In 2014, the IRS issued Notice 2014-21 describing how existing tax principles apply to virtual currency transactions. The Notice said that virtual currencies, such as Bitcoin, should be treated as property, rather than a currency. Taxpayers must record the fair market value of virtual currency in U.S. dollars on the date it was received.
Taxpayers who exchange their virtual currency for other property must recognize a gain or loss on the transaction. The character of the gain or loss depends on whether the currency is a capital asset (held for the purposes of making money) or ordinary income (in the case of a taxpayer who mines or regularly deals in virtual currency). Individuals who receive virtual currency as wages and payment for services must also report the currency’s fair market value (in U.S. dollars on the date it was received) as income.
In July 2019, the IRS began mailing letters to more than 10,000 taxpayers who may have reported transactions involving cryptocurrency incorrectly or not at all. These taxpayers may be liable for tax, penalties, interest, and even criminal prosecution. A few months later, the IRS issued a new Revenue Ruling and FAQ on Virtual Currency Transactions. This new guidance addressed common questions regarding the tax treatment of a cryptocurrency hard fork and transactions for those who hold virtual currency as a capital asset.
Just last month, the U.S. Treasury called for stricter cryptocurrency compliance with the IRS, announcing that any transfer worth $10,000 or more must be reported to the IRS. And, experts predict that it’s only a matter of time until Congress grants the SEC broader jurisdiction to regulate cryptocurrency exchanges to “help ensure investors are protected and prevent market manipulation.” Investors predict that regulatory hurdles will likely hurt their portfolios, but there’s no sign of deregulation coming anytime soon. Both Democrats and Republicans have made cryptocurrency regulation a top priority in 2021 as the volatility of Bitcoin and emergence of other digital assets have fueled concerns of market manipulation and uninformed investing.
How Have Other Developed Countries Addressed Cryptocurrency?
Canada views cryptocurrency as a commodity – Bitcoin transactions are viewed as barter transactions, and the income received is treated as business income. There are taxation differences between individuals engaged in a buying-selling business vs. pure investors. Some major Canadian banks have banned the use of their credit/debit cards for Bitcoin transactions.
Similar to Canada, Australia considers Bitcoin neither money nor a foreign currency. The Australian Taxation Office ruled that Bitcoin is an asset for capital gains tax purposes/ The European Union’s European Court of Justice ruled that buying and selling digital currencies is considered a supply of services that this is exempt from value-added tax (VAT) in all EU member states. Some individual EU countries have also developed their own Bitcoin stances. In Finland, the Central Board of Taxes has given bitcoin a VAT exempt status by classifying it as a financial service. Bitcoin is treated as a commodity and not as a currency. The Federal Public Service Finance of Belgium has also made Bitcoin exempt from VAT.
In Cyprus, Bitcoin is not controlled or regulated. The United Kingdom’s Financial Conduct Authority and Bulgaria’s National Revenue Agency have begun bringing Bitcoin under its existing tax laws. Germany recognizes Bitcoin as a “unit of account” and created a tax framework for Bitcoin-based transactions. Transactions are taxed differently depending upon whether the taxpayer is an exchange, miner, enterprise, or user.
Once the center of Bitcoin mining worldwide, Bitcoin mining, trading, and dealing is now essentially banned in China. Japan has refused to recognize Bitcoin as a currency or anything similar. Bitcoin is not regulated in Russia, though its use as payment for goods or services is illegal.
How Have Developing Countries Addressed Cryptocurrency?
Bolivia, Colombia, and Ecuador have banned Bitcoin. Conversely, many Nigerians, Venezuelans, Zimbabweans, and Iranians regularly deal in Bitcoin. Earlier this month, El Salvador became the first nation to formally adopt Bitcoin, for use as a parallel legal tender alongside the U.S. dollar. A few weeks later, the World Bank rejected a request from El Salvador to help with the implementation of Bitcoin as legal tender, citing concerns over the environmental impact of Bitcoin mining and transparency. Similarly, the IMF said it saw “macroeconomic, financial and legal issues” with El Salvador’s adoption of Bitcoin. Other critics cited the complexity and volatility of Bitcoin, in addition to the lack of financial literacy in El Salvador.
However, many see El Salvador’s move as opening an incredibly useful gateway to the world economy. Many El Salvadorans do not have bank accounts and personal remittances from family abroad—often located in South Florida—already make up 20% of El Salvador’s GDP. A cryptocurrency wallet only requires users to have access to the internet. Financial inclusion is essential for the development of a country; lack of access to financial services is linked to poverty. Increased circulation of cryptocurrency can build social trust through tools such as smart contracts and government transparency, reducing social inequality while improving economic growth and the standard of living. Furthermore, cryptocurrency may accelerate the use of other productive technologies.