Taxation of Virtual Currency: The Internal Revenue Service Prioritizes Clarification
Last May 16th, Commissioner Charles P. Retting of the Internal Revenue Service (“IRS”) acknowledged the importance of providing more guidance to taxpayers regarding the tax treatment for transactions and dealings with virtual or crypto currency and promised to publish new guidance soon. The IRS last addressed the tax treatment of virtual currency in April of 2014, when it released Notice 2014-21, which included basic guidelines regarding tax principles applicable to transactions using virtual currency.
In the Notice, the IRS explained that general tax principles applicable to property transactions apply to transactions using virtual currency, that virtual currency shall not be given the same treatment as foreign currency, and that taxpayers must recognize gain or loss on the exchange of virtual currency for cash or for other property. The IRS also clarified that: (i) self-employment tax rules apply to virtual currency; (ii) wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes; and (iii) payments made using virtual currency to independent contractors and other service providers are reportable and taxable. The Notice explains that taxpayers must determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt.
The IRS constantly reminds taxpayers that income from virtual currency transactions is reportable on their income tax returns, and that those taxpayers who do not properly report their dealings in virtual currency can be audited and be even be liable for penalties and interest. Taxpayers should report relevant transactions using virtual currency by filing Form 8949, Sales and other Dispositions of Capital Assets and by using Schedule D when filing annual tax returns. These are the forms used by taxpayers to report capital gains and losses from investment property.
However, in the past few years, there have been unanswered questions as to the tax ramifications of some types of transactions involving virtual currency. In a letter dated April 11th, congressman Tom Emmer urged the IRS to provide guidance and resolve the ambiguity around basic questions regarding virtual currency—for example, how taxpayers should calculate and track the basis of their virtual currency and how to treat virtual currency hard forks. A hard fork occurs whenever there is change in the blockchain, such as a split, that can result in two separate virtual coins.
We expect the IRS to address these questions and others, including those related to international reporting of virtual currencies and taxpayer treatment of pre-2018 exchanges of virtual currency for other types of cryptocurrency, considering that the Tax Cuts and Jobs Act of 2017 restricted the application of 1031 like-kind exchange rules to real property not held primarily for sale.
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