Taxing Definitions

Definition — Virtually taxable

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If you want to know the value of money, both real and virtual, you can try to borrow some. Or, in the case of digital currency, you could ask the Internal Revenue Service.

The buying and selling of digital assets, including coins and tokens offered and sold in “Initial Coin Offerings,” have been in the news lately. Back in 2014, the IRS issued Notice 2014-21 to describe how convertible virtual currency such as Bitcoin is taxed. Are you up on the rules? Here’s a brief quiz.

1. Virtual currency is treated as property for federal income tax purposes.

or

 

2. Taxpayers have gain or loss for federal income tax purposes when virtual currency is exchanged for other property. The gain or loss could be capital (similar to a stock or bond) or ordinary (similar to inventory).

or

 

3. Income made from “mining” virtual currency is subject to payroll and self-employment tax.

or

 

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided in the post to read the entire case.

This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.

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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.

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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.

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.

The fair market value of virtual currency paid as wages is subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2, Wage and Tax Statement.

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