IRS: Treat Bitcoins As Property, Not Currency

Published Date:
Apr 22, 2014

In a notice released on March 25, the Internal Revenue Service (IRS) clarified its position on digital currencies such as Bitcoin, declaring that such mediums of exchange should not be counted as currency for tax purposes, but should, instead, be treated as property.

The move comes five years after the launch of Bitcoins and just weeks after Mt. Gox, the largest Bitcoin exchange on the Internet, experienced a sudden and dramatic collapse, prompting allegations of fraud. (For a quick primer on Bitcoins and their history, see “Five facts to know about Bitcoin.)

According to the notice, CPAs dealing with the tax implications of a Bitcoin transaction should use the principles generally attributed to property transactions rather than to foreign currency exchanges. Because digital currencies are not technically a currency in the eyes of the IRS, this also means that they do not generate foreign currency losses or gains for U.S. federal tax purposes.

The new guidance is significant, in part, because it means that Bitcoins will be treated as capital assets, making gains or losses taxable, according to NYSSCPA member Edward Mendlowitz.  “As a currency you wouldn’t pay taxes, but as property you do,” he said. Scott M. Cheslowitz, a member of the NYSSCPA’s Tax Division Oversight Committee, noted that should the Bitcoin transaction result in capital gain treatment you can then offset that income with current year capital losses, or with prior year capital loss carryforwards, which, he said, has its own tax planning benefits.

As stated by the IRS, if the fair market value of property received in exchange for a virtual currency exceeds the taxpayer’s adjusted basis of that currency, the taxpayer has a taxable gain. Conversely, if the value is less than the adjusted basis, it’s a loss. If the gains or losses are ordinary, such as in the case of inventory or other property held mainly for sale for customers in a trade or business, then it would not be considered a capital asset.

In order to determine fair market value, a CPA would first check to see if the currency is listed on an exchange and if the exchange rate is established by market supply and demand; if it is, then the fair market value would be determined by converting it into U.S. dollars—or another currency that can be converted to U.S. dollars—at the exchange rate, “in a reasonable manner that is consistently applied,” according to the IRS.

Mendlowitz said that it was similar to when someone is paid in a stock that rises and lowers in price. 

“Let’s take Apple stock,” he said. “It varies 5 to 10 points a day. So, if I paid you in Apple stock, how would we value that? The IRS said it’s based on the opening and closing. Another way to do it is to check the ticker at the moment and [record that as the value].”

A broader look at the landscape

Beyond classification, the IRS guidance also explains how digital currencies fit into the overall tax regime. For example, taxpayers who receive some form of virtual currency as payment for goods or services must include it as part of their gross income and include its fair market value, measured in U.S. dollars, as of the date when that virtual currency was received.

Sometimes, though, digital currencies are not bought or sold from another individual but are instead “mined,” that is, created by computer programs in which extraordinarily difficult math calculations must be performed in order to generate new instances of the currency. When a taxpayer successfully mines digital currency, it counts as income, with the fair market value of that new currency being includable in gross income. If the taxpayer conducts his or her operations as part of a trade or business, and the activity is not undertaken as an employee, then the net earnings from this venture are subject to self-employment tax. Similarly, when an independent contractor is paid in virtual currency, it is also subject to self-employment tax.

Further, if you’re an employee paid in digital currency, it’s still subject to employment taxes as well, and must be reported on your W-2 form.

“Generally, the medium in which remuneration for services is paid is immaterial to the determination of whether the remuneration constitutes wages for employment tax purposes,” the IRS said.

Cheslowitz said he agreed with this point, and felt that the IRS made a good call on this.

“Anytime you get paid for a service, it will be considered compensation, and if you’re an outside contractor, you should be paying self-employment,” he said. “Whether it’s a Bitcoin or a broader system, you shouldn’t have separate standards.”

Similarly, regardless of whatever medium one makes a payment in, it’s still subject to information-reporting rules. Payments in digital currency should be reported using the fair market value of that currency as of the date of the payment. Payments are also subject to backup withholding, just like any other payment made in property, and so payers making reportable payments using digital currency will need to get a taxpayer identification number (TIN) from the payee.

In the event that a taxpayer acts as a third-party settlement organization—say, someone who settles payments made in digital currency on behalf of merchants who accept it—they are also required to report payments made to the merchant on a 1099-K form (Payment Card and Third Party Network Transactions) if, for the calendar year, both the number of transactions settled for the merchant exceeds 200 and the gross amount of payments made to the merchant exceeds $20,000.

The IRS closed out its guidance by reminding taxpayers that failure to comply with tax law does carry penalties. This, Cheslowitz said, is probably the prime reason why the IRS released the guidance—to tell taxpayers that, despite Bitcoin being a digital currency, it’s still subject to mainstream tax rules.

“I think this is the IRS’s way of dealing with something that’s becoming widespread,” he said. “They want to make it clear that if you receive [Bitcoins], you’ve got to pay tax on the value of what you receive, the same as if you receive cash or anything in  a barter transaction.”



Correction: April 2, 2014
In the original version of this story published on April 1, 2014, Scott M. Cheslowitz 's quote about possible tax planning benefits was misstated. It has been updated for accuracy. 

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