We have all heard of Bitcoin and Ethereum – Cryptocurrencies that are also considered to be virtual currencies. So, what exactly is virtual currency? According to FinCEN – (Financial Crimes Enforcement Network), virtual currency is a “medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency”. It is to be noted the virtual currencies do not have legal tender status in any country/tax jurisdiction. The ECB (European Central bank) defines virtual currency as “a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community”. From the definitions, it is clear that cryptocurrencies and virtual currencies do not have a legal tender and are not issued by Central Banks anywhere. Yet, these are used as a form of “electronic currency” and payments are made and accepted across the virtual world using the same.
How did virtual currencies/cryptocurrencies come into existence? In 2008, Satoshi Nakamoto announced the invention of a “Peer to Peer Electronic Cash System”. This was the origin of Bitcoin. Cryptocurrencies are essentially digital assets that use very strong cryptography to make them sure instruments of exchange and work on black chain technology and related protocols. Without going into the complexities of blockchain technology and the transactional process of origin and transfer of cryptocurrencies, one can simply state that with the birth of Bitcoin and the use of Bitcoin in the virtual world, tax jurisdictions and financial regulators realized that whether they liked it or not, they had another medium of exchange on hand and would need rules to regulate it.
The cryptocurrency transactions per se cannot be regulated since there is no central bank or other agency monitoring its use. However, it is another form of income and does have tax implications. More and more tax jurisdictions are coming up with rules for taxing virtual wealth. In October 2019, the IRS issued a new Revenue Ruling – 2019-24 that deals with virtual currencies and provides guidance on the treatment of specific events associated with cryptocurrencies.
The draft tax forms released by the IRS also have a new feature related to this. On Sch 1 of Form 1040, the draft form shows a checkbox question: “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
This is a simple checkbox question requiring a “Yes”/”No” answer. However, with this the IRS begins to track owners of cryptocurrency accounts and their wealth. It must be noted that even if a taxpayer has no other reason to attach Sch 1 to Form 1040, he must do so if he owns cryptocurrency accounts.