1040 Virtual Currency Confusion from Two Years Ago Is Still Confusing

Happy Valentine's Day!

Just posting a reminder today of an IRS website added two years ago on February 14, 2020 about virtual currency.  Here is the link and here is the entire text:

"The IRS recognizes that the language on our page potentially caused concern for some taxpayers. We have changed the language in order to lessen any confusion. Transacting in virtual currencies as part of a game that do not leave the game environment (virtual currencies that are not convertible) would not require a taxpayer to indicate this on their tax return."

Prior to this 2020 post, the IRS website on virtual currency stated (thanks to the Wayback Machine for the information!):

"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. Bitcoin, Ether, Roblox, and V-bucks are a few examples of a convertible virtual currency."

Today (since 2/14/20), that website reads:

"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. Bitcoin is one example of a convertible virtual currency."

I think the website post of 2/14/20 added to the confusion because convertible virtual currency per the IRS is "a digital representation of value that functions as a medium of exchange, a unit of account, and /or a store of value. They refer to "convertible virtual currency" as something that acts as a substitute for real currency.

V-Bucks and Robux are obtained with US dollars and can be converted back. They arguably act as real currency because they are needed in order to play these online games. So, why did the IRS remove them from the virtual currency website and imply that they are not virtual currency?  Not clear.

And, the 1040 instructions (page 17) on the virtual currency question* also raise issues with the 2/14/20 website because they (as well as IRS FAQ 1) states:

"Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes."

Query: How can that gaming currency not meet this broad definition of virtual currency?

I think the likelihood of tax consequences of obtaining, using and converting most gaming currency back to US dollars yields no accession to wealth (income) so has no tax consequences (the gaming currency seems to be more of a stablecoin with a set value in USD). But, that is not part of the 1040 virtual currency question. It is enough to dispose of the currency (convert it back to US dollars) that seems to warrant a "yes" answer to the question.  The instructions do state that if all a person did was acquire virtual currency, they can check "no", but disposing of it warrants a "yes."

One more observation: When the 2/14/20 virtual currency item was posted by the IRS, they already had a website of FAQs. Why wasn't that added as an FAQ? Why set it out on an isolated website where few will ever find it?

What do you think?  

*The 1040 virtual currency question for 2021 is: At anytime during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?  

Confusion Abounds - What is Virtual Currency? Issues for Your 2019 Federal Return

Likely, most people think of bitcoin, now over 10 years old, when they hear "virtual currency."  If you look at CoinMarketCap, you'll see over 2,000 cryptocurrencies listed with bitcoin at the top given its market value. Others at the top include Ethereum, Bitcoin Cash, Litecoin, and Monero.

Well, what makes something a virtual currency in the eyes of the IRS? This is even a more important question for this current tax filing season due to a new question on Form 1040 Schedule 1 - At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?

Schedule 1 is used to report other income, such as business and rental income, as well as deductions for AGI. So a lot of people file it. According to page 81 of the 1040 instructions, if the answer to the question is "no" and you don't otherwise need Schedule 1, you don't need to attach it.

This question raises a lot of questions, such as:

• What if move your VC from one wallet to another?
• What if receive VC by gift or something else with no tax consequence? Should you attach an explanation?
• What if a passthrough entity owns it? Need to ask apparently.
• What if your VC had a fork or airdrop and you didn’t know that? Per Rev. Rul. 2019-24, the IRS views that as receipt of something and arguably that is correct although you might not have income at that time or the value of what you received may be zero (but this still seems to warrant a “yes” answer).
• What if your child plays online games and there is some type of currency used in the game? Is this a virtual currency? (see more on this below and IRS activity on this question during the week of February 10, 2020)
• What if your child has unearned income subject to the kiddie tax and parent elects to report it on parent return AND child though has "yes" answer to the Schedule 1 question - must the child file return on own? I don't think so as IRS can override the statutory provision at IRC Section 1(j)(7) that parent can elect to report child unearned income on parent return if all specified requirements are met.

Additional issues:

• What happens if person doesn’t know about question such as because doesn’t otherwise need a Schedule 1?
• What if you don’t otherwise have a filing obligation but the answer would be “yes”?
• What if you are paid in VC and keep it rather than convert it or spend it? Should you attach an explanation?

If the answer is "yes" for you but there is nothing reported on the return to indicate any tax consequence because there were none, such as for someone who received virtual currency as a gift or had an airdrop even of zero value, it is likely a good idea to attach an explanation to the return. So, at that line, add "See Statement 1" and attach the explanation as Statement 1.

What about the gaming question? When the IRS issued Rev. Rul. 2019-24 on hard fork of a virtual currency and about 40 FAQs in early October 2019, it also expanded what had been a short paragraph on its website on virtual currency. With the expansion, the following paragraph was present (obtained from the Wayback Machine for 10/12/19 since removed from the IRS website around February 12, 2020):

"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. Bitcoin, Ether, Roblox, and V-bucks are a few examples of a convertible virtual currency. Virtual currencies can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies."

After the change around February 12, 2020, that paragraph now reads:

"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. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies."

Notice that the reference to the gaming currency - Roblox and V-bucks, is gone.  The IRS added an explanation in a statement added to its website (but not added as part of the FAQs or a news release, but instead added where hard to find)"

"February 14, 2020

The IRS recognizes that the language on our page potentially caused concern for some taxpayers. We have changed the language in order to lessen any confusion. Transacting in virtual currencies as part of a game that do not leave the game environment (virtual currencies that are not convertible) would not require a taxpayer to indicate this on their tax return."

That doesn't fully answer the question for all gaming currency because some of it can be sold outside of the game for dollars (and it is obtained for USD typically as well). See Geek.com post of 2/15/18 about selling Roblox for real money. What are people willing to pay for it? Does it have a fixed exchange rate or does it fluctuate?

What about certain gift cards or merchant point systems? Might they be a virtual currency?

Why doesn't the IRS clarify the definition of virtual currency and be sure it is something that is a substitute for real currency, and does not have a fixed exchange rate to USD (as most gift cards do). The IRS definition works to keep many gaming currency out (including when playing Monopoly with digital cash!), but not all.

Seems more is needed to help people with the new Schedule 1 question such as the questions I note above.

What do you think?

And, more on this later, but this same week, the GAO released another report on tax and virtual currency: Virtual Currencies: Additional Information Reporting and Clarified Guidance Could Improve Tax Compliance, GAO-20-188 (2/12/20).

And for more on virtual currency, please see tax and other information at my virtual currency/blockchain website - http://www.21stcenturytaxation.com/virtual-currency-and-tax.html.