Bitcoin is a virtual, technology-based currency that is gaining popularity as an alternative to regular currency in commercial transactions. The IRS recently issued Notice 2014-21 to address issues with Bitcoin.
The 16-question FAQ explains the tax and payroll consequences of using Bitcoin.
As a preliminary matter, the IRS defines virtual currency like Bitcoin as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros and other real or virtual currencies.
The IRS views Bitcoin and other virtual currency as property (instead of real currency) so the tax consequences related to property generally apply. The following clarifications apply to payroll processes:
- Virtual currency received by an independent contractor for performing services constitutes self-employment income. You measure the value of the payment based on the fair market value of Bitcoin at the time of receipt. Therefore, if a company pays $600 or more in virtual currency in a year, it must provide a Form 1099-MISC.
- If an employer pays an employee in Bitcoin as remuneration for services, that payment constitutes wages for employment tax purposes, including FICA tax. Again, these payments are based on the fair market value at the time of receipt and are reportable (i.e., on Form W-2).
- Payments made in Bitcoin are subject to backup withholding, just like other payments made in property. Thus, payers making reportable payments using virtual currency must solicit a taxpayer identification number (TIN) from the payee.
The IRS indicated that employers and other companies that violate these rules before March 25, 2014, are subject to the normal array of penalties. However, penalty relief may be available if the failure was due to reasonable cause.