Virtual currencies such as Bitcoin, Ethereum, Litecoin and Ripple are gaining traction as viable currencies for a wide range of transactions. However, their increasing acceptance by the public also brings increasing scrutiny by the IRS for reporting and compliance.

Virtual currency is an intangible electronic asset that is not regulated by any government or authority. IRS guidance defines a virtual currency as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Bitcoin was one of the first virtual currencies created and it exists on a digital ledger system known as Blockchain.

Unlike a traditional national currency such as the U.S. dollar, the value of virtual currencies can fluctuate widely. Taxpayers who conduct transactions using virtual currency may be required to report these transactions on their tax returns. For this reason, it is critical to note the fair market value of the virtual currency at the time of a transaction.

The IRS Strengthens Rules and Guidance on Virtual Currency

As virtual currencies gain greater acceptance, the IRS is taking note. Taxpayers who invest in virtual currencies should record the dates purchased, dates sold, purchase price and the proceeds of all their virtual currency transactions. The IRS guidance on the reporting of virtual currency transactions notes the following:

  • The specific question regarding virtual currencies has moved to the first page of Form 1040 for tax year 2020 reporting, directly beneath the taxpayer’s general information. This question previously appeared on Schedule 1. The question states: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
  • The IRS FAQ on virtual currency notes that if a taxpayer purchased virtual currency in 2020 with real currency and had no other transactions, they are not required to answer “yes” to the question on Form 1040.
  • Taxpayers who sell virtual currency are required to report the sale on Schedule D of Form 1040. Unlike stocks held in brokerage accounts, virtual currencies typically are not reported on a Consolidated 1099 Tax Statement. Taxpayers may receive a 1099-K or 1099-B related to their virtual holdings. All copies of 1099 forms are sent by the issuer to the taxpayer and the IRS. If a 1099 is not issued, the taxpayer will need to determine the cost basis and sales price of the virtual currency.

Accepting Virtual Currency as Payment for Goods and Services

If you or your business conduct transactions using virtual currency, keep in mind the following guidance:

  • If an individual or a business is paid in virtual currency for services rendered, the amount paid must be reported as income. The taxpayer should report the fair market value of the virtual currency on the date the payment was received.
  • Employers who pay wages using virtual currency must report the amount on Form W-2 and these wages are taxable to employees. The fair market value of virtual currency paid as wages is subject to federal income tax withholding and payroll taxes.
  • If a taxpayer who is an independent contractor or other service provider receives virtual currency payments, these payments are taxable. Payers must report this income through a 1099-NEC and in general, the rules for self-employment tax apply.

Failing to report transactions conducted using virtual currency can have severe tax consequences. Taxpayers are advised to inform their tax professional of any virtual currency transactions that occurred during the year.

If you have any questions about this please contact your ALL tax advisor or call us at 617-738-5200.

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