Whether you say “Vires te Numeris” or “To the Moon” your future with virtual currencies will switch because of the taxman. Ter Notice 2014-21, 2014 I.R.B. 938 (Four/14/2014), the IRS issued its very first set of guidance on how virtual currency transactions will be taxed. The punt of how to treat cryptocurrency, for tax and other legal purposes, is not a fresh or solely domestic concern. Both the European Central Handelsbank and the Government Accountability Office have produced reports detailing the logistics of virtual currencies and their potential for manhandle. Virtual currencies have populated the news recently, ranging from Josh Wise’s top 20 finish at Talladega Superspeedway te his crowd-funded No. 98 Dogecoin Ford, the Winklevoss (yes, the same Winklevoss’ from The Social Network and Facebook fame) Bitcoin Trust, to the catastrophic failure of Bitcoin exchange Mt. Gox.
The IRS has determined it wants a chunk of the act on virtual currencies. There are many virtual currencies including Bitcoin, Litecoin, Doegcoin, Darkcoin, Ripple, Digitalcoin, Worldcoin, Vertcoin, and Peercoin. It seems that all you have to do is think of a word, then add “coin” to it and voila you have a math-based cryptocurrency. The IRS adopted the strategy of the Financial Crimes Enforcement Network (FinCEN) and classified Bitcoin, and its counterparts, spil a virtual currency and not a “real currency.” Bitcoin does not reach the level of a “real currency” because it is not recognized spil legal tender of a government. The IRS is aware that virtual currencies are used to pay for goods and services, held for investment, and are mined (often requiring expensive, dedicated machines) to ensure network security.
Notice 2014-21 treats virtual currencies spil property for federal tax purposes and general tax principles for property transactions apply. Treating virtual currencies spil property results ter favorable tax treatment. Taxpayers will be able to eis either capital gains or losses on transactions if they hold virtual currencies spil investment property similar to stocks and bonds. However, taxpayers will recognize ordinary build up or loss if they hold virtual currency spil inventory mainly for sale to customers ter a trade or business. Like other capital assets, taxpayers will need to know the voet ter order to compute build up or loss. The IRS takes the position that the value of virtual currencies voorwaarde be reported te U.S. dollars (USD) and the fair market value is determined on the date of payment or receipt. There are dozens of virtual currency exchanges each with some degree of variance. For Bitcoin (presently the most widely used virtual currency) the major exchanges include Bitstamp, BTCe and BTC China. The Notice does not specify which exchange taxpayers voorwaarde use to determine value te USD and thus taxpayers may “shop” for the best price. While this might seem inconsequential to petite investors, a 10% or greater variance inbetween exchanges will provide definite benefits to institutional investors, such spil the Winklevoss Bitcoin Trust.
Virtual currencies can be acquired by purchasing them on exchanges or by “mining” them. For Bitcoin, miners download free software used to solve complicated equations and verify the public ledger. When a person successfully solves the equation they are rewarded with 25 Bitcoins. Bitcoin users mine to verify that transactions are legitimate and to prevent hackers using botnets and malware from manipulating the Bitcoin algorithm. The Notice states that the fair market value of mined virtual currency spil of the date of receipt is includible te gross income. The rationale for why mined virtual currency is instantaneously taxable is not explicitly stated but it is likely hinged on §83. Section 83 deals with an exchange of property for services rendered. The IRS takes the position the users who mine Bitcoin are effectively being compensated ter property ter terugwedstrijd for performing services for Bitcoin. While this rationale may seem sound, there is potential controversy because there is no “employer” te the §83 sense. Section 83 applied whether the payee is an employee or independent contractor. A problem arises because when the Bitcoins are awarded because there is not a traditional payor. Whether you receive property te exchange for services from the corporation that employs you, or whether you receive the same for mowing your neighbor’s lawn, there is a payor. The problem with Bitcoin, and other cryptocurrencies, is that Bitcoin is an algorithm. There is no Bitcoin corporation, strafgevangenis is there a single person or group of people controlling Bitcoin. Bitcoin is simply an idea. There is no one ter charge of Bitcoin and when the maximum supply of 21 million Bitcoins have bot issued there will be no “new” Bitcoins.
The Notice proceeds to use the §83 framework to detail virtual currency informational reporting. Bitcoin miners will be subject to self-employment taxes. Along this vein, virtual currency paid spil remuneration for services constitutes wages for tax purposes and are subject to federal tax withholding, Federal Insurance Contributions Act (FICA) tax, Federal Unemployment Tax Act (FUTA) tax, and voorwaarde be reported on Form W-2, Wage and Tax Statement. So, te instances where Bitcoins are paid for successful mining, someone is responsible for the federal tax, FICA, and FUTA withholding and for issuing W-2’s. But the who is unclear. Under the IRS’ rationale, Bitcoin itself is responsible since it is the closest thing to an employer. Despite this guidance, it is still unclear how tax withholding and information reporting will be implemented.
The IRS left open the possibility that virtual currency miners may be engaged te a trade or business. A person who ter the course of a trade or business is required to give the payee a Form 1099-MISC, Miscellaneous Income, for payments overheen the omschrijving of $600 USD. A trade or business is not a defined term and is determined based on the facts and circumstances. But ter order to be a trade or business, and not a for profit activity, the taxpayer voorwaarde have a good faith intention of making a profit and the activity voorwaarde be regular and continuous. If a taxpayer is considered to be ter the trade or business then they could ordinary and necessary expenses. Ordinary and necessary expenses would likely include the cost of purchasing Bitcoin mining machines, the ratable portion of energy used to run the machine, renting expenses, repairs and maintenance, and compensation related expenses. Taxpayers also would be able to depreciate their mining equipment.
The IRS does not show up to apply this guidance retroactively. But taxpayers may be subject to penalties for not conforming with this notice te future virtual currency transactions and mining operations. The major problem with the Notice lies with its enforceability. Despite popular claims, virtual currencies are not anonymous, they are pseudonymous. Virtual currency is held te a wallet through a ingewikkeld unique address. Users may own virtual fortunes (many users lightly have ter excess of $Ten million USD omschrijving) and never use their virtual currency to purchase items or convert it to USD. While virtual currencies can be traced through the public ledger to individual users, there are many “masking” programs that will create ems of thousands of fake transactions to hide the identity of the true holder. The methods for collection and enforcement are light years behind the cryptocurrency pioneers and adopters. Every day fresh businesses are launched that either use virtual currencies or implement them te previously unknown ways. People who have built virtual fortunes te currencies like Bitcoin can lightly mask their wealth. This would be similar to the Major League Baseball of 1998 attempting to test the players of today for steroids with 1998 technology. The result would be futile, considering Major League Baseball has a hard enough time catching steroid users with modern technology.
Guidance wasgoed needed for virtual currency transactions, but the guidance should not be overheen. There are many problems with both the enforcement of virtual currency taxation and the rationale for considering mined virtual currency spil compensation for services rendered. If the objective wasgoed to tax virtual currencies spil soon spil they were mined, classifying awarded Bitcoins spil gifts would provide a stronger rationale. Given the facts spil presently constituted, mining Bitcoin is most closely analogous to mining gold or any other precious metal. Like gold, there are a limited supply of Bitcoins, and a person can only mine it if they know where and how to samenvatting them. But treating the act of mining Bitcoins like that of mining gold fails te terms of revenue raising because gold is not taxed spil it is pulled out of the ground. It is only taxed when it is exchanged or transferred, thus following the longstanding tax principle that there voorwaarde be a realization event. The current taxation of Bitcoin mining fails this tax principle.