Bitcoin Enthusiasts Prepare to Pay Taxes as IRS Addresses Virtual Currency by Rick Bazzani

 

Posted on April 03, 2014 by Rick Bazzani

 On March 24, the IRS effectively took bitcoin out of the shadows and announced that it will treat the computer-generated currency as property for U.S. tax purposes. While many currently consider and use bitcoin as a currency, whether to purchase products and services or exchange them for legitimate forms of money, the IRS points out that it will not consider such convertible virtual currency to have any legal tender status in any jurisdiction. As a result, bitcoin users will need to consider and understand the tax implications associated with their use of the digital currency or risk penalties for failure to comply with the applicable tax and reporting requirements.

Investing in Bitcoin

As a property, bitcoin is subject to capital gains tax in the same manner that the IRS taxes gains on property transactions involving stocks and other investments. When users buy and sell bitcoin on an exchange and realize a profit, they will have to pay taxes on the capital gain. The holding period of the virtual currency will dictate whether this is short- or long-term gain. Likewise, when users sell bitcoin for less than the acquisition cost (determined by the exchange rate in U.S. dollars on the date of purchase), they may deduct the resulting capital loss.

Mining Bitcoin as a Trade or Business

The IRS considers “mining” bitcoins (by solving complex algorithms to unlock new coins) as a trade or business for which users must include in their taxable gross income the fair market value of the digital currency on the date of receipt. Moreover, individuals in the business of “mining” must recognize that income earned from this trade is subject to self-employment tax.

Buying and Selling Goods or Services with Bitcoin

Businesses, such as retailers Overstock.com and TigerDirect.com, that accept bitcoin as payment for the sale of goods or services must recognize as income the fair market value of the digital currency they receive, at the exchange rate to the U.S. dollar at the time of receipt.

Shoppers using bitcoin to purchase goods or services must calculate the gain or loss on the bitcoin based on the fair market value of the goods and services purchased against the adjusted basis of the bitcoin used in the transaction.

Tax-Reporting Considerations for Businesses Using Bitcoin

Self-employed individuals and/or independent contractors who receive bitcoin as income must include this income in the calculation of self-employment tax. Moreover, individuals who pay independent contractors using bitcoin must take into consideration the use of digital currency when determining whether they must issue and report to the IRS a 1099-MISC. More specifically, these individuals must add the value of the bitcoin payment to the cash or other payments they make in return for services to determine if they meet the threshold required to file the 1099-MISC.

Similarly, businesses and individuals that use virtual currency for all or partial payment of salaries and wages, interest, rents and other similar items must report such payments on Form W-2, Form 1099-INT, Form 1099-MISC, respectively.

About the Author: Rick D. Bazzani, CPA, is a senior manager in Berkowitz Pollack Brant’s Tax Services practice. For more information, call 305-379-7000 or email info@bpbcpa.com.