Dolly Parton says that when the doctor was born in the Smoky Mountains of Tennessee, she was a missionary who broke in on horseback.
It was customary for the family to pay with what they had. The Parton family paid with a sack of cornmeal.
I’m pretty sure the tax law never allowed a mileage rate for horse travel. Even so, the doctor had an income. Since he was paid with fortune, the measure of income was the value of the cornmeal.
Dolly was born in 1946. The Tax Act formalized the treatment of property for services in 1969. The 1969 Act was intended for the receipt of shares by business executives rather than cornmeal. However, the law applies equally to both types of property.
With the 1969 legislation, we know how to tax the receipt of company shares, options to receive shares, equity stakes in partnerships, and financed deferred compensation agreements. We could also cover cornmeal or livestock if needed.
Over time, “progress” involves the creation of new forms of property. A service provider can be paid in cryptocurrency today. Cryptocurrency refers to convertible virtual currencies that keep peer-to-peer, decentralized records that are protected by cryptography.
Some young people talk about cryptocurrency as if it were a currency. However, in the eyes of the federal government, and therefore the IRS, it is property.
When a service provider is paid in cryptocurrency, he or she has income. The measure of this income is the fair value of the virtual currency at the time of transmission.
Cryptocurrency can cause valuation problems that would be avoided if services were paid for in US currency. Since it is property, the payer may also have a profit or loss in transferring it to the service provider.
The beneficiary’s profit or loss is measured by the change in value between the purchase of the virtual currency and the time of transfer. This value can be difficult to determine if the transfer is being made outside of an exchange.
It can also be challenging to identify the unit of currency being transferred. The virtual currency has a unique identification unit. The payer can specifically identify what was transmitted or use an averaging convention to determine its cost.
As soon as the service provider reports income for the value of the virtual currency received, he now has a “base” in the currency. As the currency value changes, a gain or loss will be realized if it is later transferred as value.
This gain or loss will be inherently capital as the cryptocurrency is treated in a similar way to an investment. The tax complexity at the time of receipt and transfer date of the cryptocurrency is likely to surprise the service provider.
It can get worse. So far I’ve assumed that the service provider is like Dolly’s doctor – an independent contractor.
When an employee is paid with cryptocurrency, the employer must ensure compliance with federal and state labor law. The Fair Labor Standards Act requires workers who are not released to pay a minimum wage and overtime.
It is not clear how labor law compliance is measured when payment is made in a medium other than US currency. At least some state labor laws require wages to be paid in US currency.
The volatility of the exchange-traded cryptocurrency could lead workers to claim that the wage law has been violated if the value of the cryptocurrency falls shortly after being promoted. The outcome of such a lawsuit is currently unknown.
Why should a service provider want or want to be paid in cryptocurrency with all these problems? Perhaps the service provider thinks that receiving the cryptocurrency is not taxable.
If the recipient is an employee this is not likely. The employer has tax reporting obligations (Form W-2) and tax retention obligations. The employer should not be willing to consent to these obligations being circumvented.
If the recipient is a contractor, the payer may or may not be taxable. However, the recipient still has income.
Don’t assume the virtual currency is under the IRS’s radar. The IRS is very aware of the use of cryptocurrency and its detection is a high priority.
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at [email protected].