09 Dec Virtual Currency Tax Implications – IRS Notice 2014-21
The question of the moment is whether virtual currency is here to stay or simply a passing fad, the 8-track player of modern day finance. IMHO the answer is probably a little of both. For sure private money is here to stay for a while at least, unless of course the Banks and Other Nefarious Financial Institutions (BONFI) truly get “too big to fail” and chose to squash this most excellent way of transacting business underground.
The extent to which private money maintains organization going forward as virtual currency is still not fully determined.
Drilling down virtual currency turns out is nothing more than a digital representation of value, like the tulip bulb in 16th Century Holland, that is all that it really seems to be. So tread lightly and if inclined to engage be protected as – like the wild wild west itself – nefarious characters from time to time will take advantage of this most excellent way to transact business as it claws its way into the mainstream.
Why is virtual currency excellent?
Because it takes the wind out of the sails of BONFI’s and puts the power to transact unencumbered back in the hands of the people where it belongs.
The sources for this post are IRS Notice 2014-21 along with my practical experiences reconciling tax disputes. This particular post is generally based on the following circumstances:
- On December 1st 2011 a 21 year old Colorado taxpayer legally exchanged 5 pounds of marijuana for 1000 Bitcoins when 1 Bitcoin was worth approximately $2 US. He recorded approximately $2,000 of gross receipts on 12/1/2011 and paid income tax on those gross receipts less costs of goods sold in tax year 2011.
- Shortly thereafter the taxpayer’s computer crashed preventing him access to his virtual currency account.
- Subsequently the taxpayer in a pot induced state of tommyrot assumed, wrongfully so, that he lost all his Bitcoins, gave up and moved on with life.
- The taxpayer later meets a girl who is intrigued by the unusual set of circumstances and also happens to have a bit of common sense about herself subsequently causing her to ‘find’ the previously ‘lost’ Bitcoins.
- On November 15th 2013 the taxpayer’s girlfriend sold those same 1000 Bitcoins at $500 per Bitcoin for approximately $500,000 US less commissions and fees.
- The “deemed” $2000 “investment” in 1000 Bitcoins with a transaction date of 12/1/2011 appreciated in value over 23 months to $500,000 recognized on 11/15/2013 creating an approximate capital gain of $498,000.
- The legal question now surrounds who is the rightful owner of the Bitcoins
- The question I was brought in to address is what is the after tax value of the Bitcoins after the conversion to US $$.
Like sands through an hour glass, so are the days of our lives… I honestly wish to one day be blessed with the imagination to make this stuff up! I could write screen plays.
The fact of the matter is craziness happens ALL THE TIME in Colorado as at the end of the day it is still the wild, wild West and the powers that be seem to work in mysterious ways. I just hope all those gains aren’t eaten up by lawyers in the fight.
Nevertheless the following are the 10 most resonating points generally worth sharing from this experience:
- Virtual currency operates like any other currency that circulates as legal tender in exchange for goods or services. However, is not legal tender. It is available in various online forms and can be digitally traded or exchanged for other virtual currency forms. It can also be purchased or exchanged into U.S. dollars and money from other countries and the price fluctuates continuously.
- If you are a US Taxpayer who pays with or receives virtual currency in exchange for goods or services you absolutely must record the value of the virtual currency in US$ at the end of the business day the transactions occur for both income and capital gains reporting purposes, even if you are a third party settlement organization issuing IRS Form 1099-K.
- The fair market value of the virtual currency at the date of exchange constitutes gross receipts in the United States and is subject to income tax after subtracting out costs of goods sold as well as ordinary, necessary and reasonable business expenses.
- A payment made using virtual currency is subject to information reporting to the IRS. Basically if you make a payment of fixed and determinable income using virtual currency with a value of $600 or more to a U.S. tax payer in any given tax year you are required to report the payment to the IRS and to the payee.
- Examples of payments of fixed and determinable income include rent, salaries, wages, premiums, annuities, and compensation and are reported on IRS Form 1099-misc.
- Payments of virtual currency required to be reported on IRS Form 1099-misc should be reported using the fair market value of the virtual currency in U.S. dollars as of the date of payment.
- See the Instructions to Form 1099-MISC for more information. For payments to non-U.S. persons, see Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.
- Payments made using virtual currency are subject to backup withholding to the same extent as other payments made in property. If you make payments using virtual currency you must solicit a taxpayer identification number (TIN) from the payee.
- See Publication 1281, Backup Withholding for Missing and Incorrect Name/TINs, for more information.
- Underpayments attributable to virtual currency transactions may be subject to penalties, such as accuracy-related penalties under section 6662. In addition, failure to timely or correctly report virtual currency transactions when required to do so may be subject to information reporting penalties under section 6721 and 6722.