March 28, 2014

On Tuesday, March 25, 2014, the IRS announced its long-awaited position on bitcoin, this after years of ambiguity on how it wanted to treat profits and losses garnered from using the coins.  The changes might mean relief for some users, but headaches for others.

“The notice provides that virtual currency is treated as property for U.S. federal tax purposes,” said guidelines posted on IRS.gov this week.

Wait. Didn’t the IRS tax bitcoin already?

Traditionally, consumers who had used bitcoin weren’t clear on how to report profits or losses earned as the result of using the digital currency. As per Notice 2014-21 issued by the IRS on Tuesday, consumers and merchants have been given clarity.  Income such as wages, as well as any gains earned by the trading of the currency, and any profits gained from the selling of goods should be reported as capital gains. However, that should be nothing new according to one user we spoke to on Thursday.

“Bitcoin has always been taxable,” said Adam Gering, a bitcoin expert. “The receipt or exchange of anything of value is taxed, regardless of what the medium of exchange is.”

Consumers frequently use the currency to purchase goods. Anything from a Subway sandwich to a vacation rental in Florida can be paid for with the virtual coins.

“Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099,” said the IRS bulletin.

But perhaps the most important aspect of the IRS guidelines is the clarification that bitcoin will be considered a property and not a currency. Had it be declared a currency, it would have been subject to higher taxation. Now, the coins are to be treated like stocks.

“For example,” said Gering, “Section 988 would have treated gains and losses on bitcoin (as a foreign currency) as ordinary income and losses; unless a special election was made under Section 1256 to treat it as a capital gain or loss.

Under Section 1256, foreign currency gains and losses are subject to special 60/40 tax treatment: 60% of the gain/loss is eligible for long-term capital gains tax rates, and the remaining 40% is always taxed as a short-term capital gain.

Neither of these complicated tax sections and elections now apply to bitcoin.”

According to Gering, this means investing in bitcoin might now be more attractive to some users.

“It makes dealing with bitcoin and complying with U.S. tax law now unambiguous and less risky,” said Gering. “This guidance was necessary for the bitcoin economy in the U.S.”

In layman’s terms, the new ruling might mean better clarity, but it will require consumers to track and then report capital gains.

“The good news for investors of bitcoin is that long-term capital gains tax rates are available for bitcoin held longer than a year,” said Gering, “and bitcoin losses can be deducted against other investment gains.”

Even so, it should mean business as usual for most merchants, at least according to one tax professional we spoke to this week.

“In my experience,” said Jerry Kohler of Accounting Principles in Cottonwood, Calif., “I have found that until the IRS requires suppliers of investment products to issue IRS Form 1099-B to those individuals who invest in their products, only losses will be reported on Schedule D of a tax return. At this point in time is seems that most users of “Bitcoin” are individuals who will report tax gains only if forced. Otherwise reporting gains is voluntary.”

Bottom line, no changes for most users yet,” says Kohler.

Find a copy of the IRS guidelines here.

Photo: Jason Benjamin