Currency is money in any form when in use or circulation as a medium of exchange. When a currency is legally rec- ognized by a government to be valid for meeting a financial obligation, it is called legal tender. Coins and banknotes are usually defined as legal tender in most countries. Legal tender is backed by a central government, and the govern- ment controls the supply.

Virtual currency is not legal tender and it is not backed by a central government or bank. It is decentralized and is glob- al. It is a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the U.S. dollar or a foreign currency. Cryptocurrency is a type of virtual currency that utilizes cryptography to secure transactions that are digi- tally recorded on a distributed ledger, such as a blockchain. Units of cryptocurrency are generally referred to as coins or tokens.

Fair Market Value (FMV)
For federal income tax purposes, transactions using virtu- al currency must be reported in U.S. dollars.You will be re- quired to determine the FMV as of the date of payment or receipt of the virtual currency.

Virtual Currency Income Received
Barter income. When you barter with someone you are exchanging one good or service for another without the payment of money. Barter exchanges are common in vir- tual currency exchanges. The FMV of virtual currency re- ceived in a barter exchange is subject to income tax as if it was U.S. dollars. When virtual currency is received in the course of a trade or business, the FMV of the virtual cur- rency must be included in business income in the year of receipt and is subject to self-employment tax.

Example: Jill has a cleaning business and cleans George’s house for a year in exchange for one bitcoin. The FMV of the bitcoin when received is $15,000. Jill recognizes $15,000 as business in- come on her tax return even though she did not receive any U.S. dollars.
Employees. The FMV of virtual currency paid as wages is subject to federal income tax withholding, FICA tax, and unemployment taxes. It also must be reported on Form W-2, Wage and Tax Statement.

Virtual Currency Used to Purchase Goods or Services
For federal income tax purposes, the main difference be- tween using virtual currency to purchase goods or services versus the U.S. dollar is that virtual currency is treated as property. The tax basis of the U.S. dollar is its face value. When a product or service is purchased using the U.S. dol- lar, there is no gain or loss on the exchange of that U.S. dol- lar for the product or service. In contrast, the tax basis of virtual currency is the cost to acquire it. When a product or service is purchased using virtual currency, gain or loss is the difference between the fair market value of the product or service and the cost basis in the virtual currency that is exchanged for that product or service.

Example #1: Brad uses two U.S. dollars to purchase a cup of coffee. Since Brad’s tax basis in those two U.S. dollars is their face value ($2), and the fair market value of the cup of coffee is $2, there is no gain or loss on the transaction.

Example #2: Brad uses virtual currency to purchase a cup of coffee that is worth $2. Brad had previously acquired the virtual currency at an ATM machine by exchanging one U.S. dollar for the virtual currency. Brad has a $1 taxable gain on the purchase of the coffee, the difference between the fair market value of the coffee ($2) and the tax basis in the virtual currency ($1).

Mining Virtual Currency

For example, you do not have dominion and control if the address to which the cryptocurrency is airdropped is con- tained in a wallet managed through a virtual currency ex- change which does not support the newly-created virtual currency such that the airdropped virtual currency is not immediately credited to your account. If you later acquire

Miners. Mining is a process through which blockchain transactions are verified and accepted by adding such transactions to a blockchain ledger. Miners use comput- ers to solve mathematical equations that are part of the en- cryption process. The first miner who solves the transaction and validates it receives a digital token of virtual currency as a reward.

Gross income is realized upon the receipt of the digital to- ken. The FMV of the virtual currency as of the date of re- ceipt is includible in gross income. If you are in the trade of business of mining, the gross income is net earnings from self-employment and subject to self-employment tax.

Hard fork. A hard fork occurs when a virtual currency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing dis- tributed ledger. A hard fork may result in the creation of a new virtual currency on a new distributed ledger in addi- tion to the legacy virtual currency on the legacy distribut- ed ledger. Following a hard fork, transactions involving the new virtual currency are recorded on the new distributed ledger and transactions involving the legacy virtual curren- cy continue to be recorded on the legacy distributed ledger.

Airdrop. An airdrop is a means of distributing units of a virtual currency to the distributed ledger addresses of mul- tiple taxpayers. A hard fork followed by an airdrop results in the distribution of units of the new virtual currency to addresses containing the legacy virtual currency. However, a hard fork is not always followed by an airdrop.

Constructive receipt. You generally have constructive re- ceipt of virtual currency from an airdrop on the date and at the time it is recorded on the distributed ledger. However, you may constructively receive virtual currency prior to the airdrop being recorded on the distributed ledger if you are able to exercise dominion and control over the virtual cur- rency. Likewise, you do not have receipt of virtual curren- cy when the airdrop is recorded on the distributed ledger if you are not able to exercise dominion and control over it the ability to transfer, sell, exchange, or otherwise dispose of the virtual currency, you have constructive receipt at that time.

Tax Reporting for Virtual Currency Purchases and Exchanges
If you purchase or exchange virtual currency, it is treated as the sale or exchange of property. If held as a capital asset and disposed of, a transaction involving virtual currency is reported on Form 8949, Sales and Other Dispositions of Cap- ital Assets, and Schedule D (Form 1040), Capital Gains and Losses. There is a box to check on Form 1040 if you engaged in any transaction involving virtual currency during the tax year, even if it was not disposed of.
To report transactions involving virtual currency, your tax preparer will need information from you including the date acquired, date sold/exchanged, purchase price, sales price, number of units exchanged, and a description of the property.