I was thinking of asking one of the partners here at IRSMedic HQ if he could start paying me in bitcoins. Why would I do that? Because I think there's a good chance that the BTC is here to stay, and I like the idea of having a store of value that is protected against the whims of government.
But first, I need to check if there's a Bitcoin Tax. The problem is that there isn't any clear guidance on how I would be required to report my spending if I got paid in bitcoins and used it for my day-to-day purchases.
First, let's discuss how bitcoins are commonly used.
There are two general reasons that people acquire bitcoins: 1) for investment purposes, and 2) for transactional convenience. Many people engage in trading bitcoins on exchanges such as Mt. Gox or ICBIT. They do this for a profit, and should usually report this activity on a Schedule D in a similar manner as those who buy and sell stocks, commodities, or foreign currencies. (The particular treatment of this income will vary depending on whether the particular bitcoin trader is a "mark-to-market" trader, etc).
For those who acquire bitcoins for transactional convenience, there probably aren't any real tax implications. Many people are moving towards bitcoins as a more convenient method of transacting business over the internet. Some claim that the only reason one would do so is because of the anonymity of bitcoins – that is: people who conduct business in bitcoins are the same people who run their businesses in cash because something shady is going on.
While it is true that bitcoins are used in black market activities, or to avoid "the Feds" in other ways, there are legitimate reasons for using bitcoins in normal commercial transactions. The major reason for legitimate, legal, taxpaying businesses to take and remit payments with bitcoins is that the transaction costs can actually be much lower than using other methods on electronic payment.
When someone acquires bitcoins for transactional convenience, it usually won't have any tax implications. That's because the turnaround time is generally pretty quick. In a normal transaction, Customer sees what he wants to buy from Vendor in bitcoins. Purchaser buys bitcoins and transmits them to Vendor for the goods. Vendor (especially if the transaction is legal) will turn around and exchange the bitcoins back into Vendor's local currency. In this scenario, bitcoins are being used as a conduit for the transaction, but there is little time for the bitcoin to fluctuate in value to such an extent that it would trigger a taxable event.
But what if I was paid in bitcoins? Can I be taxed when I spend them?
If I was paid in bitcoins would there be tax implications when I went to spend my money? The answer is yes. Maybe.
At this point, there has been very little direct guidance from the Internal Revenue Service on this type of transaction, and while the recent guidance from FinCen makes it clear that a bitcoin is not considered "currency" in the traditional sense by that arm of the U.S. Treasury, the common wisdom is that bitcoin transactions should be treated in a way similarly to transactions involving foreign currency.
For simplicity sake, assume I only got paid one paycheck in bitcoins, and the value of BTC at the time was $30.00. My gross pay was 40 BTC. For income tax purposes, I received employment income in the amount of $1200 (USD). I will report this employment income as ordinary income on my tax return.
Now, let's say BTC has risen to $90.00 and I bought a computer for 30 BTC. My "basis" in each BTC (if I choose to allocate it this way) is $30.00. The computer I am buying is worth $2700.00, and my total basis is $900. The result? I have realized a capital gain of $1800. I'll need to report this on Schedule D and 8949 as a capital gain.
The cool part is that if the situation were reversed and I was spending BTC that had decreased in value, any loss that I experienced from dabbling in bitcoins would be nondeductible.
Ok – but what if the IRS doesn't treat BTC as a currency? Well, then it gets really fun. If BTC is not a currency, then the $200 exemption on recognizing gains from personal use of the BTC does not apply! If you think that BTC isn't currency, then you should be reporting EVERY transaction you make with appreciated bitcoins to the IRS.
DISCLAIMER: Nothing in this blog post is intended or written to be used, and it cannot be used by the reader or any taxpayer/bitcoin fan/nontaxpayer (i) for the purpose of avoiding taxes or penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction.