So, the IRS has issued a new FAQ on bitcoin. This FAQ lays out what the IRS believes to be “how existing general tax principles apply to transactions using virtual currency.” I disagree, but I’m not the IRS. And I think, if you want to be on the safe side, then you should not mess with the IRS.
Here’s my summary of the IRS’s newly minted FAQ (click here for a pdf version of Notice 2014-21: n-14-21.pdf)
The FAQ indicates anyone who deals in bitcoin must carefully track the value of the bitcoin during every transaction involving bitcoin. For example, if your business accepts bitcoin as payment, it is ordinary income for your business in the amount of the USD FMV of the bitcoin at the “date the virtual currency was received.” (Q/A-3). Then you acquire a basis in the bitcoin equal to that same amount.(Q/A-4). If you are using bitcoin to buy something, then you have a taxable event every time you spend bitcoin (Q/A-6). However, your losses might not be deductible. Bitcoin Miners experience a taxable event every time a bitcoin is found is the blockchain (Q/A-8). In addition, Miners might be subject to Self-Employment tax on their bitcoin (Q/A-9). Independent Contractors who are paid in bitcoin are subject to self-employment tax – based on the value of the bitcoin when received. (Q/A-10) Employees who are paid in bitcoin experience several taxable events if they try to use bitcoin as currency (Q/A-11).
What is bitcoin? well, according to the IRS, a bitcoin is “property” but the type of property the bitcoin is depends on why you are holding it. So, basically, bitcoin is kind of like a painting, kind of like gold, kind of like a plot of land, even inventory but it is definitely not currency for tax purposes. (Q/A-7).
What compliance burdens exist? Taxpayers who use bitcoin must issue 1099s in certain scenarios (Q/A-12, Q/A-13, Q/A-15)
Where? The United States.
So who pays higher taxes on bitcoin transactions?
Because of the classification of bitcoin as property, people who actually try to use bitcoin as a currency will face the most disruption, both from a record-keeping and tax-liability perspective. That is because any bitcoin that is being used as a barter conduit is probably not a capital assets in the hands of that taxpayer (Q/A-7) which means that any gain from using bitcoin as a currency would be taxed as an ordinary gain or loss instead of a capital gain or loss.