And the answer is – Property.
Not surprisingly, the question is how Convertible Virtual
Currencies (CVCs) such as Bitcoin should be classified for tax
purposes. Given the treatment of CVCs by the Financial Crimes
Enforcement Network (FinCEN) in FIN-2013-G001, it is not surprising that the
Internal Revenue Service also concluded that CVCs constitute
property in the recently released IRS Notice 2014-21. The implications of this
on U.S. users of CVCs are immediate and potentially very
expensive.
In FIN-2013-G001, FinCEN distinguished between real currency, which
is comprised of coin and paper money of the United States or other
countries that is designated as legal tender by those countries;
and CVCs, which are like real currency but do not have all of the
attributes of real currency including legal tender status in any
jurisdiction. FinCEN set out the rules applicable to transactions
involving and parties to CVCs.
Mere users of CVCs are not engaged in a money service business
(MSB), and thus do not need to register, report, or keep records
pursuant to the FinCEN regulations for MSBs. An example of
"mere users" is the individual who buys CVCs for personal
use, or a business that accepts CVCs as payment, such as
Overstock.com or the Sacramento Kings.
Administrators and exchangers who accept and transmit CVCs or who
buy or sell CVCs, however, are money transmitters and thus subject
to FinCEN's MSB regulations, unless a limitation or exemption
applies to such persons. This puts companies that accept CVC for
payment but do not immediately monetize the CVC in an interesting
– and potentially gray – area. Issues here may well
only be resolved through case and controversy in the tax
system.
While some have tried to argue that a de-centralized virtual
currency with no central repository and no single administrator
should not be included in the provisions applicable to MSBs,
FIN-2013-G001 specifically provides that administrators or
exchangers of both centralized and decentralized CVCs will be
treated as MSBs. (In this regard, it might be noted that
FinCEN's MSB category is becoming the "catch all" for
emerging payment technologies and methods – prepaid access
(gift and stored value), and now CVCs, fall under the MSB rubric.)
Based upon recent articles, we understand that U.S.-based Bitcoin
operators are seeking to register with FinCEN and the appropriate
state regulatory authorities as MSBs so as to provide regulatory
compliant CVCs to U.S. persons.
Bitcoins have been the subject of review by the tax and regulatory
authorities in a number of countries. Russia has banned the use of
Bitcoins; Australia is keeping a close eye on the use of Bitcoins
saying thus far that use does not raise any issues that do not also
arise from physical currencies or other emerging payment systems;
Canada issued a fact sheet in November 2013 clarifying that
existing tax rules, including the barter rules, apply to CVC
transactions. In addition, a number of countries have clarified
that transactions involving CVC are subject to their Value Added
Tax rules. Thus far, however, few countries have attempted to
regulate the use of CVCs other than Japan, Russia, Estonia, and the
U.S.
For U.S. federal tax purposes, and thus most state tax purposes,
most tax advisors who have addressed the tax issues arising from
the use of CVCs to pay for goods and services have analogized them
to transactions involving property that can appreciate or
depreciate in value. This approach has been followed by the IRS in
Notice 2014-21.
Accordingly, recipients of CVCs from selling goods or providing
services should recognize income equal to the fair market value of
the CVCs as of the date of receipt. Persons paying for goods or
services with CVCs should recognize gain or loss equal to the
difference between the value of the goods or services received and
their tax basis in the CVCs exchanged. For example, an individual
who purchases a unit of a CVC for $50 but buys goods worth $100
with that unit (due to appreciation in value of the CVC) also has a
reportable gain of $50. Furthermore, the "mining" of CVCs
by a person requires the inclusion in income by such person of an
amount equal to the CVC on the date mined.
The tax basis of CVCs is determined under the generally applicable
rules, so that recipients or miners of CVCs obtain a Fair Market
Value basis in the received or mined CVCs, while purchasers of CVCs
take a cost basis.
The rules applicable to information reporting apply equally to
transactions involving CVCs, so Form 1099 MISC or Form W-2 may need
to be issued by those persons hiring independent contractors or
employees and paying them with CVCs.
From the commercial and trade press, it appears that few miners or
traders of CVCs keep or maintain records that will allow compliance
with IRS Notice 2014-21. It may be that these individuals and
companies think that the current anonymity associated with CVCs
will keep the tax collectors away from their doors. We would
suggest that in view of FinCEN's focus on bringing CVCs into
the mainstream of financial products, this reliance is
misplaced.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.