Category: Taxation
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[author: Liz Prehn]

When it comes to Bitcoins and other convertible virtual assets, anonymity may not be all its cracked up to be. For one thing, an underlying assumption is that individuals who keep their financial transactions hidden have something illegal to hide.

Earlier this month in Brisbane, Australia, a Bitcoin ATM owned by a local cafe was seized by the authorities as part of a drug investigation--apparently the Bandidos Bikie Gang was using the cafe in a multimillion dollar methamphetamine trafficking network.

IRS Notice 2014-21 now makes it a requirement to report all convertible virtual currency payments.

Reporting Virtual Currency

Payment received in the form of convertible virtual currency is now subject to federal income tax withholding, payroll taxes, and information reporting to the same extent as payment earned in any other manner.

The amount reported should be the fair market value of the virtual currency (in US dollars) on the date of payment.

Penalties for Noncompliance

Taxpayers who have failed to pay tax or file an information return regarding their convertible virtual currency transactions prior to the date of the IRS guidelines (March 25, 2014) may be subject to penalties under Internal Revenue Code section 6662. Relief, however, is available to taxpayers who can show reasonable cause for their underpayment or failure to properly file their returns.
The intent appears to be a warning to traders and virtual currency businesses to heed their income tax responsibilities.

Things to watch out for

There is no such thing as the anonymity of convertible virtual currency transactions since your virtual currency holdings are not FDIC-insured, you should at least know and trust the people you work with. As with any business, those that deal in virtual currency need a certain level of professional recognition to build their reputation, something that client anonymity cannot provide.

Further, online exchanges may be forced at some point to report their clients accounts, as do banks and brokerage firms, and may even classify these exchanges as financial institutions for purposes of FATCA reporting. In addition, by classifying convertible virtual currency as property, IRS Notice 2014-21 may lead to a situation where cities and states demand that sales tax be applied to virtual currency transactions. All we know at this point is that the IRS has finally taken notice of virtual currencies and you should as well.

*photo text: Taxation of Convertible Virtual Currency