Bitcoin Is Drawing the Interest of Investors and the IRS

In a prior blog post here my colleague, Chris Weeg, discussed using Bitcoin as part of year end charitable giving. Bitcoin has been in the news lately as the value of a single Bitcoin has risen dramatically in the last month. Some financial experts view Bitcoin as the next great investment, while other financial investors believe that Bitcoin is a scam. Currently Bitcoin has limited usage beyond investment, but one of the Big 4 accounting firms says it has begun accepting Bitcoin as payment here. In addition, futures trading on Bitcoin is expected to start next week.

Bitcoin and other virtual currencies, such as Ethereum and Litecoin, allow people to buy goods and services and exchange money without involving a centralized system such as a bank or credit card issuer. Although the transactions are not completely anonymous, the identity of the parties to a transaction is difficult to discover. Due to the anonymous nature of the transactions, there are concerns that the use of virtual currencies in an unregulated global economy will lead to abuses, including unreported taxable income and money laundering.

Not surprisingly, the IRS has been very active in addressing virtual currencies. On March 25, 2014, the IRS issued guidance here declaring that virtual currency is treated as property for U.S. federal tax purposes, and that general tax principles that apply to property transactions apply to transactions using virtual currency. Among other things, this means that:

1. 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.
2. Payments using virtual currency made to independent contractors and  other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.
3. 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.
4. A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

On November 28, 2017, a U.S. Magistrate Judge in the Northern District of California ordered Coinbase, a leading Bitcoin firm, to comply with an IRS summons requesting information regarding Coinbase customers who had or have investments in Bitcoin (here). The summons to Coinbase was based in part on information obtained by the IRS in an audit of one or more taxpayers who admitted they had been using Bitcoin to underreport their taxable income. Pursuant to the court’s order, Coinbase must produce account holder information and account activity records for accounts “with at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in any one year during the 2013 to 2015 period”.

It does not appear that virtual currency is going away. Stayed tuned for future developments.  If you have any questions related to this or any other civil tax or criminal tax-related matter, please feel free to call me at (214) 749-2456 or by email at jcrouch@meadowscollier.com.