The taxation of virtual currencies has garnered increasing attention, in part due to the princely fortunes some are making from the rapid increase in the price of Bitcoins. Yet, the U.S. IRS has issued little guidance in this area. This is likely to change soon. In May 2013, the GAO issued a report on Virtual Economies and Currencies. In part, the report states:
Transactions within virtual economies or using virtual currencies could produce taxable income in various ways, depending on the facts and circumstances of each transaction. For example, transactions within a "closed-flow" virtual currency system do not produce taxable income because a virtual currency can be used only to purchase virtual goods or services. An example of a closed-flow transaction is the purchase of items to use within an online game. In an "open-flow" system, a taxpayer who receives virtual currency as payment for real goods or services may have earned taxable income since the virtual currency can be exchanged for real goods or services or readily exchanged for government-issued currency, such as U.S. dollars.
More recently, the 2013 National Taxpayer Advocate Annual Report to Congress notes the increasing use of virtual currencies, particularly Bitcoin and that the IRS has yet to issue specific guidance addressing the tax treatment or reporting requirements applicable to virtual currency transactions. The report concludes that IRS-issued guidance would promote tax compliance, particularly among those who want to report virtual currency transactions properly, and it would reduce the risk that users of virtual currencies will face tax consequences that they did not anticipate.
Despite noting that the IRS website suggests that existing guidance covers these transactions, it states that this guidance did not explain when the transactions are sufficiently analogous to be covered by existing rules. Among the remaining questions it identified the following:
When will receiving or using digital currency trigger gains and losses?
When will these gains and losses be taxed as ordinary income or capital gains?
What information reporting, withholding, backup withholding, and recordkeeping requirements apply to digital currency transactions?
When should digital currency holdings be reported on a Report of Foreign Bank and Financial Accounts (FBAR), or Form 8938, Statement of Specified Foreign Financial Assets?
In the interim, our Social Media Team's tax gurus are monitoring the issues.