With virtual currency transactions becoming more frequent in recent years, the IRS has begun addressing taxpayer noncompliance related to virtual currency transactions. In 2019, the IRS started its Virtual Currency Compliance campaign by sending educational letters to taxpayers who may have failed to report their incomes or did not report transactions properly regarding virtual currency transactions.
In addition to the educational letters, the IRS pursued virtual currency transaction compliance through the use of audits and criminal investigations. The educational letters, Letter 6173, Letter 6174, and 6174-A, informed the taxpayer:
- Why they received the letter
- What the taxpayer needed to do to amend any inaccurate tax returns
- When and how virtual currency transactions must be reported for federal income tax purposes
In addition to the letters, the IRS circulated Notice 2014-21 and Frequently Asked Questions (FAQs) about virtual currency transactions.
Letters 6173, 6174 and 6174-A
The IRS considers virtual currencies as cryptocurrency and non-crypto virtual currencies. The letters explain that virtual currency is considered property for federal income tax purposes. This definition means that all sales, exchanges, and other dispositions of virtual currency have to be reported by U.S. taxpayers.
If the virtual currency is used to pay for goods, services or to purchase another kind of virtual currency, the transactions have to be reported as property exchanges on a federal income tax return. This disclosure is required whether the account is in the U.S. or another country.
Notice 2014-21 and FAQs
One of the issues addressed by this notice is determining the fair market value of the virtual currency reported on the federal income tax form. The taxpayer must find out what the fair market value of the virtual currency was on the date the payment or receipt was achieved. The report must reflect virtual currency transactions in U.S. dollars.
Using the exchange rate, if the virtual currency is listed, can be a way to determine fair market value in U.S. dollars by conversion. Another way to accomplish this is to convert the virtual currency into another real currency, then convert that rate into a U.S. dollar value.
If the taxpayer receives virtual currency as payment for goods or services on multiple occasions, the taxpayer must find what the fair market value was on the date each payment was received and use the U.S dollar equivalent when computing gross income.