Virtual Currency Regulation

Bitcoin, Ethereum, Namecoin, Litecoin, Zcash, Dash, Ripple, Monero are just a few of the over 700 cryptocurrencies, valued at over $12 billion that have entered the market and continue to grow. Although there are still uncertainties about the treatment and taxation of this virtual currency, the Internal Revenue Service issued initial guidance regarding cryptocurrency in Notice 2014-21. Also, the New York State Department of Financial Services (NYDFS) published “BitLicense Regulatory Framework” for virtual currency business activity.

The NYS framework requires that anyone operating in or serving customers that reside in New York apply for a BitLicense if they are engaged in the following virtual currency activities:

  • Virtual currency transmission.
  • Storing, holding, or maintaining custody or control of virtual currency on behalf of others.
  • Buying and selling virtual currency as a customer business.
  • Performing exchange services as a customer business.
  • Controlling, administering, or issuing a virtual currency.

The tax treatment of virtual currency according to the Internal Revenue Service depends on how it is held and used.

  • A taxpayer who receives virtual currency in payment for goods or services must include the fair market value of the virtual currency in computing gross income. This value must be reported in U.S. dollars as of the date of payment or receipt. A payment made in virtual currency is subject to information reporting and backup withholding to the same extent as any other payment made with property.
  • An employer paying with virtual currency, must report employee earnings to the IRS on Form W-2 and the earnings are subject to federal income tax withholding to the same extent as dollar wages. The virtual currency must be converted to U.S. dollars as of the date of each payment.
  • Payments to independent contractors and other service providers with virtual currency are taxable. A payment made in the course of a trade or business with a value in excess of $600 to a U.S. nonexempt recipient must report the payment to the IRS and to the payee by issuing Form 1099-MISC, Miscellaneous Income.
  • Self-employed individuals with virtual currency gains or losses from sales transactions must convert the virtual currency to dollars as of the day earned. The figures are reported on their tax return and are generally subject to the self-employment tax rules.
  • A taxpayer has gain or loss on an exchange of virtual currency for other property. If the virtual currency is held as an investment, gain or loss on its disposition it is taxed as a capital gain or loss, similar to stocks, bonds, or other investment property. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis in the currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.
  • Property held as inventory or other property mainly for sale to customers in a trade or business is not a capital asset. If the virtual currency is held as inventory for sale to customers in a trade or business, gain or loss on its disposition is ordinary gain or loss.

As a warning, the accurate reporting of virtual currency transactions is important so that you are not subject to penalties as a result of tax underpayments under Internal Revenue Code §6662. In addition, the failure to timely or correctly report required virtual currency transactions may trigger information reporting penalties under Internal Revenue Code §6721 and 6722.