The Reporting of Virtual Currency Transactions

As virtual currency continues to evolve, it also continues to move towards the top of the IRS’ list of compliance concerns. As a result, the IRS is strengthening its rules and guidance related to the reporting of virtual currency transactions. Taxpayers who transact in virtual currency may be required to report these transactions on their tax returns.

What is virtual currency?

The IRS defines virtual currency as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” As an electronic asset, virtual currency is intangible, and it is not regulated by any government or other authority. Bitcoin, one of the first virtual currencies, exists on a digital ledger known as Blockchain. Other well-known virtual currencies include Ethereum, Litecoin and Ripple.

How is the IRS increasing its focus on virtual currency?

For tax year 2020, the IRS moved the specific question regarding virtual currencies to the first page of Form 1040, directly beneath the taxpayer’s general information. This was previously shown on Schedule 1. The question states: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” Note that according to the IRS FAQ on virtual currency, if a taxpayer purchased virtual currency in 2020 with real currency and had no other transactions, they are not required to answer “yes” to the question on Form 1040.

What to expect when virtual currency is sold

Taxpayers who sell virtual currency are required to report the sale on Schedule D of Form 1040. Unlike stocks held in brokerage accounts, virtual currencies typically are not reported on a Consolidated 1099 Tax Statement. Taxpayers may receive a 1099-K or 1099-B related to their virtual holdings. All copies of 1099 forms are sent by the issuer to the taxpayer and the IRS. If a 1099 is not issued, the taxpayer will need to determine the cost basis and sales price of the virtual currency. Taxpayers who invest in virtual currencies should record the dates purchased, dates sold, purchase price, and proceeds of all their transactions.

What if virtual currency is received as payment for goods and services?

If an individual or a business was paid for services provided in virtual currency, the amount paid needs to be reported as income. The taxpayer would report the fair market value of the virtual currency on the date the payment was received. Wages that are paid using virtual currency must be reported on Form W-2 by employers and are taxable to employees. The fair market value of virtual currency paid as wages is subject to federal income tax withholding and payroll taxes. If a taxpayer receives virtual currency payments as an independent contractor or other service provider, they are also taxable. Payers must issue this income through a 1099-NEC and in general, the rules for self-employment tax apply.

It is exceptionally important that taxpayers do not overlook the tax consequences of virtual currency and inform their tax professional of any transactions that took place during the year. For more information on the reporting of virtual currency, please contact your Marcum tax advisor.