In letter to Rep. Tom Emmer, R-Minn., IRS Commissioner Charles Rettig indicated that the agency plans to release additional guidance on issues related to virtual currencies soon in three areas raised by a letter the Congressman had sent to the agency on April 11, 2019.

The IRS has previously issued guidance on the taxation of virtual currencies in Notice 2014-21, a notice discussed on this website when the IRS issued News Release IR-2018-71 to remind taxpayers of the agency’s stated position on the taxation of virtual currencies such as Bitcoin (BTC).[1]

That news release repeated the following summary of key elements found in Notice 2014-21:

• A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

• Payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply.  Normally, payers must issue Form 1099-MISC.

• Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2 and are subject to federal income tax withholding and payroll taxes.

• Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third Party Network Transactions.

• The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.[2]

However, there are a number of questions left unanswered by Notice 2014-21 which the Representative’s office raised with the Commissioner.

The Commissioner specifically referenced three issues in his letter.  Those issues included:

•  Acceptable methods for calculating stock basis

• Acceptable methods for cost basis assignment

• Tax treatment of forks

Basis issues are troubling because of the nature of virtual currencies--they exist, but not in a physical form (at least if you aren’t counting electrons stored in silicon).  While a client might have a certain number of bitcoin, that number is likely not an pure integer number (more likely 5.287 or something similar), and were acquired in various ways—some may have been purchased on exchanges, some may have been received as payment for services, and some may have been mined.[3]  Guidance on the methods to be used to determine the initial cost basis would prove helpful.

More of an issue is the second matter--how the taxpayer assigns a portion of that basis to the Bitcoin that is sold or exchanged in a transaction.  Can (or even must) a specific identification method be used?  Is a first-in, first-out or average cost methodology acceptable? 

One of the more troubling issues is a fork of a currency, such as occurred with the creation of Bitcoin Cash (BCH) on August 1, 2017 when each holder of Bitcoin received 1 Bitcoin Cash.  Was that a taxable transaction and, if it was, what value should be assigned to the BCH received? Or was this really all the same “asset” with the even being nontaxable.  If that is the case, how much of the BTC basis should have been assigned to the BTC, if any?

The Commissioner’s letter notes:

I share your belief that taxpayers deserve clarity on basic issues related to the taxation of virtual currency transactions and have made it a priority of the IRS to issue guidance. … We have been considering these issues and intend to publish guidance addressing these and other issues soon. 

[1] Ed Zollars, “IRS Reminds Taxpayers About Agency's Position on Taxation of Virtual Currencies Published in 2014,” March 30, 2018, https://www.currentfederaltaxdevelopments.com/blog/2018/3/30/irs-reminds-taxpayers-about-agencys-position-on-taxation-of-virtual-currencies-published-in-2014?rq=Notice%202014-21

[2] IR-2018-71, https://www.irs.gov/newsroom/irs-reminds-taxpayers-to-report-virtual-currency-transactions, March 23, 2018

[3] The concept of mining is not an issue I will attempt to explain in this brief article.  Suffice it to say it is the way that new Bitcoin (or other virtual currencies) are created.