Transactions in virtual currency are taxable just the same as transactions in U.S. currency, and if your client is transacting in virtual currency they may need to report these transactions on their tax return.
Virtual currency is not legal tender in any jurisdiction, but there are tax consequences to converting virtual currency into real currency or using virtual currency to pay for goods and services. For federal tax purposes, virtual currency is treated as property, and the tax principles applicable to property transactions apply to virtual currency transactions.
An individual paying virtual currency must report the payment on a tax document such as Form 1099-B, Form 1099-MISC (if the amount is $600 or more), or Form W-2 (if considered wages).
Likewise, a taxpayer receiving virtual currency as payment for goods or services must report the fair market value of the currency received in their gross income. Additionally, a taxpayer who mines virtual currency in order to make a profit may be deemed to be operating "a trade or business" and thus will be considered self-employed, requiring the payment of self-employment tax.
When trading virtual currency, whether or not a gain or loss is classified as a capital gain or loss or an ordinary gain or loss depends on whether the virtual currency is considered a capital asset, e.g., stocks, bonds, or investments, or other than a capital asset, e.g., inventory held for sale to customers.
The virtual currency question first appeared on federal tax returns in tax year 2019, and the question was printed on Form 1040 Schedule 1. Beginning in 2020 this question was moved to the top of Form 1040, evincing its importance to the IRS.
The virtual currency question is, "At any time during 20xx, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?"
In TaxSlayer Pro desktop, this question is asked in the tax return (Form 1040 or 1040-NR) here:
- Personal Information
- Has Financial Interest in Any Virtual Currency - Select YES or NO as appropriate.
In TaxSlayer ProWeb, this question is a check box here:
- Federal Section
- Basic Information
- Personal Information
What kind of tax document did the taxpayer receive related to virtual currency?
- W-2 - Enter as a W-2 in the Wages section of the return.
- 1099-MISC - Presumably the taxpayer trades in virtual currency, so this goes to Gross Receipts in Schedule C. In TaxSlayer ProWeb, enter directly in Schedule C. In TaxSlayer Pro desktop, enter in the 1099-MISC menu and link to Schedule C.
- 1099-B, brokerage statement, or summary statement - Enter in the capital gain/loss menu.
Additional Information:
The following IRS Publications are helpful and authoritative guides in preparing the tax return for a taxpayer who engages in virtual currency transactions:
- Publication 525, Taxable and Nontaxable Income - Miscellaneous income from exchanges of property.
- Publication 544, Sales and Other Dispositions of Assets - Tax treatment of sales and exchanges of property, including the deductibility of losses.
- Publication 551, Basis of Assets - Determining the basis for property used in an exchange.
- IRS Notice 2014-21 - Virtual currency guidance
- IRS Fact Sheet FS-2007-18, April 2007, Business or Hobby? - Guidelines to help determine if a taxpayer's activity is a business or a hobby.
- IRS FAQ on Virtual Currency Transactions
