What is a Virtual Currency Taxable event? was published by JD Supra on 8/22/18.
There continues to be limited Virtual Currency (VC) guidance from the US Treasury and the IRS and VC investors ought to proceed cautiously. IRS continues to make reference to Notice 2014-21 to remind Taxpayers that VC currency is treated as property for U.S. federal tax purposes and that the general tax principles that apply to property transactions apply to transactions using VC.
What constitutes a taxable event?
- Taxable events related to VC occur if the VC Holder “does something” after obtaining the VC. Meaning: Taxpayers don’t owe taxes if they bought VC and just held on to it (not a taxable event).
- Taxpayers owe taxes if they sell the VC for a profit, exchange it for another VC or use it to buy goods or services (all taxable events).
The highlights of Notice 2014-21 are:
- VC is not treated as a currency. It is considered personal property and taxed as a capital asset.
- If VC is converted into currency and there is a gain, it is subject to capital gain.
- If goods or services are purchased with VC, the Taxpayer must also account for the gains.
- A Taxpayer that receives VC as payment for goods or services must include the fair market value of the digital currency received measured in USD in the gross income on the date of the receipt.
- VC that is held and then sold at a gain is subject to either long- or short-term capital gains tax.
- A Taxpayer, who holds VC for sale in a trade or business, is subject to ordinary gain or loss upon sale.
- VC is recognized income immediately at the fair market value. This income could be subject to self-employment tax.
- Payments made using VC are subject to backup withholding to the same extent as other payments made in property.
- A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
- A person who in the course of a trade or business makes a payment of $600 or more in a taxable year to an independent contractor for the performance of services is required to report that payment to the IRS and to the payee on Form 1099-MISC, Miscellaneous Income.
- The payment recipient may have income even if the recipient does not receive a Form 1099-MISC.
This is what we know directly from IRS as well:
- 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.
- Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third-Party Network Transactions.
- The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
Tax Reform took away a “perceived loophole”
The 2017 Tax Cut and Jobs Act (TCJA) amends Section 1031 such that “real property” is the only type of property eligible for like-kind exchanges: “SEC. 13303. LIKE-KIND EXCHANGES OF REAL PROPERTY. 13 (a) IN GENERAL. —Section 1031(a) (1) is amended by striking ‘‘property’’ each place it appears and inserting ‘‘real property’’, “the amendments made by this section shall apply to exchanges completed after December 31, 2017”. VC investors that relied on the law to exchange one VC for another VC without paying taxes and or creating tax obligations can no longer treat the transaction as a like-kind exchange under the TCJA.
IRS issues Notice that addresses potential Taxpayer temptation to hide VC income or profits
IRS was clear in its Issue Number IR-2018-71 that Taxpayers are required to report their taxable VC transactions on their income tax return; that VC transactions are taxable just like transactions with other property. It is evident that IRS continues to view VC as a conduit for tax evasion: “Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest. In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000”. IRS sentiment is that the pseudo-anonymous nature of VC transactions lend themselves to potential Taxpayer temptation to hide taxable income from IRS.
Don’t be a victim of your own making
Understand how IRS views VC transactions. Unless a Taxpayer is buying and holding VC, all VC transactions are taxable, and VC investors ought to consult and obtain guidance from a specialized tax professional for the tax treatment of VC transactions. Taxpayers engaged in VC transactions are required to keep adequate VC books and records. If you are a Taxpayer with reportable gains or withholding taxes, consult with your tax specialist, even if you have not received a Form 1099. The burden is on the Taxpayer to report voluntarily and pay taxes on gains earned.