IRS Notice 2014-7: Tax Treatment of Virtual Currency
Understand the foundational U.S. tax framework for virtual currency as outlined in IRS Notice 2014-7, from initial receipt to final transaction reporting.
The Internal Revenue Service released Notice 2014-21, its first formal guidance on the federal tax implications of digital assets. This notice, along with subsequent rulings, provides a framework for how established tax principles apply to this asset class. Since 2014, the IRS has issued additional guidance, including rulings that address hard forks, airdrops, and staking rewards. The term “digital assets” is now used for tax reporting and encompasses virtual currencies, cryptocurrencies, and other digital representations of value.
The Core Principle: Digital Assets as Property
Notice 2014-21 establishes that for federal tax purposes, digital assets are treated as property, not as currency. This classification means that general tax rules governing property transactions apply. Actions like selling property for a gain or exchanging one property for another have direct parallels in the digital asset space.
A direct consequence of this is the need to determine the fair market value (FMV) of the digital asset in U.S. dollars for every transaction. The FMV is calculated on the date the asset is received or used. Taxpayers must identify a consistent method for this valuation, such as referencing the value listed on a prominent cryptocurrency exchange.
This valuation is the basis for calculating income and gains. When a digital asset is received as a payment or earned, its FMV at that moment constitutes the income amount. When it is later sold or exchanged, this initial value becomes the basis for determining any subsequent capital gain or loss.
Tax Consequences of Acquiring Digital Assets
The method of acquiring digital assets impacts the immediate tax consequences. When an employee receives digital assets as payment for services, it is considered wages. The amount of income is the fair market value of the asset in U.S. dollars on the date it is received, and these wages are subject to federal income tax withholding and FICA taxes.
For independent contractors, receiving digital assets for goods or services constitutes self-employment income, measured by the FMV of the asset on the day it was received. This income is subject to self-employment tax.
A taxpayer who mines a digital asset realizes gross income equal to its fair market value on the date of mining. Income is also realized from staking rewards when the taxpayer gains control over the rewards. Other taxable acquisitions can include receiving digital assets from a hard fork or an airdrop.
Tax Consequences of Disposing of Digital Assets
When a taxpayer sells, exchanges, or otherwise disposes of a digital asset, a taxable event is triggered, resulting in a potential capital gain or loss. This is calculated by subtracting the taxpayer’s adjusted basis—generally the asset’s fair market value at the time of acquisition—from the proceeds of the disposition.
The character of the gain or loss depends on how long the taxpayer held the digital asset. If held for one year or less, the gain or loss is short-term. If held for more than one year, it is long-term, which often qualifies for more favorable tax rates.
Using digital assets to pay for goods or services is a disposition and is treated as an exchange of property. The taxpayer must recognize any gain or loss that has occurred from the time they acquired the asset to the moment they used it for a purchase.
Required Information Reporting
The IRS has increased its focus on compliance, and the main Form 1040 includes a question asking all taxpayers whether they have engaged in transactions involving digital assets during the year. Taxpayers must report all income and gains from these transactions.
Payers who transfer digital assets to independent contractors for services must issue a Form 1099-NEC. Employers paying wages in digital assets must report the value on the employee’s Form W-2.
When a taxpayer disposes of a digital asset held as a capital asset, the transaction details must be reported on Form 8949, Sales and Other Dispositions of Capital Assets. The totals are then summarized on Schedule D (Capital Gains and Losses) and filed with the Form 1040.
Recent legislation has expanded information reporting requirements for brokers dealing in digital assets. While the effective date for these rules has been delayed, they will eventually require brokers to issue reporting forms detailing customer transactions, similar to current reporting for stocks and bonds.