virtual currency.
As the IRS puts it, virtual currency is not really legal tender and, therefore, virtual currency is not treated as money but rather as “other property.”
The important lesson is that if a taxpayer receives virtual currency as payment for services (instead of money wages), that taxpayer has income equal to the value of the virtual currency on the date of receipt. For a self-employed taxpayer, self-employment tax would also apply. Virtual currency mining, defined as using computer resources to help manage public transaction ledgers and validate transactions, is a service for which those performing the services are usually paid in virtual currency. Mining is a service and like the payment for all other services, receipt of virtual currency for services is taxable income.
If a taxpayer sells property in exchange for virtual currency, that sale is subject to tax according to the normal rules. The tax basis in the property is measured against the fair market value of the virtual currency to determine whether there is gain or loss. The gain or loss may be either an ordinary gain or a capital gain depending on the nature of the property sold and may be long or short term gain, depending upon the length of time the property is held. The sale or exchange of virtual currency for other property is also taxable under the same rules.
Employers using bitcoins or other virtual currency to pay workers also need to report the payments either on Form W-2 for employees or Form 1099 for independent contractors.
