Bitcoin and Other Virtual Currencies

February 23rd, 2018

Bitcoin was created back in 2009. It’s a digital currency system that doesn’t have any central regulatory authority or bank. That means no government or financial institution regulates this currency.

Apart from lacking a central regulatory control, Bitcoin is also unique as users can remain anonymous and perform transactions through only an identification number. Since it’s a digital currency, there is no physical form available. So don’t expect to ‘see’ a Bitcoin. It only has a digital presence on a digital ledger (Blockchain) that records and saves digital transactions.

Due to the fact that there is no centralized network involved in Bitcoin transactions, they are more robust, efficient, and secure compared to traditional currency transactions involving a central bank or government.

Is Bitcoin the only virtual currency available?

Today, virtual currencies have become a popular choice for digital consumers. There are nearly 700 different types of these currencies in the market these days. However, not all of them are as popular as Bitcoin.

Bitcoin, being the largest digital currency today, represents a market share of $290 billion while other virtual currencies only represent around $70 billion. Ethereum is the largest virtual currency after Bitcoin with a market share approaching $60 billion.

IRS and virtual currency – What are the guidelines for payments?

The IRS has yet to provide comprehensive guidelines regarding taxation of virtual currencies. As of now, IRS has issued summary guidelines through Notice 2014-21. According to this notice, the IRS will consider virtual currency as property for the federal tax purpose.

Payments using Bitcoins and other virtual currencies are merely property transactions. They will be taxed as any other transactions involving property.

Payments made to independent contractors and employees

When payments using virtual currency such as Bitcoins are made to independent contractors, they are taxable under the self-employment rules. Similarly, when payments are made to an employee, they are subject to payroll and income tax rules. The payers must issue a 1099-Misc form in case of payment to a contractor and the employer must provide information in a W-2 form in case of payments made to an employee.

Exchange or sell virtual currency

If you exchange or sell virtual currency, you have to pay tax. As a taxpayer, you will have a taxable gain when the fair market value of your property exceeds your adjusted basis of virtual currency.

Similarly, you – the taxpayer – will have a loss when the fair market value of such property falls below the adjusted basis of virtual currency.

Most importantly, the gain qualifies for capital gain rates on the property when held for more than one year. Since virtual currencies are treated as property for the tax purposes, you could benefit from capital gain rates.

IRS, virtual currencies, and the Coinbase summons case

Coinbase is the largest broker in the US in the digital currency market. It has served over 10 million customers over the past 6 years. In 2017, IRS was granted access to the documents during a case hearing in Coinbase summons case. Due to this court decision, Coinbase is now required by law to turn over records on accounts for transactions involving virtual currencies.