With all the craze surrounding Bitcoin, spectators can't stop talking about whether the virtual currency will skyrocket or go up in flames. Eric Schmidt, Executive Chairman of Google says that "Bitcoin is a remarkable cryptographic achievement... the ability to create something which is not duplicable in the digital world has enormous value... lots of people will build businesses on top of that."
As a cutting edge business owner, you may have already begun accepting Bitcoin or considering integrating payment options for Bitcoin like Expedia, Microsoft, Overstock.com and Dish. The advantages of accepting a cryptocurrency is enormous--irreversible transactions, fraud prevention, ease of international payments and lower transaction fees.
On the other hand, you may be an investor like the founders of Yahoo, PayPal and e-BAY, or billionaires Richard Branson and Li Ka-Shing who are intrigued by the advantages over the dollar and other world currencies.
Regardless if you're a business owner or investor, it is important to know how the IRS views Bitcoin and other virtual currencies. For starters, the IRS is aware that "virtual currency" may be used to pay for goods or services, or held for investment. Below are tax consequences that may result in a tax liability from transactions with virtual currencies.
1. Cryptocurrencies are treated as property for US federal tax purpose.
General tax principles that apply to property transactions apply to transactions using virtual currency. This means that:
- 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.
- 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.
- 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.
- A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
2. Payment made using virtual currency is subject to information reporting.
A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. For example, a person who in the course of a trade or business makes a payment of fixed and determinable income using virtual currency with a value of $600 or more to a U.S. non-exempt recipient in a taxable year is required to report the payment to the IRS and to the payee. Examples of payments of fixed and determinable income include rent, salaries, wages, premiums, annuities, and compensation.
In general, the sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability. Consult the IRS' Notice 2014-21 for frequently asked questions on virtual currency, such as Bitcoin.