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Compensation Paid in Bitcoin is Subject to Employment Taxes under IRS Notice 2014-21
Practical Law Legal Update 8-562-5994 (Approx. 5 pages)
Compensation Paid in Bitcoin is Subject to Employment Taxes under IRS Notice 2014-21
by Practical Law Employee Benefits & Executive Compensation
| Published on 27 Mar 2014 • USA (National/Federal) |
In Notice 2014-21, the Internal Revenue Service (IRS) explains that payments made by an employer in Bitcoin and other convertible virtual currencies as remuneration for services will be treated as wages for employment tax purposes.
Notice 2014-21
On March 25, 2014, the IRS issued Notice 2014-21, which explains how federal tax laws apply to transactions using convertible virtual currencies, such as Bitcoin (, Mar. 26, 2014).
The IRS defines virtual currency as a digital representation of value that functions as a:
- Medium of exchange.
- Unit of account.
- Store of value.
Virtual currency is not legal tender in the US or any other jurisdiction. When it has an equivalent value in real currency or acts as a substitute for real currency, it is referred to as convertible virtual currency. Notice 2014-21 applies to convertible virtual currencies only.
Bitcoin is probably the best-known example of a convertible virtual currency. It can be bought and sold for accepted legal tender, such as US dollars, and it is also accepted by some online merchants as payment for goods and services.
Notice 2014-21 provides 16 questions and answers on the taxation of transactions using convertible virtual currencies. As a starting point, it establishes that for federal tax purposes, virtual currency is treated as property, not as currency. Therefore, general tax principles applicable to property transactions also apply to transactions using virtual currency.
Employment Taxes
Significantly, several questions and answers in Notice 2014-21 discuss the tax implications of virtual currencies in the employment context. The Notice explains that the virtual currency paid by an employer as remuneration for services constitutes wages for employment tax purposes. This follows the general rule that the medium used for remuneration of services is immaterial to whether that remuneration constitutes wages for employment tax purposes. Therefore, the fair market value (FMV) of convertible virtual currency paid as wages is subject to:
- Federal income tax withholding.
- The Federal Insurance Contributions Act (FICA) tax.
- The Federal Unemployment Tax Act (FUTA) tax.
The FMV of the virtual currency must be reported as Form W-2 wages. The FMV of a convertible virtual currency is determined in US dollars as of the date of payment or receipt. If the virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the FMV of the virtual currency is determined by converting the virtual currency into US dollars (or into another real currency which can be converted into US dollars):
- At the exchange rate.
- In a reasonable manner that is consistently applied.
An employer is generally responsible for withholding and remitting its employees' portion of payroll taxes, as well as paying the employer portion of these taxes (see Practice Note, Payroll (FICA) Taxes). Notice 2014-21 provides that payments made using convertible virtual currency, like other payments made in property, are also subject to backup withholding. This requires persons making reportable payments with a virtual currency to:
- Solicit a taxpayer identification number (TIN) from the payee.
- Backup withhold from the payment:
- if a TIN is not obtained prior to payment; or
- if instructed to do so by the IRS.
Under Notice 2014-21, virtual currency received by an independent contractor as remuneration for services constitutes self-employment income. The FMV of the virtual currency, measured in US dollars on the day of receipt by the independent contractor, is subject to the self-employment tax.
Information Reporting
Notice 2014-21 also discusses the information reporting requirements that apply when payments, including salaries, wages and other compensation, are made in Bitcoin. A payment made in convertible virtual currency is subject to information reporting to the IRS to the same extent as any other payment made in property. A person who in the course of a trade or business makes a payment of fixed and determinable income using virtual currency must report the payment to the IRS and the payee if the payment:
- Has a value of $600 or more.
- Is made in a taxable year to a US non-exempt recipient.
"Fixed and determinable income" includes salaries, wages and other compensation, as well as rent, premiums and annuities.
Information reporting is also required if, in the course of a trade or business, a person makes a payment using virtual currency worth $600 or more to an independent contractor for performing services. That payment must be reported to the IRS and to the payee:
- On Form 1099-MISC.
- Using the FMV of the virtual currency in US dollars as of the date of payment (as explained above).
An independent contractor may have income even if he does not receive a Form 1099-MISC.
Practical Implications
Bitcoin and other convertible virtual currencies that are emerging and growing in popularity represent an important new development in the world economy and may one day be commonly used instruments in the online marketplace. With Notice 2014-21, the US joins Australia, Canada and Japan in treating convertible virtual currencies as property for tax purposes. The IRS Notice has important implications for employers that want to pay employees and independent contractors with convertible virtual currencies. Employers that use convertible virtual currencies as compensation must ensure that they comply with the withholding and reporting requirements discussed in Notice 2014-21.