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January 10, 2014
Guidance Needed on Virtual Currencies, Report Says
by Eric Kroh

Full Text Published by Tax Analysts®

The need for the IRS to issue guidance addressing the tax treatment of virtual currencies such as Bitcoin is one of the most serious problems facing the agency, according to National Taxpayer Advocate Nina Olson.

Although IRS officials have said the agency is working on rules to govern digital currencies, it has still not answered basic questions, such as when receiving and using digital currencies trigger gains and losses, and what informationreporting requirements apply, Olson said in her annual report to Congress, released January 9.

The report notes that the use of digital currencies is growing. In July 2013 there were 1,708 Bitcoin transactions per hour, and the market value of Bitcoin was $1.1 billion; five months later, in December, there were 3,048 transactions per hour, and the market value was $12.6 billion, according to the report.

The lack of guidance on digital currencies has left taxpayers confused, and the regulatory void has been filled with conflicting, misleading, and incorrect information, the report says.

"It is the government's responsibility to inform the public about the rules they are required to follow," the report says. "The lack of clear answers to basic questions such as when and how taxpayers should report gains and losses on digital currency transactions probably encourages tax avoidance."

The report says the questions that need to be addressed include whether digital currencies are property that would produce capital gains or losses upon being spent, or a nonfunctional currency that would produce ordinary income or loss under the code; whether digital currencies held in a foreign account should be reported on a foreign bank account report; whether the receipt of digital currencies in excess of $10,000 would have to be reported on Form 8300, "Report of Cash Payments Over $10,000 Received in a Trade or Business"; and whether digital currency transactions would need to be reported under section 6050W payment card and third-party network rules.

An IRS spokesman said in a statement that the agency is "aware of the potential tax compliance risks posed by virtual currencies." The statement referred to a page on the IRS website outlining guidance on understanding how transactions in virtual worlds may have potential tax consequences and said that the IRS "continues to study virtual currencies and intends to provide some guidance on the tax consequences of virtual currency transactions."

The Taxpayer Advocate Service report says that the guidance on transactions in virtual worlds is inadequate and does not explain when digital currency transactions are "sufficiently analogous to the transactions described in the guidance to be covered by existing rules."

The report accorded with a report released last year by the Government Accountability Office recommending that the IRS issue additional guidance on digital currencies to reduce tax compliance risks.

Marco Santori, chair of the Bitcoin Foundation's regulatory affairs committee, told Tax Analysts that guidance on virtual currencies is absolutely necessary.

"I think that most people who use Bitcoin, excepting the crypto-anarchists, would say that taxpayer guidance is critical for increasing adoption by businesses and individuals," Santori said.

Because of the lack of guidance, accountants, lawyers, and others have been doing their best to interpret how existing guidance should apply to digital currencies, but "nobody knows who's right," he said, adding, "One gets the sense that one's feeling around in the dark."

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