Capital Gains: An overview of virtual currency taxation in the U.S.
In this four-part series, New York attorney Bryan Hollmann explains the multifaceted approach to the regulation of virtual currencies in the United States. In parts one and two, Bryan provided an overview of U.S. securities and commodities laws. Part three discussed anti-money laundering regulations under the Bank Secrecy Act and FinCEN. This fourth and final part covers the taxation of virtual currencies by the U.S. Internal Revenue Service.
For many, the virtual currency boom of 2017 may have unexpected consequences in 2018: tax liability. Counterintuitively, the United States treats virtual currencies as “property” like stocks and bonds, which means that holders of virtual currencies must meticulously keep track of their gains and losses, even for small transactions such as buying a cup of coffee or exchanging one virtual currency for another. A general overview of virtual currency taxation in the United States is provided below.
Types of U.S. Taxpayers
U.S. persons and foreign persons are treated differently for tax purposes under U.S. law. U.S. persons, such as citizens and residents of the United States as well as domestic legal entities, are obligated to pay taxes on their worldwide income, no matter where in the world they reside. In contrast, foreign persons, which include non-U.S. citizens and foreign legal entities, are obligated to pay U.S. federal taxes if they do business in the United States or receive income from sources within the United States.
General Tax Principles as Applied to Virtual Currency
On 25 March 2014, the Internal Revenue Service (“IRS”) issued a notice on the U.S. federal tax implications of transactions in, or transactions that use, virtual currency. The notice applies to the sale or exchange of “convertible” virtual currency, which is defined as virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency. Bitcoin is an example of convertible virtual currency. Although not directly addressed in the IRS notice, virtual currencies other than Bitcoin (so-called “altcoins”) likely also constitute convertible virtual currency.
Despite its name, virtual currency is characterized in the United States as “property” rather than “currency.” This characterization makes virtual currency akin to stocks or bonds, and is treated accordingly for tax purposes.
Sale or Exchange of Virtual Currency
The sale or exchange of virtual currency is a taxable event under U.S. law. The amount of taxes to be paid, if any, depends on whether there was a gain or loss. Gains or losses are determined by calculating the difference between the fair market value of the virtual currency as of the date the virtual currency was received and the fair market value of the property received in exchange for the virtual currency.
Generally, virtual currencies held for investment or personal use are “capital assets” and are taxed based on how long they are held. Virtual currencies held for one year or less are taxed as ordinary income, while virtual currencies held for more than a year qualify for lower long-term capital gains rates (i.e., 0, 15, or 20 percent).
Receipt of Virtual Currency as Payment for Goods or Services
Taxpayers that receive virtual currency as payment for goods or services must include the virtual currency in computing gross income. The value is determined by the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. For virtual currencies listed on an exchange, the exchange rate can determine the fair market value if the exchange rate is established by market supply and demand and is applied consistently in a reasonable manner.
Taxation of Virtual Currency Mining
Virtual currency obtained by mining is taxable as gross income. If the mining constitutes a “trade or business,” the net earnings are subject to a separate tax called the “self-employment tax,” which basically consists of Social Security and Medicare taxes primarily for individuals who work for themselves.
Disclaimer: This article does not constitute legal advice and does not establish an attorney-client relationship. If you need legal advice, please contact an attorney directly.