Taxation of Virtual Currency

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Copyright © 2013 Tax Analysts

Tax Notes Today

NOVEMBER 13, 2013, WEDNESDAY

DEPARTMENT: Practice Articles  

CITE: 2013 TNT 219-10

HEADLINE: 2013 TNT 219-10 TAXATION OF VIRTUAL CURRENCY. (Section 901 -- Foreign Tax Credit) (Release Date: OCTOBER 30, 2013) (Doc 2013-25091)

CODE: Section 901 -- Foreign Tax Credit;

Section 902 -- Foreign Firm Credit;

Section 905 -- Foreign Tax Credit Rules;

Section 985 -- Taxpayer's Functional Currency;

Section 988 -- Foreign Currency Transactions;

Section 1221 -- Capital Asset;

Section 1471 -- Foreign Financial Institution Withholding;

Section 1472 -- Foreign Entity Withholding;

Section 1473 -- Foreign Financial Institution Withholding Definitions;

Section 1474 -- Foreign Institution Withholding Special Rules

ABSTRACT: Mindi Lowy and Miriam Abraham explore the tax consequences of transactions dealing in virtual currencies.

SUMMARY: Published by Tax Analysts(R)

Mindi Lowy and Miriam Abraham explore the tax consequences of transactions dealing in virtual currencies.

AUTHOR: PricewaterhouseCoopers LLPLowy, Mindi;

Abraham, Miriam

GEOGRAPHIC: United States

REFERENCES: Subject Area:

 Capital gains taxation;

 Credits;

 FATCA;

 Goods and services tax;

 Individual income taxation;

 Information reporting;

 Withholding taxes

TEXT:

Release Date: OCTOBER 30, 2013

Published by Tax Analysts(R)

[Photo Omitted]Mindi Lowy is a tax director and Miriam Abraham is a tax manager in the New York alternative investments practice of PricewaterhouseCoopers LLP. They would like to thank Gina Biondo, Simcha David, Kara Friedenberg, Meredith Jensen, Jennifer Kennedy, Rebecca Lee, David Shapiro, Mark Tibaldi, and Michael Yaghmour for their comments on and contributions to this article. Lowy can be reached at mindi.lowy@us.pwc.com, and Abraham can be reached at miriam.abraham@us.pwc.com. The views expressed in this article are those of the authors and don't necessarily reflect the views of PwC or any other person or entity. They were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties.

This article explores the tax consequences of transactions dealing in virtual currencies, such as the Bitcoin. It provides background on virtual currencies and their growing popularity and discusses the complications created by the uncertainty of potential tax character treatments, the timing of taxable income recognition, the calculation of basis, and compliance and reporting requirements. Finally, the article discusses recent regulations regarding virtual currencies.

                                              Copyright 2013 Mindi Lowy and

                                                     Miriam Abraham.

                                                  All rights reserved.

                                                       * * * * *

A. Introduction

The low-interest-rate environment has spurred investment funds to seek new opportunities to increase the yield on their investments. The desire for yield has led funds to explore new forms of alternative investments, which include a wide array of investment types such as life settlement contracts, litigation and patent claims, and peer-to-peer lending. A recent addition to that list is the investment in virtual currencies. Funds are exploring the prospect of investing in virtual currencies, and this year alone several funds have been launched with the intention of gaining exposure to those currencies. For example, on July 1 celebrity entrepreneurs Cameron and Tyler Winklevoss filed a registration statement with the SEC for an exchange-traded fund gaining exposure to the Bitcoin, the most popular form of virtual currency. This article will discuss the tax challenges and tax reporting requirements generated by the use of virtual currencies in real economies.  n1

Currency is generally defined as a system of money (or any other item) used as a medium of exchange. For much of economic history, that medium of exchange has been tangible and ranged from items such as salt to the most widely used media today, coins and paper bills. However, currency has always been shaped by, and adapted to, the social and economic norms of the times.

A new currency may be in its embryonic stage. As the Internet gradually infiltrated our entire social fabric, new forms of online interaction developed and became normative. That virtual interface ultimately led to opportunities for economic activity and dealings, and the creation of virtual currencies as a medium of exchange between online participants.

For example, World of Warcraft, an online gaming community, created its own internal virtual economy and, as of December 2012, boasted more than 9.6 million users.  n2 In massively multiplayer online role-playing games (MMORPGs), players can earn virtual currency and accumulate valuable objects, such as potions and magic weapons, by performing tasks or successfully completing missions. Many MMORPGs have their own virtual marketplace, where virtual currency can be exchanged for virtual goods and services, and sometimes for real-life goods and services. Third parties have taken that exchange further and allowed players to sell their virtual currency for real-world money.