On March 23, 2018, the IRS issued IR-2018-71, reminding taxpayers that they must report income from virtual currency transactions on their income tax returns. The IRS defined virtual currency as “a digital representation of value that functions in the same manner as a country’s traditional currency.” The IRS emphasized that, as with any other property transactions, virtual currency transactions are taxable.
We have previously alerted our readers to the fact that in Notice 2014-21, 2014-16 I.R.B. 938, the IRS provided guidance on how existing general tax principles apply to virtual currency transactions. The Notice is clear that for federal tax purposes, virtual currency is treated as property. For example, the Notice clarifies for taxpayers that if the fair market value of property received in exchange for virtual currency, such as Bitcoin, exceeds the adjusted basis of virtual currency, the taxpayer has a taxable capital gain. For example, a taxpayer using Bitcoin with an adjusted basis of $70 to buy property worth $100 has realized a gain of $30. On the other hand, the taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of Bitcoin. Taxpayers and their return preparers should carefully review Notice 2014-21.
The IRS elaborated in IR-2018-71 that Notice 2014-21 also clearly provides the following:
According to the IRS, currently over 1,500 known virtual currencies exist-with Bitcoin and Ethereum being among the most popular. The IRS was clear in IR-2018-71 that “because transactions in virtual currencies can be difficult to trace and have an inherently pseudo-anonymous aspect, some taxpayers may be tempted to hide taxable income from the IRS.” However, the IRS stated that “taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest.” The IRS continued by warning taxpayers that they could even face criminal prosecution for failing to properly report virtual currency transactions. Tax evasion and filing a false tax return were listed as criminal charges a taxpayer may confront. The penalties for either of these charges are heavy. The IRS explained that “anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.”