IRS Provides Guidance on Tax Treatment of Bitcoin

Its status has been up in the air for some time now, but today the IRS provided guidance on the tax treatment of online currency such as Bitcoin.  The official position is that virtual currency is not to be treated as legal-tender currency, but should be treated as property instead.  Bitcoins, therefore, should be reported and taxed as ordinary income, or as assets subject to capital gains, as the case may be.

[V]irtual currency is treated as property for U.S. federal tax purposes.  General tax principles that apply to property transactions apply to transactions using virtual currency.

Therefore, in real world applications, employees who are paid in virtual currency must pay taxes on that income just as they would pay taxes on dollars.  And an employer would have to withhold taxes, report these wages on a W-2, and comply with payroll tax laws.  And, of course, a 1099 is required for the self-employed who are paid in Bitcoin.

Perhaps of greater concern to some Bitcoin users around the world is the impact this IRS notice will have on “miners” (computer geeks who compete to unlock new Bitcoin by cracking codes).  If they want to be 100% legit, they will have to go back and determine how much Bitcoin they mined throughout the year, its fair market value on the date it was mined, and include it in their income.

Are Bitcoin Transactions Taxable?

In an IRS audit today I was amused by all the preliminary questions about income sources.  The auditor asked about wage income, 1099 income, interest, dividends, royalties, alimony, child support, law suit settlements & awards, reimbursements, gifts, inheritances, grants, scholarships, life insurance proceeds, tips, etc., etc.  But the one thing she failed to ask about was digital currencies, like Bitcoin.  And I don’t mention this because I think the auditor missed something or that the client failed to report all his income.  He probably wouldn’t even know what Bitcoin is.  I mention this to illustrate the fact that the IRS has been slow to recognize digital currencies as income and/or supply guidance as to the specific reporting requirements.  But they’re going to have to act on this soon because it is becoming more prevalent:

In the four months between July and December 2013, bitcoin usage has increased by over 75 percent — from about 1,700 transactions per hour to over 3,000.  Over the same period, the market value of bitcoins in circulation increased more than ten-fold from about $1.1 billion to $12.6 billion.  Over 10,000 businesses reportedly accept payment in bitcoin.

~ TAS 2013 Annual Report to Congress

The only guidance (if you can call it that) from the IRS is found on a single web page on entitled “Tax Consequences of Virtual World Transactions.”  The IRS essentially likens virtual currency to bartering, gambling, and hobby income:

The IRS has provided guidance on the tax treatment of bartering, gambling, business and hobby income – issues that are similar to activities in online gaming worlds.

It’s clearly not the same thing.  Legitimate law abiding geeky businesses (and individual geeks) deserve some more guidance from the IRS on this issue.