Jim Witt, Senior Attorney, National Legal Research Group
The virtual currency known as "Bitcoin," created by anonymous computer programmers, has been traded on online exchanges as an item of investment, subject to few fees and no government regulation. The price has fluctuated wildly, from a few cents to more than $1,000 per Bitcoin unit. Programmers are able to obtain new coins through a computer technique known as "mining."
With a growing number of merchants now accepting Bitcoin as payment and general pressure on governments to regulate virtual currency (especially in view of the collapse of the largest virtual currency exchange, Mt. Gox), the Internal Revenue Service ("IRS") has announced its position on the income tax treatment of Bitcoin. I.R.S. Notice 2014-21, 2014-16 I.R.B. 938.
The IRS defined "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," id. sec. 2, and noted that Bitcoin fit this definition as a form of currency convertible into legal tender.
The general announcement was that virtual currency such as Bitcoin would be treated as property rather than currency and that the sale or exchange of such convertible virtual currency, or the use of convertible virtual currency to pay for goods or services, has tax consequences.
General tax principles applicable to property transactions apply to transactions using virtual currency such as Bitcoin. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. With its classification as property, Bitcoin sales are subject to capital gains taxes but with long-term gains subject to a top rate of 20%, as opposed to the general top rate of 39.6%. Employers who pay in Bitcoin will have to report those wages in the same manner that they report any payment made with property; Bitcoin income will be subject to federal income tax withholding and payroll taxes.
Online exchanges that include Bitcoin in their dealings will have to provide customers with annual reports of the exchanges' Bitcoin transactions in the same way that stock brokerages and investment firms do.
The reaction by Bitcoin advocates to the IRS's announcement has been generally positive, on the basis that this is a step toward the legitimization of virtual currency.
