Virtual currency is the second name of cryptocurrency. It’s a digital representation of the stored value, and unit of account, and can also be used as a medium of exchange. In some economies of the world, it’s just like the normal money of the state. However, in the United States, it’s not legally recognized. Further, virtual/crypto currency transactions are digitally reflected on the blockchain (distributed ledger).
Virtual currency like Bitcoin can be converted into paper/real currency and is called convertible virtual currency. It’s important to note that Bitcoin is one of the examples of a cryptocurrency that can be traded, used for purchases, and exchanged against paper money like Euros, US dollars, and other virtual currencies of the world.
Tax implications on the virtual currency (United States perspective)
There are tax implications on the Cryptocurrencies when you sell, exchange, pay for the goods/services, and hold them as an investment. Internal Revenue Service – IRS has issued Notice 2014-21, 2014-16; it guides tax liability calculation on a virtual currency transaction.
Overall, crypto is considered property for tax calculation purposes. Hence, regulations on the property transactions are applied to the transactions dealing with the crypto. For US tax purposes, the cryptocurrency is not treated as real currency that can generate foreign gain/loss.
Let’s have a detailed understanding of the tax implications on the virtual/cryptocurrency.
- If the taxpayer has sold goods/services and collected payment in cryptocurrency, the collected cryptocurrency is revalued to the market value on the date of receipt. The revalued market value is used as a gross income in the computation of tax liability.
- For tax purposes, the value of the cryptocurrency is measured in US dollars. So, a taxpayer is required to value the currency in US dollars. Further, if the cryptocurrency is listed on the exchange and the value of a security is determined by demand/supply factors. In that case, the value needs to be converted into USD at the transaction time. Although, market value can be measured in any currency. However, it needs to be converted into USD when calculating tax liability.
- If the fair market value of the property received is more than the virtual currency given, the taxpayer has made a taxable gain and tax has to be paid. On the other hand, if the value of the property received is less than that of the virtual currency, it’s a loss for the taxpayer.
- Characteristics of gain/loss depend on the fact that the cryptocurrency in the hands of a taxpayer is a capital asset. So, if the virtual currency is considered capital assets in the hand of the taxpayer, the capital tax will be applicable when sold. It’s the same as investment property, bonds, and stocks. On the other hand, crypto might be treated as a capital asset and ordinary gain/loss needs to be calculated. It’s the same as inventory and other current assets sold.
- For cryptocurrency miners, the fair value of the currency at the date of receipt is treated as gross income.
- If crypto mining is done under business or trade. And the taxpayer is not an employee of the arrangement. Under such circumstances, the income will be classified as self-employment income and tax will be payable at the rate of the self-employment tax rate. For tax purposes, gross income will be calculated by deducting allowable expenses from gross income.
- If you make a payment using virtual currency, the same reporting obligations are applicable as in the case of a normal payment made. For instance, the payment of $600 or above is reported to the IRS; the same goes for the payment through virtual currency. These payments may fall in compensation, annuities, salaries, wages, rents etc. Further, it’s important to note that the payer needs to report the payment to both the payee and IRS.
- To report a payment made to an independent contractor amounting to $600 and above, form 1099-MIsc Miscellaneous income is used by the taxpayers to report payment. Similarly, if payment is made using virtual currency, the form-1099 Mis Miscellaneous should mention the payment in the USD currency.
Virtual currency is the second name of cryptocurrency. It’s a digital representation of the value stored and can be used to exchange value in the execution of trade/transactions. Some countries of the world accept virtual currency as a normal currency. However, the USA does not legally recognize it.
In the United States, taxpayers must pay tax on the gain if they use virtual currency. The fair market value of the currency is used while calculating taxable income. Similarly, if a taxpayer uses virtual currency to make a payment amounting to $600 or more, it must be reported to the IRS and payee using Form-1099.