In the wake of the Bitcoin craze, the IRS has released some clarifications for its rules surrounding virtual currencies. If you are someone that engages in Bitcoin “mining” or any other form of virtual currency trading, it is important to understand how the federal government views your transactions from a tax standpoint.

Virtual Currencies NOT the Same as Foreign Currencies: Perhaps the biggest takeaway from the IRS update on virtual currency rules is their determination that Bitcoin and other similar currencies are not treated the same as a foreign currency. If they had been, the gains made from trading the currency would have been subject to a much more complicated tax regime. Instead, the buying and selling of virtual currencies are treated as a property that is subject to a capital gain or loss, depending on which side of the spectrum you end up.

For 2013, the capital gains tax rate has been 15% for individuals earning between $36,250 and $400,000, and 20% for individuals earning above $400,000. It should also be noted that an additional 3.8% investment tax for Medicare has been added for individuals earning above $200,000 and married couples earning above $250,000.

Payments Made in Virtual Currencies Subject to Gains and Losses: Bitcoin is being used in greater frequency to pay directly for goods and services of all kinds. However, paying for something in virtual currency does not exempt you from your tax responsibility. For example, if you purchased $1000 in Bitcoin, the value appreciated to $2000 and you used the $2000 in Bitcoin to book an international flight on cheapair.com, you would be subject to capital gains on your $1000 profit.

This could become an accounting nightmare for those in the habit of buying smaller items with Bitcoin, such as Subway sandwiches or haircuts because you must keep track of the value of your virtual currency at the time of each purchase and how much of a capital gain you realized on each transaction.

Money Received in Virtual Currency Must Be Reported as Income: This one is pretty straightforward; if you receive a payment in a virtual currency, the market value of the currency at the time you received it must be reported as income. Also, if an employer pays an employee virtual currency in lieu of wages, this is subject to income tax withholding. Additionally, virtual currency payments to subcontractors exceeding $600 are subject to 1099 regulations.

Virtual Currency Traders May Be Subject to Self-Employment Taxes: If you make a living buying and selling Bitcoin, the IRS may consider your Bitcoin mining activities a trade or business. This means that you would be responsible for self-employment taxes such as Social Security, Medicare, etc.

If you are engaged in Bitcoin or any other type of virtual currency trading, it is important that you stay in compliance with IRS regulations. Talk with a professional accountant about your personal situation to determine what virtually currency taxes (if any) you may be responsible for.