The IRS Takes A Position On Bitcoin

Bitcoin used to be something like Schrodinger’s currency. With no regulatory observers, it could claim to be money and property at the same time.

At this point the Internal Revenue Service has opened up the box, and the virtual currency’s problem is established – at least for federal tax purposes.

The IRS lately issued guidance on how it will treat bitcoin, and any other stateless electronic competitor. The short answer: as property, not currency. Bitcoin, as well as other virtual currencies that can be exchanged to get legal tender, will now be taken care of in most cases as a capital asset, and a few situations as inventory. Bitcoin holders who are not dealers is going to be subject to capital gains tax upon increases in value. Bitcoin “miners, ” who unlock the currency’s algorithms, will need to report their finds as income, just as other miners do when extracting more traditional resources.

Though this decision is improbable to cause much turbulence, it is worth noting. Now that the INTERNAL REVENUE SERVICE has made a call, investors plus bitcoin enthusiasts can move forward having a more accurate understanding of what they are (virtually) holding. A bitcoin holder who wants to conform to the tax law, rather than avoid it, now knows how to do this.

I think the IRS is right in determining that bitcoin is not really money. Bitcoin, and other virtual foreign currencies like it, is too unstable in worth for it to realistically be known as a form of currency. In this era associated with floating exchange rates, it’s real that the value of nearly all currencies modifications from week to week or even year to year relative to any particular standard, whether it’s the dollar or a barrel or clip of oil. But a key feature of money is to serve as a store of value. The worth of the cash itself should not change drastically from day to day or hour to hour.

Bitcoin utterly fails this test. Purchasing a bitcoin is a speculative investment. It is far from a place to park your idle, spendable cash. Further, to my knowledge, no mainstream financial institution will pay curiosity on bitcoin deposits in the form of more bitcoins.
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Any return on a bitcoin holding comes solely from a change in the bitcoin’s value.

Whether the IRS’ decision will help or hurt present bitcoin holders depends on why they will wanted bitcoins in the first place. For those hoping to profit directly from bitcoin’s fluctuations within value, this is good news, as the guidelines for capital gains and losses are relatively favorable to people. This characterization also upholds the way some high-profile bitcoin enthusiasts, including the Winklevoss twins, have reported their particular earnings in the absence of clear assistance. (While the new treatment of bitcoin applies to past years, penalty reduction may be available to taxpayers who can show reasonable cause for their positions. )

For those hoping to use bitcoin to pay their rent or buy coffee, the decision adds complexity, since investing bitcoin is treated as a taxable form of barter. Those who spend bitcoins, and those who accept them as payment, will both need to notice the fair market value of the bitcoin on the date the transaction occurs. This will be used to calculate the spender’s capital gains or losses as well as the receiver’s basis for future gains or losses.

While the triggering occasion – the transaction – is simple to identify, determining a particular bitcoin’s schedule, or its holding period in order to determine whether short-term or long-term capital gains taxes rates apply, may prove difficult. For an investor, that might be an acceptable trouble. But when you are deciding whether to purchase your latte with a bitcoin or just pull five dollars out of your wallet, the simplicity of the latter is likely to earn the day. The IRS guidance simply makes clear what was already correct: Bitcoin isn’t a new form of cash. Its benefits and drawbacks are different.

The IRS has also clarified several other points. If a company pays a worker in virtual currency, that payment counts since wages for employment tax reasons. And if businesses make payments worth $600 or more to independent companies using bitcoin, the businesses will be required to file Forms 1099, just as they might if they paid the contractors in cash.

Clearer rules may cause new administrative headaches for some bitcoin customers, but they could ensure bitcoin’s long term at a time when investors have valid reason to be wary. “[Bitcoin is] getting legitimacy, which it didn’t have previously, ” Ajay Vinze, the associate dean at Arizona State University’s business school, told The New York Times. He said the IRS decision “puts Bitcoin on a track to becoming a genuine financial asset. ” (1)

As soon as all bitcoin users can understand and agree on the type of asset it is, that outcome is likelier.

The minority of bitcoin users saw its former unregulated status being a feature, not a drawback. Some of them oppose government oversight for ideological reasons, while others found bitcoin an useful way to conduct illicit business. But as the recent collapse of prominent bitcoin exchange Mt. Gox demonstrated, unregulated bitcoin exchange can lead to catastrophic loss with no safety net. Some users may have thought they were protecting themselves simply by fleeing to bitcoin to escape the particular heavily regulated banking industry, yet no regulation at all isn’t the solution either.

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