Virtual currencies (synonymous with the term Bitcoin) can be used to make electronic purchases of physical items or digitally traded or exchanged into dollars, Euros, and other real or virtual currencies. Peer-to-peer and retail transactions occur electronically using electronic credits without an exchange of physical currency.
Users make money in 1 of 3 ways: acting as an approval agent (mining); through gains and losses in the underlying exchange value of the Bitcoin for a US dollar or dollar valued product or service; or through the actual purchase and sale of Bitcoins.
In February 2015, the number of merchants accepting bitcoins for products and serviced passed 100,000. It is probably many times that by now. Merchants accepting bitcoin often pay less in transaction fees than is typical for credit cards. Digital theft and volatility have been issues for bitcoin users.
The IRS published IRS Notice 2014-21 regarding tax treatment of bitcoin. The IRS is treating bitcoin as investment property, not as currency that generates a foreign currency gain or loss. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in US dollars , as of the date that the virtual currency was received.
The use of a virtual currency to purchase a good or service will be treated as the sale of an investment type asset using the exchange rate on the date of use. Exchange rates are available at www.preev.com. For historical values, many investment websites, such as investments.com, now have cryptocurrency data.
For US tax purposes, transactions using virtual currency must be reported in US dollars. Therefore, taxpayers will be required to determine the fair market value of virtual currency in US dollars as of the date of payment or 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 US dollars (or into another real currency which in turn can be converted into US dollars) at the exchange rate, in a reasonable manner that is consistently applied.
The tax character of the gain or loss generally depends on whether the virtual currency is a capital gain or asset or investment (most taxpayers would see this ) or an ordinary gain asset like inventory in the hands of Bitcoin traders. Bitcoin held more than a year would qualify for long term capital gains treatment (lower tax rates) for most taxpayers other than Bitcoin traders.
A taxpayer who “mines” virtual currency (for example, uses computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger) will record the fair market value of the virtual currency as of the date of receipt, which is then includible in gross income and is subject to self-employment tax when a trade or business. Similarly, payments made to a independent contractor as payment would be taxable to the contractor and potentially subject to self-employment tax. Wages paid as virtual currency are subject to withholding and FICA at fair value of the currency paid. Both wages and payments to contractors are also subject to normal W-2, 1099 information reporting requirements.
As an example, you normally receive a net deposit of $2500 each pay period but you have opted to have 20% paid in Bitcoin. You would now receive $2000 into your bank as normal, and then, say, 1 BTC into your wallet. The cost basis of that Bitcoin is $2500-$2000 = $500, which you should record for when you come to sell or spend it. You still have $2500 in taxable wage income and you could have gain or loss when you eventually spend or exchange the Bitcoin.
If you buy one bitcoin at $500, and then spend it after it has risen in value to $750, then you report income of $250, and that example applies for any transactions of any dollar value.
If you bought Bitcoin in January, 2014 at a price of $5, then bought a $5.00 cup of coffee with it in January 2018 when the Bitcoin exchange value price was $795, receiving $790 in US currency in change, you just made $790 on the appreciation. That difference of $790 is taxed as a long term capital gain and reported on Form 8949.
This does seem to suggest that, by treating each transaction as a separate piece of property, transactions could be matched to selective purchases to minimize gain on transactions, or even to realize a loss, as long as recordkeeping is consistent and demonstrably accurate.
Virtual Currency Tax Reporting
|Type of Activity||Income Reporting||Subject to SE Tax?|
|Gain/Loss on Currency use for Purchase of Product or Service||Form 8949
Short Term if held < 1 year
Long Term if held > 1 year
|Gain/Loss on Conversion of Bitcoin to Currency such as US Dollars||Schedule C (or other business reporting form) if operating as a trade or business||Yes if trade or business
No if casual
|Data Mining Receipt of Bitcoin||Schedule C (or other business reporting form) if operating as a trade or business||Generally, yes|
A business that pays for business services in Bitcoin is also subject to filing Forms 1099 or W-2 for the recipient, just like in conventional currency. Similarly, though Bitcoin is not a currency to report on the FBAR Form 114, if the cash account is held in a foreign country, reporting will be required.
AFS – USE THE BEST FOR LESS