On March 25, 2014, the IRS issued Notice 2014-21, which is its first major ruling in the area of the tax treatment of “virtual currencies” such as Bitcoin.1 The ruling comes on the heels of an urging by the GAO that the IRS provide guidance in the areas of virtual economies and currencies.2 The first significant conclusion in Notice 2014-21 is that virtual currencies are treated as “property” for U.S. income tax purposes, and not currency. This conclusion is consistent with some recent conclusions by tax authorities in other countries, including the U.K. and Canada. The remainder of the notice is set out in a “Frequently Asked Questions” format, many of them addressing the use of virtual currencies in retail transactions. Among the conclusions:
- A person who receives virtual currency as a form of payment must take into account the fair market value of the virtual currency at the time of the transaction when determining the gross proceeds of the sale.
- A person who uses virtual currency for purchasing a product is treated as if the virtual currency was sold on the date of the transaction and the person has a taxable gain (or loss) equal to the value of the currency sold, minus the adjusted basis of the virtual currency.
- Virtual currency is generally treated as a capital asset unless it is considered inventory in a trade or business.
- A person who "mines" virtual currency realizes gross income on the date of receipt of the virtual currency and if the mining activity constitutes a trade or business, the income would be subject to self-employment tax.
- Payment for services using virtual currency will be treated similar to payments made to persons for cash (i.e., Form W-2; Form 1099-MISC and employment tax requirements are applicable).
- Backup withholding is applicable, similar to other transactions involving property exchanges.
- Persons who settle payments on behalf of merchants that accept virtual currency from their customers may be subject to the requirements of Code Section 6050W and the Form 1099-K filing requirements.
Some significant questions remain and new ones are raised after the issuance of this notice. For instance:
- How is fair market value of the virtual currency determined? The notice states that this determination must be based on virtual currency exchange quotes; however, quotes on various exchanges vary dramatically at any point in time.
- After the release of Notice 2014-21, the recordkeeping requirements for retail purchasers using virtual currency is extremely onerous. Will recordkeeping relief be granted for small retail transactions?
- More guidance is necessary on Form 1099 reporting obligations in connection with virtual currency transactions, especially Form 1099-B (barter exchanges) and 1099-K (third-party settlement organizations).
- How will companies comply with Form 1099 reporting requirements given the anonymous nature of many virtual currency transactions?
It is likely that Notice 2014-21 is just the beginning of the IRS’ attempt to improve reporting and tax compliance of transactions involving virtual economies and currencies, but it is clear that the IRS believes that the potential impact of this aspect of e-commerce could have a significant economic impact at some point in the future.