The IRS released a technical notice this week which definitively affirmed Bitcoin’s taxability in the United States and clarified how transactions involving Bitcoin and other so-called virtual currencies should be reported by US taxpayers. Notice 2014-21 declared that bitcoins should be treated as property, not as currency, echoing guidance provided by taxing authorities in most other western countries. Other matters addressed by this notice include the following:
- Mined bitcoins are taxable as ordinary income at the time of receipt, not at the time of conversion to dollars.
- Profits from Bitcoin mining carried on as a trade or business are subject to self-employment tax.
- Bitcoins received as salary income are subject to withholding of federal income, Medicare and Social Security taxes and should be reported on Form W2.
Curiously, Notice 2014-21 mentions the possibility that bitcoins might not be a capital asset for some taxpayers, leaving open the option of inventory treatment for Bitcoin dealers, while ruling out the possibility that a miner could be a dealer. Though some users may see them as a setback, it is important to note that these provisions should not be considered punitive or unusual with respect to Bitcoin. They are comparable to the treatment of similar types of transactions in the Internal Revenue Code in which something of value other than cash is received by a taxpayer. Bitcoin prices remained essentially unchanged in response to the announcement.
The decision by the IRS comes as a mixed blessing to US Bitcoiners, ensuring that bitcoins will be treated as capital assets in the hands of most taxpayers (and granting access to lower long term capital gain rates under certain circumstances), but imposing burdensome record-keeping requirements that are likely to significantly hinder Bitcoin’s widespread adoption as a means of payment in the United States. To the extent that fungibility has driven Bitcoin’s price appreciation so far, capital asset treatment may prove to be a drag on continued growth.
Bitcoin has come a long way from the 10,000 bitcoin pizza, attracting some very welcome positive attention recently for its use in non-illegal sales of luxury cars, a villa in Bali, and tickets to space. However, it is the common and mundane transactions that could push Bitcoin into the mainstream of world economies: groceries, energy, and the proverbial cup of coffee. US taxpayers are now faced with the requirement to maintain records of basis, date purchased and date “spent” for every bitcoin that passes through their hands during the year. Under current law, each of these transactions will be considered a separate, reportable, taxable disposition that must be individually notated, much like securities transactions. That morning cup of coffee? How would you like to key it into TurboTax a couple hundred times for the year (making sure, of course, to note the exchange rate in effect at the time of purchase, along with the amount you paid for the fraction of a coin that you used to pay for the coffee)? Well, now you won’t have a choice. Outsourcing tax returns to China, anyone?
Capital asset treatment also virtually guarantees that US-based exchanges and trading platforms will eventually be required to track and report trade and basis information each year on Form 1099. Traditional securities brokers have been required to do this for financial instruments since January 1, 2013. It isn’t unreasonable to suggest that large retailers might also be forced to track and record payments in bitcoin as taxable dispositions. Don’t believe me? Check out how aggressive collection strategies such as pass-through nexus treatment for sales tax are forcing companies like Amazon to cooperate with the tax man, even in states where they have no physical presence. The resulting overhead costs are likely to put smaller exchanges totally out of business, raise transaction costs at exchanges and retailers with the resources to comply, and push barriers to entry just a little higher for anyone contemplating launching the next new Bitcoin startup.
Jason M. Tyra writes about US Federal Income Tax, regulatory and financial accounting issues that affect individuals, entrepreneurs and small businesses using Bitcoin as a means of payment and store of wealth. Jason is a Certified Public Accountant licensed to practice in the State of Texas. Opinions do not constitute tax or accounting advice. Feedback is always appreciated. You can contact Jason by e-mail at firstname.lastname@example.org.