USA Tax and Virtual Currency

 

[Disclaimer] - This white paper should not be used as a legal advice of the author. This is only for information purpose. For your individual case contact us or a practitioner in the relevant area.

In 2021, there are more than 7,000 types of virtual currencies. Some of the more well-known virtual currencies and their characteristics are listed below. The numerical values for characteristics are approximate and subject to change. Additional information about each virtual currency is available on its website.

Virtual currency is recognized in few countries, while banned by few countries. Recognition  / non-recognition of virtual currency add a complexity and risk.

 Coinbase (www.coinbase.com) is a US based platform for virtual currency transactions. Coinbase allows trading of few virtual currency. Coinbase is licensed to engage in money transmissions in most U.S. jurisdictions. Coinbase is registered as a money service business with FinCEN.

 You can use virtual currency for following purposes

1.      Purchase and sale of goods and services

2.      Pay to employee / contractor for their services

3.      As an investment

4.      Donation to a charitable organization

5.      Settle any outstanding balances

Due to increase usage virtual currency, IRS has expressed concern about the lack of reporting of virtual currency transactions and came up with virtual currency compliance. Depending on nature of transaction, the taxpayer need to comply with legal requirements.

There are civil penalties and criminal penalties for compliance. Call us  services@surefintaxsvs.com for solutions and compliance.

Court Case: The IRS served a summons on Coinbase seeking records regarding all its customers. Coinbase refused to comply. The IRS narrowed the scope of the records request, and Coinbase again refused to comply. The court determined that the IRS had a legitimate purpose of investigating unreported virtual currency transactions and therefore ordered Coinbase to produce documents on 14,000 customers who had at least $20,000 in any one transaction in one year between 2013 and 2015 (United States v. Coinbase, Inc., United States District Court Northern California, November 28, 2017)

VIRTUAL CURRENCY TO PURCHASE AND SALE OF GOODS AND SERVICES.

As you know, you can use virtual currency to purchase and sale of the goods and services. When you can use virtual currency, it triggers a taxable event.  Let us consider below example

Example -1: Brad uses two U.S. dollars to purchase a cup of coffee. Since Brad’s tax basis in those two U.S. dollars is their face value ($2), and the fair market value of the cup of coffee is $2, there is no gain or loss on the transaction

Example - 2: Brad uses virtual currency to purchase a cup of coffee that is worth $2. Brad had previously acquired the virtual currency at an ATM machine by exchanging one U.S. dollar for the virtual currency. Brad has a $1 taxable gain on the purchase of the coffee, the difference between the fair market value of the coffee ($2) and the tax basis of the virtual currency ($1).

In case of example 1, there is no taxable event, while example 2 raises a taxable event and reporting requirement.

As of now many business houses accept virtual currency as a consideration for their goods and services. There are few well-known companies accept virtual currency, such as AT & T, Amazon, MotiveTickets etc.

 

If a taxpayer receives virtual currency for performing services, he or she must recognize ordinary income. The amount of income received is the fair market value of the virtual currency in U.S. dollars on the date and time received.

The taxpayer may recognize a gain or loss if the virtual currency is later exchanged or sold. The taxpayer’s basis in the virtual currency is the amount of ordinary income from payment received for services

 

VIRTUAL CURRENCY TO PAY AN EMPLOYEE OR INDEPENDENT CONTRCATOR.

The fair market value of virtual currency paid as wages is income and subject to federal income tax withholding, FICA tax, and FUTA tax and must be reported on Form W-2 for employees. Taxpayers who are employees report wage and salary information on line 1, Form 1040, U.S. Individual Income.

The fair market value of virtual currency paid to an independent contractor is income and is subject to income tax. Independent contractors are required to report the income on Schedule C (Form 1040), Profit or Loss From Business. If net profit is $400 or more, it is subject to self-employment tax. The taxpayer files Schedule SE (Form 1040), Self-Employment Tax, to calculate self-employment tax, which is reported on line 4, Schedule 2 (Form 1040). Additional Taxes

 Tax Return

VIRTUAL CURRENCY AS A DONATION

If a taxpayer donates virtual currency to a charitable organization described in IRC section 170(c), he or she will not recognize income, gain, or loss from the donation. A charitable contribution of virtual currency is treated as a noncash donation.

VIRTUAL CURRENCY TO SETTLE BALANCES.

Businesses may desire to pay employees or independent contractors in a virtual currency. Payment in a virtual currency may be a competitive advantage in attracting talent. However, employers paying in a virtual currency must satisfy legal requirements. Refer to state law, some state requires wages to be paid in certain currencies.

If the employer pays for a service using virtual currency held as a capital asset, then he or she will have a gain or loss on the transaction. The gain or loss is the difference between the fair market value of the services received and the adjusted basis of the virtual currency exchanged.

Businesses who pay employees or independent contractors in virtual currency are subject to information reporting (e.g., Forms W-2, Form 1099-NEC and payroll tax reports).

Currently, third party settlement organizations such as virtual currency exchanges are required to produce Form 1099-K, Payment Card and Third-Party Network Transactions, if the user exceeds $20,000 in transaction amount and has more than 200 transactions in a year.

VIRTUAL CURRENCY AS AN INVESTMENT

A taxpayer can identify a specific unit of virtual currency either by documenting the specific unit’s unique digital identifier such as a private key, public key, address, or by records showing the transaction information for all units of a specific virtual currency held in a single account, wallet, or address.

Capital gain or loss from virtual currency transactions are calculated and reported on Form 8949, Sales and Other Dispositions of Capital Assets, and then summarized on Schedule D (Form 1040), Capital Gains and Losses