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IRS Updates Guidelines on Bitcoin Treatment: What You Need to Know

Learn how the IRS is adapting to the changing landscape of digital currencies and what it means for taxpayers. Discover the recent updates to IRS guidelines on virtual currency treatment and the introduction of a new tax return, Form 1099-DA, which exclusively reports information on digital assets. 

IRS Updates Guidelines on Bitcoin Treatment
IRS Updates Guidelines on Bitcoin Treatment

The Internal Revenue Service (IRS) has made minor adjustments to its 2014 guidelines on virtual currency treatment, acknowledging that some nations now recognize Bitcoin as a legal tender.

On Monday, the IRS released Notice 2023-34, essentially amending Notice 2014-21, which previously declared that digital currencies were not considered legal tender. The IRS highlighted that since then, a few international jurisdictions have implemented legislation that classifies Bitcoin as a legal tender.

Consequently, the statement in the background section of Notice 2014-21, which claimed that virtual currency lacked legal tender status in any jurisdiction, is now outdated concerning Bitcoin, according to the IRS.

In 2021, El Salvador’s government made global news by embracing Bitcoin as an official currency. The Central African Republic adopted Bitcoin as a legal tender in April last year. In contrast, some nations have completely prohibited the use of cryptocurrencies.

Nearly a decade ago, the IRS issued Notice 2014-21, which treated virtual currencies like cryptocurrencies as property for federal tax purposes. This allowed general tax principles applicable to property transactions to apply to convertible virtual currency transactions. The background section of the notice mentioned that virtual currencies did not have legal tender status in any jurisdiction, which is no longer accurate.

Furthermore, the IRS noted that the background section could overemphasize the similarity between convertible virtual currencies and “real” currencies, as virtual currencies like Bitcoin used to perform “real” currency functions remains limited. As a result, the new guidance modifies Notice 2014-21 by updating the third sentence in the first paragraph of the background section as follows:

“In specific situations, virtual currency may fulfill one or more of the functions of ‘real’ currency — that is, the coin and paper money of the United States or any other country designated as legal tender, circulating, and customarily used and accepted as a medium of exchange in the issuing country — but the use of virtual currency to perform ‘real’ currency functions is limited.”

However, the IRS emphasized that this change in the background section does not impact the responses to the frequently asked questions in Section 4 of Notice 2014-21, including Q&A-2, which determines that convertible virtual currency is not treated as currency capable of generating foreign currency gains or losses for federal tax purposes.

In late March, the IRS and the Treasury Department released a notice containing preliminary guidance on nonfungible tokens (NFTs) and announced plans to provide more comprehensive guidance on NFTs. NFTs, like cryptocurrencies, are digital assets tracked on a blockchain (see story). Earlier this month, the American Institute of CPAs requested specific guidance from the IRS on crypto losses.

Another significant development in tax reporting is the introduction of Form 1099-DA. This new tax return, which is yet to be implemented officially for taxpayers and preparers, will require the reporting of digital asset information from the previous year.

The IRS had initially planned to introduce Form 1099-DA for the tax year 2023, with taxpayers expected to file the form in early 2024. However, sources suggest there could be a delay in the implementation of the form.

Despite the uncertainty surrounding the implementation of Form 1099-DA, it is clear that the IRS is ramping up its focus on digital assets. This is not surprising, given the increasing popularity and prevalence of cryptocurrencies and other forms of digital assets.

Once introduced, Form 1099-DA will exclusively report information related to digital assets, which may include cryptocurrencies such as Bitcoin, Ether, and Litecoin, as well as other types of digital assets such as nonfungible tokens (NFTs).

It is worth noting that the specimen copy of Form 1099-DA has not yet been made available for public comment. Therefore, it is difficult to speculate on what information will be reported on the new form.

Given the complexities involved in the taxation of digital assets, taxpayers need to seek expert advice to ensure compliance with IRS regulations. This is particularly true for those who engage in frequent digital asset transactions, as the tax implications can be significant.