Virtual currency is digital money that has been issued by online developers and is used for transactions inside that defined cyber community.
It's also called virtual money, digital money, or altcoins, and is not regulated by any agency.
IRS Notice 2014-21, states that virtual currencies, like popular Bitcoin, are classified as property. The IRS is aware of the growing use of this medium of exchange, and that it's not considered legal tender by any government.
The IRS notice hopes to clarify how you must treat your use of this new technology. The outcome for users is not good. Here's what you need to know about classifying virtual currency:
As property. Property is subject to gains and loses. So if you use a virtual currency like Bitcoin, you must keep track of the original cost of the coin and its value when you use it. As a capital asset you must also know whether your gain or loss on use of the virtual currency is a short-term or long-term.
As income. Wages paid in virtual currency are taxable to the employee, must be reported on a W-2, and are subject to employment taxes. Income received as an independent contractor has self-employment rules applied and must follow Form 1099 reporting requirements.
As currency? Per the IRS, no. Businesses have the ability to calculate foreign currency gains and losses on their financial statements. This foreign currency gain or loss calculation is not available for virtual currencies like Bitcoin.
Determining value. If you purchase or sell something using a virtual currency, you need to determine the fair market value of the transaction using a valid virtual currency exchange and translating it into U.S. dollars.
Virtual miners have income. Miners are those who receive Bitcoins and other virtual currencies by validating transactions and maintaining public Bitcoin ledgers. If you are someone who “mines” virtual currency, you create income upon receipt of the currency. This is a taxable event.
As the technology of alternative methods to exchange goods and services evolves, so will your need to understand it. Should someone offer to provide you with virtual currency for products and services, you should understand there are tax implications to accepting this form of payment.