Confusion Abounds – What Is Virtual Currency? Issues For Your 2019 Federal Return

Annette Nellen on Virtual Currrency

Likely, most people think of bitcoin, now over 10 years old, when they hear “virtual currency.” If you look at CoinMarketCap, you’ll see over 2,000 cryptocurrencies listed with bitcoin at the top given its market value. Others at the top include Ethereum, Bitcoin Cash, Litecoin, and Monero.

Well, what makes something a virtual currency in the eyes of the IRS? This is even a more important question for this current tax filing season due to a new question on Form 1040 Schedule 1 – At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?

Schedule 1 is used to report other income, such as business and rental income, as well as deductions for AGI. So a lot of people file it. According to page 81 of the 1040 instructions, if the answer to the question is “no” and you don’t otherwise need Schedule 1, you don’t need to attach it.

This question raises a lot of questions, such as:

What if move your VC from one wallet to another?
What if receive VC by gift or something else with no tax consequence? Should you attach an explanation?
What if a passthrough entity owns it? Need to ask apparently.
What if your VC had a fork or airdrop and you didn’t know that? Per Rev. Rul. 2019-24, the IRS views that as receipt of something and arguably that is correct although you might not have income at that time or the value of what you received may be zero (but this still seems to warrant a “yes” answer).
What if your child plays online games and there is some type of currency used in the game? Is this a virtual currency? (see more on this below and IRS activity on this question during the week of February 10, 2020)
Additional issues:
What happens if person doesn’t know about question such as because doesn’t otherwise need a Schedule 1?
What if you don’t otherwise have a filing obligation but the answer would be “yes”?
What if you are paid in VC and keep it rather than convert it or spend it? Should you attach an explanation?
If the answer is “yes” for you but there is nothing reported on the return to indicate any tax consequence because there were none, such as for someone who received virtual currency as a gift or had an airdrop even of zero value, it is likely a good idea to attach an explanation to the return. So, at that line, add “See Statement 1” and attach the explanation as Statement 1.

What about the gaming question? When the IRS issued Rev. Rul. 2019-24 on hard fork of a virtual currency and about 40 FAQs in early October 2019, it also expanded what had been a short paragraph on its website on virtual currency. With the expansion, the following paragraph was present (obtained from the Wayback Machine for 10/12/19 since removed from the IRS website around February 12, 2020):

“Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin, Ether, Roblox, and V-bucks are a few examples of a convertible virtual currency. Virtual currencies can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.”

After the change around February 12, 2020, that paragraph now reads:

“Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.”

Notice that the reference to the gaming currency – Roblox and V-bucks, is gone. The IRS added an explanation in a statement added to its website (but not added as part of the FAQs or a news release, but instead added where hard to find)”

“February 14, 2020
The IRS recognizes that the language on our page potentially caused concern for some taxpayers. We have changed the language in order to lessen any confusion. Transacting in virtual currencies as part of a game that do not leave the game environment (virtual currencies that are not convertible) would not require a taxpayer to indicate this on their tax return.”

That doesn’t fully answer the question for all gaming currency because some of it can be sold outside of the game for dollars (and it is obtained for USD typically as well). See post of 2/15/18 about selling Roblox for real money. What are people willing to pay for it? Does it have a fixed exchange rate or does it fluctuate?

What about certain gift cards or merchant point systems? Might they be a virtual currency?

Why doesn’t the IRS clarify the definition of virtual currency and be sure it is something that is a substitute for real currency, and does not have a fixed exchange rate to USD (as most gift cards do). The IRS definition works to keep many gaming currency out (including when playing Monopoly with digital cash!), but not all.

Seems more is needed to help people with the new Schedule 1 question such as the question I note above.

What do you think?

Have a question or comment? Annette Nellen.

Annette Nellen, CPA, Esq., is a professor in and director of San Jose State University’s graduate tax program (MST), teaching courses in tax research, accounting methods, property transactions, state taxation, employment tax, ethics, tax policy, tax reform, and high technology tax issues.

Annette is the immediate past chair of the AICPA Individual Taxation Technical Resource Panel and a current member of the Executive Committee of the Tax Section of the California Bar. Annette is a regular contributor to the AICPA Tax Insider and Corporate Taxation Insider e-newsletters. She is the author of BNA Portfolio #533, Amortization of Intangibles.

Annette has testified before the House Ways & Means Committee, Senate Finance Committee, California Assembly Revenue & Taxation Committee, and tax reform commissions and committees on various aspects of federal and state tax reform.

Prior to joining SJSU, Annette was with Ernst & Young and the IRS.

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