States Begin to Issue Guidance on Tax Treatment of Bitcoin and Other Virtual Currencies

separator

States Begin to Issue Guidance on Tax Treatment of Bitcoin and Other Virtual Currencies


Although still a relatively new phenomenon, the virtual currency Bitcoin is accepted by an increasing number of retailers and other vendors, including prominent Internet sellers Newegg.com and Overstock.com.  See //www.wired.com/2014/09/overstock-com-becomes-first-major-retailer-accept-bitcoin-worldwide/ .  As virtual currencies such as Bitcoin gain wider acceptance both as an investment vehicle and as a medium for payment, some state revenue departments have started to take notice.

Evaluating the possible tax implications of transactions involving Bitcoin requires a basic understanding of the nature of virtual currency.  The Federal Reserve Bank of Chicago offers a useful Bitcoin primer.  In effect, Bitcoin is a digital means of storing value, represented by a unique string of zeros and ones stored in a digital “wallet” (a computer file) managed by an application installed on the holder’s computing device.  Id. at 2.  The value of the string of zeros and ones is validated by its entry on a public ledger of transactions on the Bitcoin network.  The ledger is maintained by Bitcoin “miners,” users on the Bitcoin network who volunteer to participate in a competitive validation process that involves solving difficult mathematical algorithms in order to confirm the transaction, in return for which the successful miner is awarded a small amount of newly-created Bitcoin.  Id.  You do not have to be a “miner” to obtain Bitcoin, however; once created, it can be purchased through a Bitcoin exchange that facilitates transactions on the network.  The Bitcoin network protocol regulates the amount of new Bitcoin awarded in a way that limits the total number of Bitcoins that can ever be created to 21 million.   Id.  However, unlike physical currency, whose smallest sub-unit is typically 1/100th (e.g., $0.01), Bitcoins are divisible to the eighth decimal place.  That means the total sub-units of Bitcoin ultimately in circulation could exceed two quadrillion.  How much value, in U.S. dollar terms, is stored in Bitcoin will depend upon the value of each unit (or sub-unit) of Bitcoin in circulation.

Although commonly referred to as virtual “currency,” the IRS has determined that Bitcoin is a form of property for federal income tax purposes.  IRS Notice 2014-21 (Mar. 25, 2014).  According to the IRS Notice, virtual currency “does not have legal tender status in any jurisdiction.”  Id.   As a form of property, if virtual currency appreciates in value from the time it is acquired by a taxpayer, the taxpayer may be required to report a taxable gain upon transferring the virtual currency to another person or using the virtual currency to make a purchase (or in exchange for other value).  Id.

In the wake of the IRS ruling, state revenue departments have not yet offered any state income tax guidance regarding virtual currency, but a handful of states have issued bulletins on various sales tax considerations presented by transactions involving virtual currencies such as Bitcoin.  Three states,   California, Wisconsin and Kentucky, have made clear that purchases of taxable goods or services made with Bitcoin are subject to state sales tax, just like any other purchase.  California Board of Equalization, Special Notice L-382 (June 2014) (“CA BOE Special Notice L-382”); Wisconsin DOR, Sales and Use Tax Report, Issue 1-14, at 4-5 (March 2014) (“March 2014 Report”); Kentucky DOR, Sales Tax Facts (June 2014) (“June 2014 Sales Tax Facts”).  The sales price in U.S. dollars is the proper measure of the tax.  Not surprisingly, a retailer is required to collect and remit sales tax to the state as with any other sale.

Although virtual currency is treated as property, guidance from the departments in Wisconsin and Missouri indicates that sales of Bitcoin itself are not subject to sales tax, because Bitcoins are intangible, and thus not taxable as tangible personal property.  Wisconsin DOR March 2014 Report at 5; Missouri DOR, Letter Ruling LR 7411 (September 12, 2014).  Interestingly, the Wisconsin DOR also comments that if the sale of Bitcoin is a proxy for a sale of a taxable good or service, then the transaction is subject to tax.  March 2014 Report, at 5.  Finally, while not asserting that sales of virtual currency are taxable, the Nebraska DOR has made clear in a bulletin explaining the tax exempt treatment of traditional currency sales that the term “currency” does not include Bitcoin or other virtual currency.   Nebraska DOR, Frequently Asked Questions About Currency and Bullion (eff. April 1, 2014).

The most significant state tax issues facing online sellers who decide to accept Bitcoin may relate to record keeping.  The revenue departments in California, Wisconsin, and Kentucky each stress that he retailer is required to maintain sufficient records to verify the taxable sales price at the time of the transaction.  The California BOE will accept evidence of the standard sales price in U.S. dollars of an item sold to customer at the time of the Bitcoin transaction.  Cal. BOE Special Notice L-382.  Guidance from the Wisconsin DOR notes that the taxable sales price is based on the value of the consideration received (i.e., the value of the virtual currency) on the date of the sale (see March 2014 Report, at 5) – which is likely the same as the item’s price in U.S. dollars, but might vary if Bitcoin prices are volatile or some additional processing fees are included.  The Kentucky DOR specifies that retailers “must maintain documentation to verify the value of Bitcoin at the time of the transaction.”  See June 2014 Sales Tax Facts.  Daily historical Bitcoin values are available online from some exchanges.  See, e.g., //www.coindesk.com/price/.

States have only just begun to scratch the surface of the tax implications of virtual currency transactions.  As more significant developments arise, we will keep our readers apprised.

Posted by Matthew Schaefer

Print Friendly, PDF & Email
separator

No comments so far!

separator

Leave a Comment