IRS Taxes Bitcoin as Property
The Internal Revenue Service issued Notice 2014-21 to address the taxable status of convertible virtual currencies, or a digital representation of value that functions as a medium of exchange, unit of account, and/or store of value, but does not have legal tender status in any jurisdiction. Convertible virtual currency has an equivalent value in real currency, or acts as a substitute for real currency. Bitcoin is the leading example of a convertible virtual currency. See more on the nature of convertible virtual currencies in the Department of the Treasury’s guidance FIN-2013-G001.
In Notice 2014-21, the IRS confirmed the taxable status of convertible virtual currency.
[T]he sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability.
The IRS is in some ways and circumstances treating convertible virtual currency like stock, i.e. property with a fair market value listed on an exchange for an exchange rate established by market supply and demand. There is the potential for capital gain or loss, for example, and receipt of convertible virtual currency triggers a reportable income for the fair market value at the time of receipt, i.e. its basis. For Bitcoin, that includes receipt from mining activities. Reports to the IRS are to be made in USD.
Receipt of convertible virtual currency for services rendered as an independent contractor – or if self-employed in a mining capacity – is subject to self-employment tax. If convertible virtual currency is paid by an employer as remuneration for services, it constitutes wages for employment tax purposes, and the fair market value is subject to withholding, FICA and FUTA, and must be reported via W2. Remuneration paid in convertible virtual currency is subject to backup withholding and information reporting, for example via 1099-MISC where the convertible virtual currency is valued at $600 or more on the date of payment.
As usual, taxpayers may be subject to penalties for failing to comply, including underpayment, inaccuracy, untimeliness, etc. However, relief may be available to those required to file an information return if error is due to a reasonable cause.
The IRS is taking comments on this subject via email. If you write, be sure to include Notice 2014-21 in the subject line, and be aware that comments will be available for public inspection and copying in their entirety.