IRS Notice 2014-21 & Virtual Currency

August 6, 2019

In a previous article, we discussed in detail the content of a recently IRS statement on virtual currency, or cryptocurrency, tax collection. The statement, IRS Notice IR-2019-132, says 10,000+ letters will be sent out this month to individuals with virtual currency accounts. In its statement, the IRS also made reference to an earlier piece of material on virtual currency. This earlier document is IRS Notice 2014-21, and it discusses the tax principles which apply to virtual currency. IRS Notice 2014-21 is a fairly important document. That’s because it lays out the IRS’ position on the taxation of bitcoin and other virtual currencies. Before this document, the IRS’ stance was more or less unknown. With publication of the Notice, though, we got a sense of how cryptocurrencies will be treated for tax purposes. 

In this post, we will go over the basics of Notice 2014-21. Many of the core principles set forth in this document are found in its Q&A section. We will focus our post on the essentials of this section.  

Notice 2014-21 Classifies Virtual Currency for Tax Purposes 

According to Notice 2014-21, bitcoin and other virtual currencies are classified as “property” for tax purposes. This means that the tax treatment of virtual currencies is just like that of other intangible personal property. That is, assets such as patents, copyrights, stocks, bonds, partnership interests, and so forth. The document doesn’t make reference to which “asset class” virtual currencies will be placed in. And so, as of right now, virtual currencies don’t have a formal “asset class”. This may have implications for virtual currencies as investment vehicles. But the IRS considers such currencies “property” just like traditional stocks and bonds, at least when it comes to taxation. In short, virtual currency holders can’t simply see themselves as having something which exists “outside” of the normal system. This is true even though many virtual currency owners may wish to see their currency in that way.  

The Basis of Virtual Currency Received as Payment 

When a person receives virtual currency as payment for goods or services, it will acquire an initial tax basis. This tax basis is the fair market value of the virtual currency as of the time of its receipt. The recipient needs to determine the fair market value, measured in U.S. dollars, by examining its exchange rate. Virtual currencies often sell on commercial exchanges, in a manner similar to securities exchanges. Recipients should consult with one of these commercial exchanges when establishing the fair market value of the virtual currency. 

The Character of Gain Depends on Circumstances 

As with other types of property, the character of gain derived from virtual currency depends on the circumstances. If the virtual currency is an investment, the gain is a capital gain following a sale. It’s then taxed at applicable capital gain tax rates. However, if the virtual currency is sold as part of a business (e.g., in a commercial exchange), it’s ordinary income. This means that the tax liability is computed just like for any other normal business owner. Again, this is all consistent with virtual currency’s classification as property. Running a virtual currency commercial exchange is essentially no different than running any other business. That is, at least from a tax standpoint. 

Virtual Currency Mined in a Trade or Business 

What if a person “mines” or collects bitcoin or other virtual currencies as part of their principal trade of business? In this situation, the person is considered self-employed and, therefore, subject to self-employment tax. This is, of course, on top of the other taxes which would be due on the income generated from the business (federal income tax, unemployment, etc.). What’s more, if an independent contractor receives at least $600 worth of virtual currency in a single year for services, that would require a Form 1099 filing by the payor. This would be the case if a person were to receive any other property worth $600 or more during a year for services.  

Straightforward Tax Treatment

As you can see, the tax treatment of virtual currency is fairly standard. The difficulties surrounding virtual currency, from a tax perspective, mostly have to do with its enforcement. There is still a shroud of ambiguity and uncertainty regarding the accumulated value of virtual currency and to whom the value has accumulated. And it’s still a very volatile market, subject to rapid rises and rapid falls.

No doubt, the IRS will ultimately have to settle (or write off) a lot of early gains attributed to virtual currency, if for no other reason than the lack of proper accounting makes correct tax assessment impossible. But, even though that may be, the recent letter from the IRS (2019-132) shows that the IRS is very serious when it comes to enforcing taxes on virtual currency. Those who have virtual currency should come forward and disclose their back tax liabilities.  

Contact MC&C to Learn More Today! 

At Mackay, Caswell & Callahan, P.C., we make an effort to stay on the cutting-edge of tax law. This means we often have to go the extra mile and spend time gathering new information. The subject of virtual currency taxation is a great example of this in action. If you have virtual currency, you definitely need to know about Notice 2014-21, or work with someone that does. We do. Why not call us today and and tell us the facts of your case. One of our New York City tax attorneys is here to help. 

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