A new type of potential charitable gift is Virtual Currency. And, this gift could be right around the corner now that the Internal Revenue Service has specified the many tax ramifications of Virtual Currency transactions. I’ll sometimes use the word Bitcoins because it’ is the current well-known type of Virtual Currency. The Service IRS doesn’t give the tax rules for charitable gifts of Bitcoins. I’ll give you my take after reporting the IRS’s pronouncement on how existing general tax principles apply to Virtual Currency.
Notice 2014-21 (3/25/14)
Background. The IRS says that it’s aware that Virtual Currency may be used to pay for goods or services or held for investment. Virtual Currency is a digital representation of value that functions as a medium of exchange, a unit of account and/or a store of value. In some environments, it operates like "real" currency—for example, the coin and paper money of the United States, or of any other country, that’s designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance. But, Virtual Currency doesn’t have legal tender status in any jurisdiction.
A Virtual Currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as "convertible" Virtual Currency. A Bitcoin is one example of a convertible Virtual Currency. It can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros and other real or Virtual Currencies.
For a more comprehensive description of convertible Virtual Currencies to date, see Financial Crimes Enforcement Network (FinCEN) Guidance on the Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (FIN-2013-G001, 3/18/13).
Generally, the sale or exchange of convertible Virtual Currency, or the use of convertible Virtual Currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability. The IRS’s Notice on Virtual Currency addresses only the U.S. federal tax consequences of transactions in, or transactions that use, convertible Virtual Currency. No inference should be drawn, says the IRS, regarding Virtual Currencies not described in the IRS’s Notice 2014-21.
The IRS’s assumptions in what follows: Taxpayer's functional currency is the U.S. dollar; that he uses the cash receipts and disbursements method of accounting; and is not under common control with any other party to a transaction.
• Virtual Currency is treated as property for federal tax purposes. General tax principles applicable to property transactions apply to Virtual Currency transactions.
• Virtual Currency isn’t treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
• A taxpayer who receives Virtual Currency as payment for goods or services must, in computing gross income, include its fair market value, measured in U.S. dollars, as of the date that the Virtual Currency was received. See Publication 525, Taxable and Nontaxable Income, for more information on miscellaneous income from exchanges involving property or services.
• The basis of Virtual Currency that a taxpayer receives as payment for goods or services is the Virtual Currency’s fair market value in U.S. dollars as of the date of receipt. For more information on the computation of basis when property is received for goods or services, see Publication 551, Basis of Assets.
• Transactions using Virtual Currency must be reported in U.S. dollars. Thus, taxpayers will be required to determine the fair market value of Virtual Currency in U.S. dollars as of the date of payment or receipt. If a Virtual Currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the Virtual Currency is determined by converting it into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.
• If the fair market value of property received in exchange for Virtual Currency exceeds the taxpayer's adjusted basis of the Virtual Currency, he has taxable gain. He has a loss if the fair market value of the property received is less than the adjusted basis of the Virtual Currency. For more information about the tax treatment of sales and exchanges, such as whether a loss is deductible, see Publication 544, Sales and Other Dispositions of Assets.
• The character of the gain or loss generally depends on whether the Virtual Currency is a capital asset in the hands of the taxpayer. He generally realizes capital gain or loss on the sale or exchange of Virtual Currency that’ is a capital asset in his hands. For example, stocks, bonds, and other investment property are, generally, capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of Virtual Currency that is n’ot a capital asset in his hands. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that isn’t a capital asset. For more information about capital assets and the character of gain or loss, see Publication 544.
The IRS gives Bitcoins as an example of “mining” Virtual Currency. The taxpayer uses computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger. When he successfully mines Virtual Currency, its fair market value as of the date of receipt is includable in his gross income.
If a taxpayer's mining of Virtual Currency constitutes a trade or business, and the mining activity is not undertaken by him as an employee, the net earnings from self-employment (generally, gross income derived from carrying on a trade or business less allowable deductions) resulting from those activities constitute self-employment income and are subject to the self-employment tax.
Generally, self-employment income includes all gross income derived by an individual from any trade or business carried on by the individual as other than an employee. Consequently, the fair market value of Virtual Currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax.
Virtual Currency paid by an employer as remuneration for services constitute wages for employment tax purposes. Generally, the medium in which remuneration for services is paid is immaterial to the determination of whether the remuneration constitutes wages for employment tax purposes. Consequently, the fair market value of Virtual Currency paid as wages is subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2, Wage and Tax Statement
A payment made using Virtual Currency is subject to information reporting to the same extent as any other payment made in property. For example, a person who in the course of a trade or business makes a payment of fixed and determinable income using Virtual Currency with a value of $600 or more to a U.S. non-exempt recipient in a taxable year is required to report the payment to the IRS and to the payee. Examples of payments of fixed and determinable income include: rent, salaries, wages, premiums, annuities, and compensation.
Generally, a person who in the course of a trade or business makes a payment of $600 or more in a taxable year to an independent contractor for the performance of services is required to report that payment to the IRS and to the payee on Form 1099-MISC, Miscellaneous Income.
The principal author of Notice 2014-21 is Keith A. Aqui of the Office of Associate Chief Counsel (Income Tax & Accounting). For further information about income tax issues addressed in this notice, contact him at (202) 317-4718; for further information about employment tax issues addressed in this notice, contact Neil D. Shepherd at (202) 317-4774; for further information about information reporting issues addressed in this notice, contact Adrienne E. Griffin at (202) 317-6845; and for further information regarding foreign currency issues addressed in this notice, contact Raymond J. Stahl at (202) 317-6938.
The Treasury and the IRS say that there may be other questions regarding the tax consequences of Virtual Currency not addressed in this notice that warrant consideration. Thus, they request comments from the public on other types or aspects of Virtual Currency transactions that should be addressed in future guidance.
Send comments to:
Internal Revenue Service, Attn: CC:PA:LPD:PR (Notice 2014-21), Room 5203,
P.O. Box 7604, Ben Franklin Station,
Washington, D.C. 20044.
Or hand deliver, Monday through Friday between the hours of 8 A.M. and 4 P.M. to:
Courier's Desk, Internal Revenue Service, Attn: CC:PA:LPD:PR (Notice 2014-21),
1111 Constitution Avenue, N.W.,
Washington, D.C. 20224.
Alternatively, submit comments electronically via e-mail to: [email protected] Include "Notice 2014-21" in the subject line. All comments submitted by the public will be available for public inspection and copying.
NOW, CHARITABLE GIFTS OF BITCOINS — MY TAKE
Charitable Gifts by Individuals
Outright charitable gifts of appreciated Bitcoins held long term to public charities: Ffair market value contribution — deductible up to 30 percent of adjusted gross income (AGI), with a five- year carryover for any “excess.”
Outright gifts of appreciated Bitcoins held short term to public charities: Ccost-basis contribution — deductible up to 50 percent of AGI, with a five-year carryover for any “excess.”
Outright charitable gifts of appreciated Bitcoins held long or short term if the donor is the creator (the miner): This is “ordinary income” and not “capital gain” property. Thus, deductible at cost basis — up to 50 percent of AGI, with a five-year carryover for any “excess.”
Substantiation — receipt. As with all gifts of $250 or over, the donor needs a receipt acknowledging and describing the gift, together with a statement that no goods or services were given in consideration of the gift. If goods or services were given, the receipt should state the value and state that the value of the gift is reduced by the value of the goods and services.
Substantiation — appraisal. A qualified appraisal and Form 8283 are required for non-publicly traded property, such as Bitcoins, and real estate valued at over $5,000. An appraisal and Form 8283 are required for closely held stock — non-publicly traded securities — valued at over $10,000.
The definition of publicly traded securities from the Code and regulations is summarized in the instructions to Form 8283:
• Securities listed on an exchange in which quotations are published daily, e.g. for example, the New York Stock Exchange.
• Securities regularly traded in national or regional over-the-counter markets for which published quotations are available, or
• Securities that are shares of a mutual fund for which quotations are published on a daily basis in a newspaper of general circulation throughout the United States.
See generally: IRC §Section 170(e)(5); Regs. §§Sections 1.170A-13(c)(7)(ix), 1.170A-13(c)(7)(xi)(A).
And now, for my favorite type of definition: Non-publicly traded securities are
securities that are n’ot publicly traded as defined above.
Gifts by Corporations
Appreciated Bitcoins held long term: Ddeductible at fair market value up to 10 percent of the corporation’s “contribution base” (taxable income computed without regard to charitable deductions and certain losses and loss carryovers) — with a five-year carryover for any “excess.”
Appreciated Bitcoins held short term: Ddeductible at cost basis, up to 10 percent of contribution base — with a five-year carryover for any “excess.”
Appreciated Bitcoins if the corporation is a dealer (“miner” of Bitcoins).: Deductible at cost basis, up to 10 percent of contribution base — with a five-year carryover for any “excess.”
Receipt and appraisal requirements: Ssame as for individuals, above.
Who is a qualified appraiser? An individual who: (1) has earned an appraisal designation from a recognized professional appraiser’s organization or has otherwise met minimum education and experience requirements set forth in regulations to be prescribed by the Treasury;
(2) regularly performs appraisals for which the individual receives compensation; and (3) meets such other requirements as may be prescribed by the Treasury.
An individual will not be treated as a qualified appraiser unless that individual: (1) demonstrates verifiable education and experience in valuing the type of property subject to the appraisal; and (2) has n’ot been prohibited from practicing before the Internal Revenue Service by the Treasury at any time during the 3-year period ending on the date of the appraisal.
Heads up for multiple gifts of Bitcoins each valued at $5,000 or under. The appraisal rules apply when the aggregate claimed value of all “similar items of property” for which charitable deductions are claimed or reported by the donor in the same taxable year exceeds $5,000, even if the items aren’t contributed to the same charity-donee. Reg. Section §1.170A-13(c)(1)((i).
“Similar items of property” are items of the same generic category or type, including coins, lithographs, paintings, books, non-publicy traded stock, land or buildings. As a further example, stamps, books on philately, and sundry stamp-collecting supplies are similar items of property; and, thus, they require an appraisal if their aggregate claimed value exceeds $5,000. Reg. Section §1.170A-13(c)(7)(iii).
Gifts worth over $500,000. If a gift is valued at over $500,000, the donor (whether an individual, partnership, or corporation) must attach the qualified appraisal to the donor’s tax return. For purposes of the dollar thresholds, property and all similar items of property donated to one or more donees are treated as one property. Note. The $20,000 rule requiring that a copy of the appraisal be attached to the tax return still applies to artworks and other tangible personal property.
Another heads up in determining whether the $5,000 appraisal threshold is crossed: Only the part of a gift claimed as a charitable deduction counts. Thus, if real property worth $20,000 is placed in a charitable remainder unitrust, the appraisal requirements apply only if the charity’s remainder interest is worth more than $5,000, and the donor claims an income tax charitable deduction. Similarly, in determining whether the $5,000 threshold is crossed for a corporate inventory gift described in IRC Section §170(e)(3) or (4), the corporate donor’s basis in the property (“cost of goods”) doesn’t count; an appraisal is required only if the allowable appreciation element to be deducted exceeds $5,000. Reg. Section §1.170A-13(c)(1)(ii).
Charitable Remainder Unitrusts
Two Bitcoin valuation issues here: (1) the valuation needed to compute the remainder interest deduction; and (2) the valuation needed to determine the yearly unitrust payments.
Charitable Remainder Annuity Trusts
The valuation of Bitcoins at the trust’s creation is needed to determine the value of the charitable remainder interest.
For both CRUTs and CRATs, always remember: tThe 5-percent - minimum -payout requirement; the 50-percent -maximum -payout re-quirement and the 10-percent minimum remainder interest require- ment. And for CRATs, be sure to pass the 5-percent- probability test of Rev. Rul. 77-374; 1977-2 CB 329.
Charitable Gift Annuities
Valuation of Bitcoins is needed to determine the annuity payment, the values of the charitable gift portion, the exclusion ratio and any capital gains implications; it’s also required to determine whether the gift portion exceeds 10 percent of the amount transferred for the annuity.
Caution. Determine whether Bitcoins are an allowable investment under applicable state law — and how quickly the charity can dispose of the Bitcoins after the gift so as to invest the proceeds in other assets.
© Conrad Teitell 2014. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.