Law Office of Charles W. Cope, PLLC | GAO Recommends IRS Issue Guidance on Taxation of Virtual Currencies
This links to the home page
Tax Insights Blog
  • GAO Recommends IRS Issue Guidance on Taxation of Virtual Currencies
    May 2013
    In May 2013, the U.S. Government Accountability Office (the “GAO”) issued a report to the Senate Finance Committee (the “Report”) recommending that the IRS provided additional guidance on the tax issues raised by virtual economies and currencies.[1] The Report was released to the public in June 2013, after the IRS was given the opportunity to review the Report and respond to its findings. As discussed below, the Report is significant because it focuses attention on the growth of virtual economies and virtual currencies and tax issues raised by each.
    The Report notes that there is no legal definition of "virtual economy" or "virtual currency." The Report defines a virtual economy as economic activities among a community of entities that interact within a virtual setting, such as an online, multi-user game. Second Life™ is an example of a virtual economy
    A virtual currency is defined as a digital unit of exchange that is not backed by government-issued legal tender. Examples of virtual currencies include Linden dollars, used in Second Life™, and the decentralized digital currency, bitcoin.[2]
    The Report draws a distinction between three types of virtual currency systems: (i) closed-flow systems, in which a virtual currency can be used to purchase only virtual goods or services; (ii). hybrid systems, in which the virtual currency can be used to purchase real goods or services; and (iii) open-flow systems, in which the virtual currency can be used to purchase both real and virtual goods or services and the virtual currency is freely exchangeable with U.S. dollars.
    The Report states that, due to data limitations, the size of the virtual economy and currency markets is not readily measurable. The Report does note, however, that as of May 1, 2013 approximately 11 million bitcoins were in circulation. During April 2013 the price of a bitcoin ranged between approximately $79 and $237.
    Virtual currencies also have drawn the attention of federal law enforcement authorities because transactions in some virtual currencies, e.g. bitcoins, can be conducted anonymously. In March 2103, the Financial Crimes Enforcement Network (“FinCEN”) issued guidance describing how FinCEN’s regulations apply to transactions in virtual currencies.[3]
    Uncertainty Concerning Taxation of Transactions in Virtual Currencies
    The Report identifies various transactions that may be taxable under the Internal Revenue Code:
    • A US taxpayer creates virtual tools as part of an online game that he then sells to another player in exchange for U.S. dollars on a third-party exchange.
    • A US taxpayer successfully “mines” bitcoins during the year.
    • A US taxpayer sells merchandise online in exchange for bitcoins during the year.
    The Report then identifies various tax compliance risks. The first risk is that taxpayers generally are ignorant of the broad definition of income in US tax law and fail to self- report the proper amount of income. Taxpayers may be uncertain as to how to characterize income from virtual transactions. They also may be unable to calculate gain realized on such transactions and third parties may not be reporting such transactions as required by US law.
    The Report notes that beginning in 2007 the IRS's Electronic Business and Emerging Issues policy group determined that "virtual economies presented opportunities for income underreporting and developed (1) a potential compliance strategy, including initiating a compliance improvement project to gather research data and analyze compliance trends, and (2) a potential action plan for specific compliance activities."  Due to resource constraints and other priorities the IRS did not implement this action plan.
    In November 2009 the IRS posted some information on its website on the tax consequences of transactions in virtual economies. The Report notes that the IRS has not assessed tax risks raised by open-flow virtual currencies used outside of virtual economies. The IRS also has not issued guidance concerning the use of virtual currencies outside of virtual economies due to "competing priorities and resource constraints." The Report observes that "given the uncertain extent of noncompliance related to virtual currency transactions, formal guidance, such as regulations, revenue rulings, or revenue notices, may not be warranted at this time."
    The IRS’s Response
    In a letter to the GAO responding to the Report, Steven T Miller, Deputy IRS Commissioner for Services and Enforcement, states that the IRS is aware of “the potential tax compliance risks posed by offshore and anonymous electronic payment systems." According to the letter, the IRS is taking various actions including holding discussions with other federal agencies, evaluating field agent's expertise, developing a training curriculum for field agents and creating materials for agents to use during examination of taxpayers. The letter also states that "We will provide information to taxpayers on the basic tax reporting requirements for transactions involving virtual currencies by linking to existing relevant guidance."
    [1] VIRTUAL ECONOMIES AND CURRENCIES: Additional IRS Guidance Could Reduce Tax Compliance Risk, GAO-13-516 (May 2013).
    [2] See Bitcoin: A Peer-to-Peer Electronic Cash System. Available at
    [3] FIN-2013-G001. Available at:
    KEYWORD: Currency