With Bitcoin hitting the $100k milestone this month, it’s an opportune time to examine the U.S. income tax treatment of virtual currencies.
The U.S. tax principles regarding virtual currencies have evolved significantly since the Internal Revenue Service issued its initial guidance in 2014. Those rules have paved the way for other jurisdictions’ emerging tax laws concerning these assets, including New Zealand’s.
This article looks at the initial development of U.S. tax principles concerning virtual currencies, and more recent guidance issued.
Early developments (2014-2019)
In 2014 Notice 2014-21 was issued by the Department of the Treasury and the Internal Revenue Service.
The notice referenced Bitcoin and was specifically limited to convertible virtual currencies, ones which can be converted into fiat currencies.
Notice 2014-21 sets forth:
- that for federal tax purposes, virtual currency is treated as property.
- That virtual currency received as consideration for services, whether through employment, or self-employment, is gross income.
- That virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
- That basis in virtual currency is the fair market value of the currency in U.S. dollars as of the date of receipt.
- That virtual currencies from mining is gross income.
- That reporting and withholding, including back up withholding, is required to the same extent as other payments made in property.
- That merchants accepting virtual currencies can be required to report payments made to a merchant on Form 1099-K Payment Card and Third-party Network Transactions if certain conditions are met[1].
- How taxpayers may be penalized for not complying with Notice 2014-21, including penalty relief provisions concerning information reporting requirements under Section 6721 and 6722.
In 2019 the Treasury and the IRS issued Revenue Ruling 2019-24, which modified and updated Notice 2014-21.
Rev. Rul. 2019-24 sets forth:
- Rules associated with hard fork[2] and airdrop transactions, when these are required to be treated as gross income, including the application of the doctrine of constructive receipt.
- Examples of hard fork and airdrop transactions, and the U.S. tax treatment of those transactions.
Recent Developments (2023-2024)
Pursuant to Notice 2014-21 and Rev. Rul. 2019-24, there were no new developments in U.S. taxation until 2023.
2023 brought new guidelines further refining previously issued guidelines.
- Notice 2023-34 was issued, updating Notice 2014-21 to remove a statement in Notice 2014-21 that virtual currency does not have legal tender status in any jurisdiction.
The change was made to recognize that some countries have enacted laws that characterize Bitcoin as legal tender[3].
- Notice 2023-27 – Treatment of certain nonfungible tokens (‘NFTs’)[4] as collectibles.
This notice signals that the Department of the Treasury and the Internal Revenue Service intend to issue guidance to the effect that NFTs are collectible under section 408(m) of the Internal Revenue Code, which in turn subjects transactions to those implications including the 28% long-term capital gains tax rate applicable to collectibles.
- Revenue Ruling 2023-14 – Taxability of staking income.
The ruling states that taxpayers have gross income where they are cash-method taxpayers, stake virtual currency on a proof-of stake blockchain[5] and receive a reward in additional units of virtual currency.
2024
This year the Department of the Treasury and the Internal Revenue Service issued four pronouncements, signalling the agency’s intentions to develop further guidance.
Key to note is the development of the term ‘digital assets’ which includes but is not limited to ‘virtual currencies’. Early developments in this field of U.S. taxation referred to virtual currencies only.
Digital assets include any assets that exist in digital form and are secured and verified through blockchain technology.
The four pronouncements are:
- Notice 2024-56 providing transitional relief from penalties for brokers who fail to report certain sales of digital assets in 2025, involving Form 1099-DA, Digital Asset Proceeds From Broker Transactions and/or furnish statements to the payee[6].
The broker has an obligation to make a good faith effort to file the information reports and pay backup withholding tax required to be withheld[7].
- Notice 2024-57 providing a safe harbour for brokers conducting certain digital asset transactions whilst the IRS determines how to facilitate appropriate reporting.
- Revenue procedure 2024-28 containing safe-harbour provisions and is effective from 1 January 2025. Safe-harbour provisions relate to how taxpayers holding digital assets as capital assets allocate basis. R.P. 2024-28 becomes effective on January 1, 2025.
- Final regulations 2024-07-09 concerning certain transactions using virtual currencies was issued on July 9, 2024.
These regulations finalize the information reporting requirements involving transactions conducted by brokers, require a payee statement to be furnished to the payee, and extend reporting requirements to real estate transactions involving digital assets.
Conclusion
As digital assets continue to evolve and integrate into the global economy, the U.S. tax landscape must keep pace with these innovations. The regulatory journey from initial guidance to the latest comprehensive rules highlights the increasing complexity and importance of this sector. With new regulations, such as those in Revenue Ruling 2023-14 and the Final Regulations 2024-07-09, the IRS demonstrates its commitment to providing clear, actionable guidance for taxpayers dealing with digital assets.
As technology advances and new digital asset classes emerge, staying informed and compliant with tax obligations will be crucial for individuals and businesses alike. The ongoing evolution of tax treatment for digital assets reflects the dynamic nature of this financial frontier. With its proactive and comprehensive approach, the U.S. continues to lead the way, setting standards for the taxation of digital assets that others may follow. The ongoing development and refinement of these regulations underscore the country’s commitment to providing clarity and guidance in this dynamic financial frontier.
[1] If both the number of transactions settled for the merchant exceeds 200 and the gross amount of payments made to the merchant exceeds $20,000.
[2] Situation involving the creation of a new virtual currency through distributed ledger technology, stemming from an existing virtual currency. May result in the transfer of newly created virtual currency to multiple holders of the original, existing virtual currency, an “airdrop”.
[3] As of the date of publication of this article, only two countries accept Bitcoin as legal tender: El Salvador and the Central African Republic.
[4] A unique digital identifier that is recorded using distributed ledger technology.
[5] Briefly, this is a mechanism through which new blocks in a blockchain network are created.
[6] As required under Section 6045 of the Code.
[7] As required under Section 3406 of the Code.
