Virtual Currency Subject to Very Real Taxes

The Internal Revenue Service has issued a notice on the use of virtual currency that puts the use of the digital dough squarely in taxable territory.

For the record, digital or virtual currency was defined by the European Central Bank in 2012 as, "a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community."

While virtual currency operates in many ways like “real” currency – it circulates, it is accepted as a medium of exchange in the country of issuance – it does not have legal tender status in any jurisdiction. Virtual currency allows online parties to make exchanges across borders using a common currency, without having to exchange it for the local “real” currency.

In 2014, Bitcoin is the leading virtual currency in use. And before the IRS issued its stance, the tax code was unclear how virtual currency should be treated for tax purposes. No more.

The Real Deal

The IRS says virtual currency is treated as property for U.S. federal tax purposes. General tax principles that apply to property transactions apply to those transactions that use virtual currency. And there are some very concrete implications.

Wages paid to employees in virtual currency are taxable to the employee, and must be reported by an employer on a Form W-2. Virtual wages are subject to the same federal tax withholding and payroll taxes as the standard dollar.

Virtual currency payments made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. And, just as in the world of dollars and cents, virtual currency payers must issue Form 1099-NEC.

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.

And a payment using virtual currency is subject to the same reporting requirements as any other payment made in property.

The complete IRS statement – including a set of questions and answers – can be found in Notice 2014-21.