The IRS issued Notice 2014-21 yesterday, which describes how the IRS will apply U.S. tax principles to transactions involving virtual currency.  The GAO had previously issued a report on virtual economies and currencies, calling for additional IRS guidance on the basic tax reporting requirements applicable to virtual currencies.

The major decision reflected in the guidance is the IRS’s classification of Bitcoin and similar virtual currencies as property, resolving what had been an open question in the minds of some observers about whether Bitcoin should be treated for tax purposes as an asset or like foreign currency.  Beyond clarifying that point, the balance of the guidance is largely an articulation of existing tax law in the context of Bitcoin and other convertible virtual currencies.

The notice does not utilize the definitions and classifications of virtual economies and currencies established in the GAO report, but rather by and large adopts the definition of convertible virtual currency set out by FinCEN in the virtual currency guidance it issued last March.  Following FinCEN, the IRS notice defines virtual currency as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.  In some environments, it operates like ‘real’ currency…but it does not have legal tender status in any jurisdiction.”  Real currency is described in the notice as “the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance.”  Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to in the notice as “convertible” virtual currency, and includes Bitcoin.

Borrowing the FinCEN definition means that Bitcoin and other convertible virtual currencies fall outside of the definition of “currency,” which is limited to legal tender, and hence will be treated as property for U.S. tax purposes.  As a result, income from convertible virtual currency transactions will be treated as either ordinary income or capital gain, as applicable.  (Had the IRS treated virtual currency like foreign currency, transactions would have been taxed as ordinary income.)

Some of the major issues raised by the IRS notice for various participants in the virtual currency ecosystem are summarized below.  The IRS notice is general and assumes away many issues that can be complicated to apply, even in areas outside of virtual currency.  Taxpayers should therefore consult their tax advisors regarding the tax implications of their particular business or situation.

It bears emphasis that the IRS views the notice as an explanation of how U.S. tax laws have always applied to virtual currency.  Thus, the rules discussed below apply to past transactions as well as future transactions.  If audited with respect to a virtual currency transaction that occurred prior to the March 25, 2014 release date of the notice, taxpayers may be able to avoid penalties due to the lack of prior guidance by the IRS, but such a waiver of penalties is not guaranteed.


The IRS notice is generally good news for taxpayers who hold virtual currency as investments, because lower capital gain tax rates may be applicable to those who have held their virtual currency for more than one year, rather than the higher ordinary income rates which apply to almost all transactions in foreign currency.  An investment in virtual currency should be taxable at capital gains rates (maximum of 20% on capital assets held for more than a year) and possibly could be subject to the 3.8% tax on unearned income (applicable to investors with more than $200,000 of income).


Mining virtual currency is a taxable event.  All taxpayers who mine virtual currency recognize income upon receipt of the virtual currency.  The notice presumes that the income from mining would be ordinary, and provides that a taxpayer who is self-employed and actively mines virtual currency will be subject to self-employment taxes on the resulting income (i.e., Social Security and Medicare taxes).


Virtual currency held mainly for sale to customers will likely be treated as noncapital assets.  In such case an exchange that sells virtual currency to customers in its trade or business has gross revenue equal to the value for which the virtual currency was sold.  An important issue not addressed by the guidance is whether virtual currency constitutes a commodity, such that brokers in virtual currency would be subject to information reporting in the same manner as brokers in securities and commodities.


The notice confirms that any disposition of virtual currency generally is a taxable event, including where virtual currency is used to acquire another asset.  Although the notice does not mention the use of virtual currency to pay for services, under the general tax principles being applied by the IRS in the notice, such a payment would also give rise to a taxable event to the payor.  Accordingly, use of virtual currency in a retail transaction is taxable to the person paying with the virtual currency if the value of the merchandise received is higher than their basis in the virtual currency.  For example, an investor purchasing an item using bitcoins would recognize income in an amount equal to the difference between the item purchase price and the price at which the bitcoins were acquired.  If the bitcoins had been held for more than a year, long-term capital gains tax would apply (and possibly unearned income tax, as noted in the investor section above).  This is the same general result as if virtual currency was treated like foreign currency, except that a de minimis rule applies to many foreign currency transactions involving gain of less than $200.

Payments made using virtual currency are subject to U.S. tax reporting and backup withholding to the same extent as other payments made in property.  For example, a person in a trade or business making a payment in excess of $600 (or its equivalent fair market value in virtual currency) to a non-exempt recipient would have to report such payment to the IRS.  Backup withholding rules also apply if the person reporting the transaction is unable to obtain the recipient’s TIN.  Similarly, although not directly addressed by the notice, a person making U.S. source income payments to a foreign person generally would be required to report such transaction to the IRS and to withhold tax of 30%.  It is important to note here that failure by the payor to report the transaction will not excuse the recipient of the payment from being liable for U.S. income taxes.  All withholding of U.S. taxes, at least currently, must be in U.S. dollars even if the payment was made in virtual currency.

Employees and Independent Contractors

All taxpayers who receive virtual currency as compensation for services, whether as an employee or an independent contractor, are taxed in the same manner as if the amounts paid were U.S. dollars.  Employees will be subject to wage withholding and employment taxes.  Independent contractors will be liable for income taxes and self-employment taxes.  Note that all payment of U.S. taxes must be in U.S. dollars even if the compensation was paid in virtual currency.

Payment Processors

The information reporting rules currently applicable to third party settlement organizations (TPSOs) as defined by the IRS apply to payment processors who settle transactions in virtual currency.  If a virtual currency payment processor is a TPSO under the IRS’ rules, it must report payments made to a merchant if, for the calendar year, the number of transactions settled for the merchant exceeds 200, and the gross amount of payments to the merchant exceeds $20,000.  The dollar value of payments denominated in virtual currency is based on the fair market value of the currency on the date of payment.

IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with Treasury Department and IRS regulations, we inform you that any federal tax advice contained in this communication is not intended or written by Perkins Coie LLP to be used, and cannot be used for the purpose of (i) avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Email this postTweet this postLike this postShare this post on LinkedIn
Photo of J. Dax Hansen J. Dax Hansen

J. Dax Hansen helps innovators transform and adopt technology and financial services. He is a technology transactions and regulatory attorney who has pioneered blockchain, digital currency, payments, and fintech law.

Photo of Bryan Smith Bryan Smith

Bryan Smith, a partner with the firm’s Corporate practice, has experience in many aspects of federal income tax, including mergers and acquisitions, international and cross-border transactions, executive compensation, public and private offerings, joint ventures, real estate investment trusts (REITs), real estate and leasing…

Bryan Smith, a partner with the firm’s Corporate practice, has experience in many aspects of federal income tax, including mergers and acquisitions, international and cross-border transactions, executive compensation, public and private offerings, joint ventures, real estate investment trusts (REITs), real estate and leasing transactions, and federal tax controversies.