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REPORTING OF VIRTUAL CURRENCY RELATED INCOME
Recently, the IRS sent letters to more than 10,000 taxpayers informing them of additional taxes that may be due in connection with their virtual currency holdings. Specifically, the IRS sent Letters 6173, 6174 and 6174-A (the “Letters”) notifying taxpayers that the IRS had information regarding one or more of the taxpayers’ accounts that had not properly reported virtual currency related income. In addition, the Letters provided instructions to taxpayers on how to report virtual currency related income.
Previously, the IRS has only addressed the taxation of virtual currency in 2014 through IRS Notice 2014-21. Please find a summary of IRS Notice 2014-21, regarding the taxation of virtual currency, in pertinent part below.
1: How is virtual currency treated for federal tax purposes?
For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.
2: In computing gross income, must a taxpayer who receives virtual currency as payment for goods or services include the fair market value of the virtual currency?
Yes. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.
3: What is the basis of virtual currency received as payment for goods or services in Question 2?
The basis of virtual currency that a taxpayer receives as payment for goods or services in Question 2 is the fair market value of the virtual currency in U.S. dollars as of the date of receipt.
4: How is the fair market value of virtual currency determined?
For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency, which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.
5: Does a taxpayer have gain or loss upon an exchange of virtual currency for other property?
Yes. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual 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.
6: What type of gain or loss does a taxpayer realize on the sale or exchange of virtual currency?
The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset.
7: Does a taxpayer who “mines” virtual currency (for example, uses computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger) realize gross income upon receipt of the virtual currency resulting from those activities?
Yes, when a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.
8: Is an individual who “mines” virtual currency as a trade or business subject to self-employment tax on the income derived from those activities?
If a taxpayer’s “mining” of virtual currency constitutes a trade or business, and the “mining” activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment (generally, gross income derived from carrying on a trade or business less allowable deductions) resulting from those activities constitute self-employment income and are subject to the self-employment tax.
9: Does virtual currency received by an independent contractor for performing services constitute self-employment income?
Yes. Generally, self-employment income includes all gross income derived by an individual from any trade or business carried on by the individual other than an employee. Consequently, the fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax.
10: Will taxpayers be subject to penalties for having treated a virtual currency transaction in a manner that is inconsistent with the tax law?
Taxpayers may be subject to penalties for failure to comply with tax laws. For example, underpayments attributable to virtual currency transactions may be subject to penalties, such as accuracy-related penalties under section 6662. In addition, failure to timely or correctly report virtual currency transactions when required to do so may be subject to information reporting penalties under section 6721 and 6722. However, penalty relief may be available to taxpayers and persons required to file an information return who are able to establish that the underpayment or failure to properly file information returns is due to reasonable cause.
Click here to see IRS Notice 2014-21 in full.
REVIVAL OF FORM 1099-NEC FOR NON-EMPLOYEE COMPENSATION
The IRS is bringing back a form last used in 1982, Form 1099-NEC, Non-Employee Compensation, to be used starting in 2021 to report non-employee compensation paid in 2020.
The IRS previously moved the information on Form 1099-NEC to Form 1099-MISC beginning with payments made in 1983 and has since required businesses to instead file Form 1099-MISC to report non-employee compensation paid to contract workers and freelancers.
The recently issued draft Form 1099-NEC is aimed at alleviating confusion that resulted from the passage of the PATH Act in 2015. The PATH Act brought the due date for reporting non-employee compensation in box 7 of Form 1099-MISC from March 31 to January 31. However, the due date for reporting payments to individuals other than non-employee compensation on Form 1099-MISC remained March 31, effectively creating two different due dates for the same form.
The draft Form 1099-NEC is to replace the amount of compensation paid to independent contractors that is reported in box 7 of Form 1099-MISC. The Form 1099-NEC also is to be completed when reporting direct sales of $5,000 or more, replacing box 9 of Form 1099-MISC. The draft Form 1099-NEC does not request any additional information that was not requested on Form 1099-MISC.
The Form 1099-NEC would be due by February 1, 2021. Presumably, a revised Form 1099-MISC will be released for reporting in 2021 that removes current boxes 7 and 9, and will continue to be due on March 31.
Like all IRS draft forms, more work is necessary before draft Form 1099-NEC can be adopted.
Click here to view draft Form 1099-NEC in full.