AICPA steps up to IRS to recommend that IRS provide Virtual Currency Clarity was published by JD Supra on 7/31/18.
On 5/30/18, the American Institute of CPAs (AICPA) sent a letter (https://www.aicpa.org/content/dam/aicpa/advocacy/tax/downloadabledocuments/20180530-aicpa-comment-letter-on-notice-2014-21-virtual-currency.pdf) to the IRS presenting the AICPA’s updated recommendation to the IRS Guidance on Virtual Currency (VC) Notice2014-21 (https://www.irs.gov/pub/irs-drop/n-14-21.pdf). The recommendations are set forth in 27 Frequently Asked Questions covering 12 different areas of VC. These FAQ’s were developed by the AICPA Virtual Currency Task Force and approved by the AICPA Tax Executive Committee.
The AICPA is recommending to IRS that IRS release immediate guidance regarding the tax treatment of VC; as VC has “taken off” and the tax rules that currently apply to VC transactions and the value of VC are not clear. Taxpayers and tax practitioners are seeking Authoritative Guidance on how to apply tax laws to VC.
Here are the AICPA’s Suggested FAQ’s covering the 12 areas noted in the letter:
- Expenses of Obtaining Virtual Currency: “Virtual currency mining or similar activities produce virtual currency treated as ordinary income in the year it is mined and the expenses of mining are deducted as incurred”.
- Acceptable Valuation and Documentation: “Taxpayers are allowed to use an average of different exchanges as long as they are consistent in how they calculate the valuation. Taxpayers may use the average rate for the day to calculate the exchange rate, provided they are consistent in how they make this determination for every virtual currency transaction. Taxpayers may rely on virtual currency tax software as a reasonable and consistent method for determining fair value if the software is consistently using aggregated price data. Taxpayers should use time stamps whenever possible and transactions with dates should only have a reasonable and consistent method applied. A virtual currency, such as Bitcoin, meets this test in both methods because a combination of time stamps and dates are used. Taxpayers should apply the same reasonable and consistent method to all the transactions on a per virtual currency wallet or exchange basis. Taxpayers should use time stamps whenever they are available. Otherwise, the use of a reasonable and consistent method should apply to the transactions. Taxpayers may have one method applied to one wallet and another method applied to another exchange when determining the fair value of all the Bitcoin transactions. Taxpayers using this combination of methods can meet the overall test for reasonable and consistent determination of fair value. Taxpayers may use a price index provided they are consistent in applying prices for every virtual currency transaction”.
- Computation of Gains and Losses: “The taxpayer may choose either specific identification or FIFO (First In/First Out) as long as the method is consistently applied from year to year.”
- Need for a De Minimis Election: Section 988 – Treatment of certain foreign currency transactions – of the IRC addresses the treatment of certain foreign currency transactions in that any foreign currency gain or loss attributable to a section 988 transaction shall be computed separately and treated as ordinary income or loss (as the case may be). Part (e) of Section 988 applies to Individuals and provides an exclusion for certain personal transactions if: “(A) nonfunctional currency is disposed of by an individual in any transaction, and (B) such transaction is a personal transaction, so gain shall be recognized for purposes of this subtitle by reason of changes in exchange rates after such currency was acquired by such individual and before such disposition. The preceding sentence shall not apply if the gain which would otherwise be recognized on the transaction exceeds $200”. The AICPA recommends that “Individuals may use a de minimis rule, similar to section the 988(e)(2) exclusion, for virtual currency transactions to alleviate the burden or recordkeeping for individuals who use virtual currency as a medium of exchange. This de minimis rule allows taxpayers to exclude transactions resulting in $200 or less of gain.”
- Valuation for Charitable Contribution Purposes: “Virtual currencies that have a readily determinable market value on at least two commonly used exchanges are treated similar to contributions of publicly traded stock under Section 170(f) -Charitable, etc., contributions and gifts – and do not require a qualified appraisal. The taxpayer must document, and calculate the average of, the fair market value on at least two exchanges (at the date and time of the contribution) and the basis of the virtual currency contributed”.
- Virtual Currency Events: “Virtual currencies received from airdrops are akin to a bonus or a free prize. Taxpayers should include the amount as ordinary income based on the fair value of the token on the date of receipt. The income recognized becomes the basis in the virtual currency. The holding period begins on the date of distribution and is the first day of the holding period. Within 30 days of the event, taxpayers may report the event by making an “Election to Include a Virtual Currency Event as Ordinary Income in Year of Transfer,” similar (but not subject) to the process for making an election under Section 83(b) – Property transferred in connection with performance of services. If the virtual currency is a capital asset in the hands of the taxpayer, future disposition of the asset will generate a capital gain or loss and the income reported becomes the basis in the virtual currency. Taxpayers have the option to report events as they deem appropriate. However, if they choose to make an “Election to Include a Virtual Currency Event as Ordinary Income in Year of Transfer,” the IRS will not challenge that method of treatment for 2017. Specifically, a taxpayer makes the election that states they received Bitcoin Cash in the August 2017 split event and the currency has zero basis. A taxpayer should file this election with the 2017 tax return by the extended due date. If a taxpayer does not make the election, then the virtual currency event is reported as ordinary income when a taxpayer later disposes of the virtual currency received in a prior event (where the election was not made). Taxpayers may make the “Election to Include a Virtual Currency Event as Ordinary Income in Year of Transfer,” within 60 days of the release of IRS guidance on this issue. Within 30 days of the event, taxpayers may report the event by making an “Election to Include a Virtual Currency Event as Ordinary Income in Year of Transfer.” When one virtual currency is burned in exchange for another virtual currency (as required when the developers of one cryptographic protocol and/or blockchain decide to adopt a new and different cryptographic protocol and/or blockchain), the basis and holding period of the original virtual currency is applied to the new virtual currency version. If the swap is other than a 1:1 basis, the total value of the original virtual currency is divided by the number of new tokens received. Taxpayers should report virtual currencies that become worthless on Form 8949, Sales and Other Dispositions of Capital Assets, thus applying the same methodology used for worthless securities. Staking is akin to virtual currency mining and treated as ordinary income. The income recognized becomes the basis in the virtual currency and the holding period begins on the date the staking rewards are received. Expenses, if any related to staking, are deducted as ordinary expenses and expensed as incurred”.
- Virtual Currency Held and Used by a Dealer: “Virtual currency is property and its character is considered inventory when a dealer buys and sells virtual currencies to customers in the ordinary course of business. The sale of virtual currency is ordinary income and the inventory sold becomes the cost of goods sold. This type of business is a virtual currency exchange or a dealer. A virtual currency dealer can also have virtual currency held as property with related capital gain and loss calculations when it is used to pay for goods and services outside of the business context. Personal property acquired for resale includes both tangible and intangible property considered inventory for sale to customers in the ordinary course of business. Virtual currency is intangible personal property and a virtual currency exchange is subject to the rules of Section 263A – Capitalization and inclusion in inventory costs of certain expenses – (other than for small taxpayers excepted from section 263A)”.
- Traders and Dealers of Virtual Currency: “The nature of virtual currency trading is akin to dealers and traders of securities and commodities and a taxpayer may elect mark-to-market treatment. The taxpayer must otherwise qualify as a dealer or trader in order to make the election”.
- Treatment under Section 1031: “Notice 2014-21 provides that virtual currency is treated as property. Thus, if the property is held for investment or business (not dealer property), and all requirements of Section 1031- Exchange of real property held for productive use or investment – are satisfied, like-kind exchange treatment applies if the exchange occurs before 2018”.
- Treatment under Section 453: “Where a taxpayer disposes of virtual currency with at least one payment received after the close of the tax year of the disposition, the installment method of Section 453 – Installment Method – applies. The installment method would not apply if the currency is held as dealer property or inventory, or the owner elects not to have the method apply. The installment method applies to virtual currencies that are not dealer property or inventory and requires reporting on Form 6252, Installment Sale Income. If the taxpayer elects out of the installment method treatment, this method would not apply”.
- Holding Virtual Currency in a Retirement Account: “Virtual currency is considered property and taxpayers may hold it in an IRA if all other IRA requirements are satisfied”.
- Foreign Reporting Requirements for Virtual Currency: “The value of virtual currencies should aggregate with fiat currencies and any other assets required for reporting under both FBAR and FATCA if their respective reporting thresholds are met. Virtual currency wallets are owned and controlled by the taxpayer when in possession of the private key for that particular wallet. In this case, the virtual currency is considered cash which resides wherever the taxpayer resides and is therefore not considered a Foreign Financial Institution or subject to either FBAR or FATCA compliance”.
Don’t be a victim of your own making
The tax treatment of VC remains a gray area with minimal IRS guidance. The AICPA is recommending positions to the IRS on the reporting and tax treatment of various situations so that taxpayers and ax practitioners have clarity.
Taxpayers holding VC ought to consult their specialized tax representative to analyze potential reporting requirements and the proper application of tax laws covering VC.