The sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability.
USING BITCOIN TO PAY FOR GOODS, SERVICES AND THE IRS
Despite the lack of consumer protection regulation, the IRS taxes Bitcoin. Virtual currency can be treated as income for the purpose of tax reporting and as property for capital gains tax.
When examining the IRS approach to the taxation of virtual currencies, the most basic question is whether they will be treated as currency or property.
PAYING FOR SERVICES WITH BITCOIN
In IRS Notice 2014-2, 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.
In IRS Notice 2014-21, 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.
BITCOIN AND THE CHANGING FEDERAL LAW LANDSCAPE
Virtual currency issued to fund software development projects is relatively new. Not relying on the usual venture funding or traditional bank lending, software project managers seek financing directly from investors. This is called crowdfunding.
The virtual currency is offered to the public in a coin offering. It can be sold on an exchange or held in a wallet. In pre-offer sales it must be held for a specified period of time.
The reason this new business financing paradigm developed was to free newer software projects from the usual financing framework (banks) and level the playing field. Further, many investors view mining and exchanging this virtual currency as the new frontier for making money.
Bitcoin is one of over 2,500 different of virtual currencies. Virtual currency value often fluctuates by the hour. In some environments, virtual currency operates like “real” currency but it does not have legal tender status in any jurisdiction.
In light of these developments over the past year, people have asked me a number of questions about earning and trading Bitcoin, particularly as a non-US citizens in the US.
Here is one of them.
Is trading crypto currency considered “employment income” if I trade on my H visa in the US?
It depends. For people who use Bitcoin mainly as an investment, capital gains, as you may know, are taxed at lower rates than ordinary income. Think about Bitcoin in terms of common stock. If you sell stock within a year of buying it, the profit is taxed as ordinary income. But if you hold that stock for longer, it is taxed at the capital gains rate.
In IRS Notice 2014-21, 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.
According to the IRS, when a taxpayer successfully “mines” Bitcoins and has earnings from that activity whether in the form of Bitcoins or any other form, he or she must include it in his gross income after determining the fair market dollar value of the virtual currency as of the day he received it.
If a bitcoin miner is self-employed, his or her gross earnings minus allowable tax deductions are also subject to the self-employment tax.
LACK OF REGULATION
In order to purchase virtual currencies, you must buy directly from someone who owns them or through an exchange platform. These platforms tend to be unregulated.
Cybersecurity crime in the US continues to rise. The FBI reports 22,000 complaints per month in 2014, totaling $800 million in consumer losses per year (Source: https://www.fdic.gov/consumers/assistance/protection/cybersecurity3_10_16.pdf)
While securities accounts at U.S. brokerage firms are often insured by the Securities Investor Protection Corporation (SIPC) and bank accounts at U.S. banks are often insured by the Federal Deposit Insurance Corporation (FDIC), bitcoins held in a digital wallet or Bitcoin exchange currently do not have similar protections.
Dena Wurman is a New York licensed attorney who has practiced federal law since 2005. She blogs on topics that explain new federal regulations and how they relate to business. She was told at a recent blockchain meet-up event in Manhattan that there is a big need for good legal counsel in the blockchain space. She decided it’s worth exploring. This is a first in a series of articles.