The Bitcoin boom has given rise to a whole new class of tech-savvy capitalists; comprised of enthusiasts, speculators, and entrepreneurs – many of whom now find themselves in a much higher tax bracket. In the wake of Bitcoin’s skyrocketing growth , there’s been a lot of uncertainty about working this burgeoning economy onto a traditional tax return. This guide seeks to clarify some of the ambiguity surrounding Bitcoin’s tax status and income reporting requirements.
Bitcoin is Property
According to guidance published by the Internal Revenue Service, Bitcoin (or any other virtual currency) is considered property; making holders of the cryptocurrency subject to capital gains taxes on any appreciation in its value.
These rules apply to anyone using Bitcoin, whether a business, an investor, or a customer – anyone that buys, sells, or spends Bitcoin is expected to report profits or losses. For example, if a user buys $10 in Bitcoin, and later spends that Bitcoin, at a value of $30, this user is expected to report a $20 profit to the IRS.
Receiving Bitcoin Payments
Entrepreneurs and businesses receiving payments in the form of Bitcoin will also be subject to income taxes. The tax bill on Bitcoin payments received is based on the Bitcoin’s market value, in U.S. Dollars, at the time of the transaction.
Income taxes also apply to those mining Bitcoin. Newly generated Bitcoin is treated as income, and taxed at the market price, at the time of receipt.
Capital Gains vs Ordinary Income
Bitcoin transactions are treated very differently, depending upon how long the Bitcoin has been held. If Bitcoin is held for less than a year, it will be treated as ordinary income, and subject to income taxes. If the Bitcoin is held for more than a year, it will qualify as a long-term capital gain, and be subject to the generally more favorable, long-term capital gains tax rate, which currently stands at 15% – less than half that of the top federal income tax rate.
The Bottom Line
In essence, every Bitcoin transaction is treated as a taxable event, in which both buyer and seller are expected to record any fluctuation in the Bitcoin’s value, for later reporting to the IRS, as a capital gain or loss.
If these policies seem less than practical – and far from ideal – that’s because they are. The guidance issued by the IRS is not new policy, but rather old policy, reiterated to address new technology.
Simplifying Bitcoin Taxes
While this interpretation of the tax code does create some hurdles that complicate the idyllic vision of the Bitcoin economy, for the time being – until more intuitive policies are implemented – this is what’s necessary to use Bitcoin in compliance with U.S. tax law. Still, there is hope for filing a timely and accurate tax return in the age of Bitcoin.
There’s no shortage of software out there that can calculate the capital gains on Bitcoin transactions – in fact just about any modern tax software can handle the task. The most important factor, as with most tax matters, is proper record keeping; the times, dates, and values of all Bitcoin transactions will be needed, to accurately calculate taxes.
More Time to File
Given the haphazard schedules, and propensity for missing deadlines, of the stereotypical technologists and creative types who drive the world of Bitcoin, the standard due dates for tax returns may just not work around a Bitcoin enthusiast’s time table.
Fortunately, anyone who needs some extra time, can submit IRS form 4868, or form 7004 for businesses, to receive an automatic six month extension of time to file. This can be done through the Internal Revenue Service’s Free File website, by signing in and selecting “File an Extension”, from the menu at the top of the page.
Best of Luck
Now, hopefully, with some knowledge and resources in hand to help in effectively porting these digital assets to an analog tax system, Bitcoin users can take a collective sigh of relief and face the tax man with confidence.
This guide is provided solely for informational purposes, and shouldn’t be considered a substitute for professional tax advice. This guide also only addresses U.S. tax policies; while some aspects of this material may also be pertinent to Bitcoin users from elsewhere in the world, it’s best to consult with local tax authorities, for proper Bitcoin accounting guidance.