Prepared by Jonathan Kim, CPA – Senior Accountant
Virtual currency, also known as cryptocurrency, has gained quite a lot of attention as of late, given Bitcoin’s astronomical rise to nearly $20,000 a piece in December of 2017 (coming from being worth a mere fraction of a penny each). Long before this euphoric rise in value (and its subsequent fall to less than a quarter of that), the IRS was well aware of the existence of virtual currency as a medium of exchange. Back in March of 2014, the IRS released a notice providing guidance on the taxation of virtual currencies.
In short, existing tax principles regarding property transactions apply to virtual currency transactions as well. This means, for example, anyone who receives virtual currency as payment for products or services must report the fair market value of the virtual currency on the date of receipt as income. The income reported becomes your basis in the virtual currency received.
If you own virtual currency, you either received it in payment, purchased it, or created it yourself (referred to as “mining”). In the first two situations, when you either use it as currency to acquire goods or services or sell it by converting it back to cash, you recognize a capital gain or loss, either short-term or long-term depending upon how long you have held the virtual currency. The selling price, if used to acquire goods or services, is the fair market value of what you acquired. Virtual currency that you create is considered to be inventory, so when you either sell it or use it to pay for goods or services, the income (or loss) is ordinary.
There is additional guidance provided for those who mine virtual currency – the fair market value of the virtual currency as of the date of creation is includable as income. This income would also be subject to self-employment rules (i.e. additional taxes) if you did this yourself as a trade or business.
So, despite the anomalous nature of virtual currency, it is equally subject to ordinary income, capital gain, and self-employment taxes. In addition, although virtual currency inherently provides an anonymous realm to conduct transactions, underreporting and accuracy related penalties still apply.