Virtual currency refers to any digital currency which is only available in an electronic form and not as a physical form of money. Virtual currencies, like Bitcoin, are created by a process known as “mining,” where an individual, using powerful computers, authenticates transactions in what is known as a “blockchain,” or a ledger of digital transactions.

Virtual currencies may be traded on digital trading platforms, such as the third-party Coinbase, and can be used as a form of online payment, held as an investment, or used in loans to other individuals.

The IRS And Virtual Currencies

According to IRS Notice 2014-21, “the sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability.”  This means, per IRS determination, virtual currencies, such as Bitcoin, are treated as property, and subject to tax regulations.

The IRS states that virtual currencies, while not physical in nature, are subject to due taxation, as laid out in IRS Publication 551. This is especially true for those individuals who receive virtual currencies as a form of payment for goods or services.  The taxation of virtual currencies will be determined by fair market value, as judged by the date on which the digital currency was received.

Mining Digital Currency

Similarly, any individual who mines virtual currencies must report these transactions on their tax returns, as this is considered a form of self-employment income by the IRS. Similarly, any wages garnered from an employer or customer paid in virtual currency as renumeration for work done must be reported, as outlined in IRS Publication 535.

Penalties For Not Reporting Virtual Currency

Failing to report virtual currencies on tax returns may result in the individual or entity being subject to penalties as stated in IRS Tax Code Section 6662 for accuracy-related penalties, or failure of reporting penalties, as outlined under Sections 6721 and 6722.  Penalties vary depending on the nature of the specifics of the case but may include late penalties, interest on the owed tax, or even criminal charges for fraud.

Failing to comply with the US tax code concerning virtual currency reporting is a serious matter. If you knowingly or willfully hid digital assets from the US government, you may become subject to – not only to stiff fines and penalties, but also a criminal investigation by the Department of Justice and IRS.

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