While we have not yet evolved into a completely cashless society that some foresaw, more and more commerce (and leisure activity) is taking place using digital currency, credits, or simple direct swaps. How does the IRS view this alternative economy and how might it impact you?
Bartering has been around forever but times have changed the way in which we negotiate. The use of digital payment services such as PayPal make e-commerce almost effortless. Online gaming often permits players to accumulate points or tokens which they can sometimes exchange for tangible goods. “Virtual currency” such as bit coins permit instant transactions around the globe with relative anonymity and without foreign exchange rate risk.
The act of bartering is simply trading one product or service for another. Generally cash is not involved in this type of transaction. Bartering can range from a simple “I’ll do this for you, you do that for me, and we’re even” to a more sophisticated barter with credits on an organized barter exchange with parties you have never met.
The tax code treats the fair market value of any goods or services received in a bartering transaction as income, the same as if you had received cash instead. Exchange of services results in income to both parties. Of course, the IRS is interested in capturing the income from these transactions. Barter clubs or exchanges are required to issue a Form 1099 for each member who earns credits or units during the year. While informal transactions are not normally required to be reported separately, questions regarding engaging in bartering activity are routinely asked during all IRS examinations.
Virtual currency is a digital medium of exchange that replaces local coin or currency but is not backed by any country’s sovereignty nor has legal tender status in any jurisdiction. They are essentially an unregulated and untraceable currency. The most publicized is perhaps Bitcoin, a convertible virtual currency that can be digitally traded between users and purchased for, or exchanged into U.S. dollars, Euros, and other currencies.
In March 2014, the IRS issued guidance on the tax treatment of virtual currency. The Service made clear that virtual currency is treated as property for U.S federal tax purposes, and the general tax principles that apply to property transactions apply to transactions using virtual currency. Compensation paid with virtual currency must be reported, either on a W-2 or 1099. Gain or loss from the sale or exchange of virtual currency depends on whether the currency is a capital asset in the hands of the taxpayer. Payments for goods using virtual currency are subject to information reporting the same as any other payment made in property. Note however, that virtual currency is not treated as currency that could generate foreign currency gain or loss for tax purposes.
Foreign Account Reporting
U.S. citizens who have an interest in or signature authority over a foreign account are required to separately file an annual report (FBAR) with the U.S. government if the account is worth $ 10,000 or more at any time during the year. How are virtual accounts treated?
In June, a district court ruled that online poker accounts were in fact controlled by overseas entities and were required to be reported on a FBAR report. The taxpayer had accounts with PokerStars and PartyPoker and used FirePay to remit and receive cash. Penalties for not reporting the accounts on a FBAR were assessed because the court stated the entities were organized outside the U.S. and in fact met the definition of “financial institution”, requiring reporting.
Although not authoritative, during a recent IRS webinar an IRS representative stated that for 2013 reports, taxpayers are not required to report virtual currencies on a FBAR report. He also indicated that the issue is up for review and could change. There is considerable discussion and debate regarding bitcoins—is there a “financial account” with a “financial institution” as outlined in the regulations? Stay tuned for updates in this area!
With the explosion of online transactions, it is difficult, if not impossible to quantify the extent of virtual economy and currency markets. Obviously, governments have a vested interest in potential revenue loss for unreported transactions. This will certainly be an area which will receive a lot of interest and activity in the coming years.
By: George Monger, CPA