Our Federal income tax laws take a broad view of what counts as income and gain.
The tax law then imposes a ridged framework for classifying and computing tax on income or gain.
By casting the net wide, the tax law is able to capture just about every type of transaction that one could dream up. It also allows for tax planning to avoid or minimize taxes.
While this is a flexible way to determine income taxes, it does have its limits.
The application of our income tax laws to virtual currencies provides an example. The IRS recently issued CCM PRESP-114156-20 that addresses the income tax consequences of virtual currency received as payment for performing microtasks.
This IRS memorandum shows how our tax laws can be applied to virtual currency transactions. It also shows that a strict application of the income tax rules is highly ineffective. Compliance with the rules may not even be possible in some cases.
Income Taxes & Virtual Currency
The IRS issued Notice 2014-21 to address the Federal income tax implications for transactions involving virtual currency.
Notice 2014-21 announces the IRS’s position that virtual currency is property. It is not treated as currency.
The general rule is that virtual currency received for rendering services or for the sale of property is subject to Federal income tax. The amount of tax is computed using the standard formula for computing taxable gain or loss, i.e., the amount realized less tax basis equals taxable gain or loss.
The amount realized is the fair market value in U.S. dollars as of the date the virtual currency is received.
The adjusted basis follows the normal tax basis rules. The IRS describes these rules in Rev. Rul. 2019-24:
Section 1011 of the Code provides that a taxpayer’s adjusted basis for
determining the gain or loss from the sale or exchange of property is the cost or other
basis determined under § 1012 of the Code, adjusted to the extent provided under
§ 1016 of the Code. When a taxpayer receives property that is not purchased, unless
otherwise provided in the Code, the taxpayer’s basis in the property received is
determined by reference to the amount included in gross income, which is the fair
market value of the property when the property is received. See generally §§ 61 and
1011; see also § 1.61-2(d)(2)(i).
These rules provide the background needed to consider the IRS’s current question about virtual currency received for performing microtasks.
Income Tax for Microtasks
The IRS memorandum describes microtaks as:
Certain crowdsourcing platforms specifically facilitate the practice of microtasking, which may involve subdividing larger tasks into smaller tasks and distributing the tasks via online crowdwork platforms. In general, microtasks are simple, menial activities that still require some degree of human interaction beyond the current ability of artificial
Certain microtasking platforms allow those who perform microtasks to receive payments in consideration for completing each microtask in the form of convertible virtual currency. For example, a firm may offer to pay workers in units of Bitcoin or other convertible virtual currency if the worker processes data or reviews images. Other
examples include an offer of convertible virtual currency in exchange for downloading a
particular app from an app store and leaving a positive review including a comment,
downloading games and reaching certain milestones, completing online quizzes and
surveys, or registering accounts with various online services. These types of
microtasks may provide individuals with “rewards” in the form of convertible virtual
These examples suggest that the recipient of the virtual currency is performing a service in exchange for the virtual currency.
Given the rules noted above, the IRS memo concludes that the person who receives virtual currency for performing a microtask recognizes income equal to the fair market value of the virtual currency received. The person pays Federal income tax on this amount. This amount is the tax basis in the virtual currency received.
The person will have a taxable gain if they hold the virtual currency and sell it for a higher amount at a later date. They will have a tax loss if they sell it for less than their tax basis.
The IRS Memo also notes that the gain may also be subject to self-employment tax.
The IRS Memo does not break new ground. The holding is to be expected. Nevertheless, the implication of the IRS’s holding is problematic.
Taxpayers may not be able to easily compute their gain or loss for microtasks. The value of the payments may be too small to warrant extensive tracking by the recipient. In other cases, the transaction volume and access to information may be problematic.
This means that the recipient may not be able to accurately track their tax basis in the virtual currency received. If this is the case, the taxpayer may end up paying tax on the virtual currency twice–once when it is received and, absent any tax basis information, again when it is sold.
Even the crowdsourcing platforms may not be in a position to accurately value the virtual currency paid for microtasks. Depending on the platforms at issue, they may not even be able to track the transactions. This raises serious compliance questions for taxpayers. These platforms will need to help taxpayers and ultimately the IRS identify and track this information. They may also need to report this information to the IRS via one of the IRS’s information reporting forms.
The holding in the IRS Memo also raises serious questions about how the IRS can enforce compliance. Many transactions will not be reported to the IRS–by the recipients or by the crowdsourcing platforms.
As far as compliance goes, it should be noted that the IRS Memo was answering the question for the IRS SB/SE national fraud counsel. It would not be surprising to see additional guidance or audit initiatives from the IRS SB/SE function for microtask payments.
Those who receive virtual currency for microtaks and those who operate crowdfunding platforms should take the time to examine this issue prior to the IRS showing up for an audit.