The IRS has reminded taxpayers that income from virtual currency transactions is reportable on their returns and that these transactions are taxable just like those involving any other property.
Virtual currency is a digital representation of value that functions in the same manner as a country’s traditional currency. Because transactions in virtual currencies could be difficult to trace and have an inherently pseudo-anonymous aspect, some taxpayers could be tempted to hide taxable income from the IRS.
General tax principles that apply to property transactions apply to transactions using virtual currency. This means, for example, that:
- A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
- 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-MISC.
- 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.
- Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third Party Network Transactions.
- 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.
Taxpayers are advised to refer to IRS Notice 2014-21 for more information on transactions involving virtual currency.
Taxpayers failing to report could be audited, and could be liable for penalties and interest. In extreme cases, criminal prosecution could be instituted. Conviction of tax evasion could result in a prison term of up to five years and a fine of up to $250,000. Conviction of filing a false return could result in a prison term of up to three years and a fine of up to $250,000.