Bitcoin: What are the U.S. Tax Implications?

May 26th, 2015 | Posted by Sarah Jones in Guest Blogs - (Comments Off)

Although many critics are already considering Bitcoin irrelevant or even dead, technology behind Bitcoin is here to stay. This week on NVTC’s blog, John Calanog of member company CohnReznick LLP discusses the basic U.S. tax implications of using the Bitcoin currency.


In my first blog on the subject, I described Bitcoin and its increasing popularity as an alternative currency.  As the digital currency is becoming more and more prevalent in the marketplace, and for those already exchanging Bitcoins, the following article discusses the basic U.S. tax implications of using the currency. Although there may also be Foreign Bank and Financial Accounts (“FBAR”) and Foreign Account Tax Compliance Act (“FATCA”) compliance requirements, that is not covered in this blog.

What is the U.S. Taxation?

On March 25, 2014, the IRS released guidance in Notice 2014-21 explaining that Bitcoin would be treated as “property” and not as “currency” for federal income tax purposes.  From a practical standpoint, this means that gains and losses on the disposition of Bitcoin will not be treated as “exchange gain or loss” and will not be ordinary in character.  This is bad news for investors who hold depreciated Bitcoin and were hoping to take exchange losses as ordinary losses. However, it is good news for investors who hold appreciated Bitcoin and prefer capital gains treatment.

For those holding Bitcoin for sale in a trade or business (i.e., for “miners”  [1] and “dealers”), income resulting from the sale of such Bitcoin may be taxed as ordinary income.  However, for most investors who merely “trade” in Bitcoin, gains or losses will likely be capital and not ordinary.

From a tax compliance standpoint, the taxpayer has the burden of keeping a record of their tax basis in the Bitcoin and determining the fair market value of the Bitcoin at the time they seek to sell or otherwise dispose of it.  Fortunately, most exchanges and e-wallets have been implementing tools that enable customers to receive the needed documentation.  Still, users without any obtainable records should seek professional tax advice as they are likely going to need to estimate their tax liability from the records they do have on file.

Virtual Currency as Net Earnings from Self-Employment

A taxpayer who receives virtual currency, such as Bitcoin, as payment for services has gross income equal to the fair market value (“FMV”) of the currency, in U.S. dollars, as of the date of receipt.

Moreover, an independent contractor who receives virtual currency for performing services has self-employment income.  The amount of the income is the FMV of the currency, in U.S. dollars, as of the date of receipt.

If a taxpayer’s “mining” of virtual currency is a trade or business and is not undertaken as an employee, the net earnings from self-employment from that activity is treated as self-employment income.

Additional Tax Considerations

There may also be filing FinCEN Form 114, Report of Foreign Bank and Financial Accounts, (FBAR) or Foreign Account Tax Compliance Act (FATCA) reporting requirements.  However, that is beyond the scope of this blog.

Conclusion

Bitcoin has only been around for six years (since 2009) and many critics are already considering it irrelevant or even dead.  However, such pessimism is missing the point.  The technology behind Bitcoin is here to stay.  And that technology is likely to become more significant as developers create new and improved versions.

With the IRS issuing a Notice to give guidance for the tax treatment of this means of exchange suggests that Bitcoin is a real and lasting phenomenon. Technology companies and others using the Internet will need to deal with it in the future.  Our monetary system was not originally designed for the internet or for globalized trading.  This is where Bitcoin comes in – as a truly globalized currency.

_________________________________________________________________________________

The content of this article is intended to provide a general commentary on the subject.  Please seek the advice of a tax professional regarding your specific circumstances.

John Calanog, CPA, is a Tax Manager with CohnReznick LLP and is a member of the Firm’s Technology Industry Practice.  John’s experiences over the last fifteen years include U.S. tax compliance and consulting for C Corporations, S Corporations, Partnerships, and high net worth individuals who operate businesses in a wide variety of industries and taxing jurisdictions.  Contact John at john.calanog@cohnreznick.com. Follow CohnReznick’s Technology Practice on Twitter via @CR_TechInd


[1]Mining is the verification process of running mathematical operations on digital data in order to validate transactions and provide the requisite security for the public ledger of the Bitcoin network. The speed at which you mine is measured in hashes per second.

The Bitcoin network compensates “miners” for their effort by releasing Bitcoin to those who contribute the needed computational power. This comes in the form of both newly issued coin and from the transaction fees included in the transactions they validate when mining. The more computing power that is contributed, the greater their share of the reward.

Share and Enjoy

  • Facebook
  • Twitter
  • Delicious
  • LinkedIn
  • StumbleUpon
  • Add to favorites
  • Email
  • RSS