BITCOIN AND TAXES
Bitcoin is not subject to taxation by the IRS any more than it can tax any other foreign currency, or collect taxes from the sand on Mars, for that matter. Bitcoin is a “stateless” currency, however you want to classify it. As of November 2016, the Inspector General for the IRS is recommending that the IRS create new procedures by which the currency can be taxed, but this doesn’t change the tax status of the currency, it’s immune from taxation (i.e., not exempt, or just not recognized). Failing to collect taxes from Bitcoin transactions does not contribute to the “tax gap”, in fact, if Bitcoins are exchanged for USD, the USD may become subject to taxation under the current rules, and this would offset the true contributors to the “tax gap”.
As of today, state and federal tax agencies want you to report your Bitcoin income in terms of USD, and that would be taxable. The real question is when do I have to report my Bitcoin in terms of USD, just like the question, when do I have to report how much money I saved with coupons as if it were taxable income in USD? I’m going to refer to the recent memorandum published by the Internal Revenue Service, “Notice 2014-21” it’s found at http://www.irs.gov/pub/irs-drop/n-14-21.pdf. Remember that this is not a law and it’s not been published in the Federal Register (a daily publication of the US federal government that issues proposed and final administrative regulations of federal agencies). This notice only refers to existing legal standards. Keep in mind that you will need to review the definitions in 26 USC 7701 http://www.irs.gov/pub/irs-tege/eotopici92.pdf such as “trade or business” 7701(a)(26) as this term specifically means “the performance of the functions of a public office”, and does not include Bitcoin mining as indicated in this memorandum. Also, the term “wages” means specifically remuneration paid to officers, employees and elected officials of the United States government, within territories and possessions of the United States government (which specifically exclude the 50 states, except federal lands an enclaves within the 50 states). You’d have to review the statues and regulations for Sections 3401 and 3121, both in the United States Code and Code of Federal Regulations, but I’ve summarized it for you above.
However, if you invest in Bitcoin from a fiat currency of a country, and then sell your Bitcoin for the fiat currency, and realize a gain, that will be subject to taxation in the fiat currency.
If you convert your after-tax money into Bitcoin and never convert it back into fiat, it cannot be taxed, no matter what laws are in place; however, if you report your Bitcoin activities as being taxable on a government form and under penalty of perjury, you will be taxed and subject to taxation. In order for Bitcoin to be taxed, there would need to be a central authority responsible for the administration of Bitcoin. Of course the opposite of this is true. Bitcoin was designed to operate within a network over which no one party has exclusive power or responsibility. It is regulated by its mathematical protocols and changes are made by a consensus within the network. There is no taxing authority for Bitcoin and by its design, it can never be taxed.
The volatility of precious metals comes from measuring the purchase price of precious metals with fiat currency. It is the fiat currency that is volatile, not the precious metal. Gold can buy the same amount and quality of materials today as it did 2,000 years ago. The same appears to be true for Bitcoin since it is also a deflationary (or stable against fiat) currency.
There are no new tax laws imposing a tax on the use of Bitcoin or any cryptographic currencies. There is only a memorandum recently published by the IRS that discusses reporting procedures so that any transaction that should be taxed is understood by the taxpayers under the same laws to which they are accustomed to following.
Does money deposited in Bitcoin change in value like a stock? No, 1 Bitcoin will always = 1 Bitcoin, but if you convert it to fiat, you will have a fluctuating price (not necessarily value).
I thought it protected our money from US currency volatility. It does, if you use Bitcoin for its intended purpose, to buy goods and services.
Just based on the concept of a crypotocurrency, I would have thought it should remain constant. Not true? It does, if you use Bitcoin for its intended purpose, to buy goods and services.
Stock price for Bitcoin, if I bought Bitcoin stock, would be volatile, of course, that’s the nature of the stock market, but why would a deposit in a Bitcoin account change in value?
There is a Bitcoin investment that I know of called the Bitcoin Investment Trust (BIT Trust), XBTFUND, for accredited investors. I’m not sure if it’s a domestic company within the United States, but it is an unregistered investment vehicle and you can learn more at:
http://bitcointrust.wpengine.netdna-cdn.com/wp-content/uploads/2014/12/Fact-Sheet_Dec.pdf
I also know of one Russian company that I mentioned in one of my previous articles, Exante. Buying into these types of funds is one way to invest in Bitcoin but why tie in your Bitcoin investment with a fiat currency this way? Why not invest in an existing Bitcoin exchange or a mining pool?
How does classifying Bitcoin as property change your recommendation? It does not.
It seems as though it would take away it’s advantage as a currency that the government can’t sink it’s teeth into. If it’s property, IRS can tax it, right? Or is their taxation relevant only to the stock?
See above http://www.irs.gov/pub/irs-drop/n-14-21.pdf and Q-3; A-3 of the IRS Notice, quoting:
“Q-3: Must a taxpayer who receives virtual currency as payment for goods or services include in computing gross income the fair market value of the virtual currency?
A-3: Yes. A taxpayer who receives virtual currency as payment for goods and services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. Dollars, as of the date that the virtual currency was received. See Publication 525, Taxable and Non-taxable Income, for more information on miscellaneous income from exchanges involving property or services.”
In other words, if you signed a voluntary withholding agreement (W-4) for example, with an employer, and that employer is reporting your “wages” on Form W-2 to the IRS, and some or all of those “wages” are paid to you in Bitcoin, you will need to keep records of the USD value of the Bitcoin, at that time (date of paycheck), for income tax reporting requirements. You will likely have a different USD amount for each pay period. Now remember that this is not a law, but a procedure by which you can account for the USD tax liability. This is not yet even a standard and it’s not published in the Federal Register and there are no statutes or implementing regulations pertaining to cryptographic currency, nor are there any legal definitions of what constitutes a cryptographic currency (that is, none appearing in a statute or as the holding by any of the higher courts). Remember also that the Sixteenth Amendment did not change the U.S. Constitution and give the United States any new powers of taxation beyond those it already had under Article I, Section 8 (see Stanton v. Baltic Mining Co., 240 U.S. 103 (1916))
Maybe the legal definition will be determined to be that any cryptographic currency pertains to one’s freedom of expression, or it’s the exchange of information, or it’s language, or represents a property right (a record of a property right) and not property in itself. We have a long way to go before these considerations become part of the legal framework of regulation and taxation.
If your restaurant sells toast and coffee for $3.00, and you sell this to a customer for an equivalent amount of Bitcoins, it is logical to conclude that your restaurant must report the sale in terms of taxable currency, the USD value of the Bitcoin at the time of the sale. But what if your restaurant is a tax deferred business? The Bitcoin sale would then not be considered a taxable gain until it was converted into USD. If you are using a merchant service such as Bitpay, this could be managed so that you could allocate your Bitcoin into an account to be reinvested, pre-tax and tax deferred, back into your business.
Remember one important fact, out of the 25+ volumes of tax code and 50 or so volumes of income tax regulations, there is not one definition of what constitutes “income”. The term income is not defined in the Income Tax Code.
Trading Gains & Losses – Property, Not Currency, (Investopedia.com)
The most widely reported aspect of the IRS ruling on Bitcoin has to do with its treatment as property. This is a favorable ruling (very important to note is that a letter ruling from the IRS pertains only to one taxpayer and one transaction, there is no letter ruling as stated in this article, it’s a notice, much like an open letter) for most investors given Bitcoin’s stellar performance to date, as accrued long-term gains and losses will be taxed at the taxpayer’s applicable capital gains rate (15% in Joe’s case, we will assume that Joe is married and that he and his wife made a combined $100,000 of taxable income in 2013), rather than ordinary income rates (25% for Joe). For many early Bitcoin “miners” and investors, this constitutes a massive difference in marginal rates. That said, active traders who have racked up short-term capital gains may still be taxed at ordinary income rates.
Investors with trading losses, on the other hand, might not be so happy with the ruling. It will be much more difficult to write off bad Bitcoin bets now that they are considered property rather than currency. The IRS limits the amount of property losses (net capital losses, to be specific) that can be claimed on personal tax returns to $3,000 per year for both married and single filers, a limit that hasn’t been raised since 1978. For these unfortunate folks, large short-term trading losses will need to be carried forward, in some cases for many years. Trading losers would have been much better off if they could have written off “foreign currency” losses against their ordinary income. – – –
The comments in the audio “The Beginning of the End of Bitcoin” are opinions of the same type of people that thought that no one would ever need more than 64K of memory in his computer. This is a comment I received recently: A few weeks back I heard part of program about bitcoins with examples of some losing their money b/c bitcoin and its encryption is relatively new and not perfected as yet. Why is the Federal Reserve Bank of St Louis Vice President, David Andolfatto, quoted on January 18th 2015 stating “We’re a Protocol Just Like Bitcoin.” The quote was actually longer, but you can see for yourself: http://www.coindesk.com/federal-reserve-bank-vp-protocol-just-like-bitcoin/ Why is this one hundred year old institution, that has been robbing us blind since its inception, now comparing itself with a new monetary system that will ultimately end its existence?
In any case, referring to your comment, this is not the reason someone would lose his Bitcoins. The cryptographic protocols within Bitcoin and the Blockchain are perfect, but if you lose your private key, you lose access to your money, even though it still can be “seen” on the blockchain. You will want to get the Kindle version of Mastering Bitcoin by Andreas M. Antonopoulos. Once you’ve read this, none of these wacky comments will ever matter to you.
Please note that you may believe what I’ve explained here contradicts what the IRS explains in its publications, but be careful about the meaning of the terms. The terms used in the Internal Revenue Code and implementing regulations are not the same as the street terms we use everyday, such as “trade or business”. The key point here is that if a third party is reporting a payment to you in Bitcoins on forms such as the W-2, K-1 or 1099, you should then report as they explain unless you can make other arrangements. Remember that none of these publications or notices are binding as a matter of law, they are merely guides for tax professionals and taxpayers.
There is a speakers forum regarding cryptographic currency scheduled for February 12th 2015. You can register at:
http://www.foreignaffairs.com/about-us/sponsors/cryptocurrency-policy-forum
You will want to see the agenda and list of speakers and it’s free to register from what I can see. Once you click on the link to register, you will only have 30 minutes to register before your seat is released. My guess is that a summary of the conference will be published afterward.
References:
Publication 551: http://www.irs.gov/pub/irs-pdf/p551.pdf
Publication 544: http://www.irs.gov/pub/irs-pdf/p544.pdf
Notice 2014-21: http://www.irs.gov/pub/irs-drop/n-14-21.pdf
FinCEN: http://fincen.gov/statutes_regs/guidance/html/FIN-2013-G001.html
amended FinCEN http://www.fincen.gov/news_room/rp/rulings/pdf/FIN-2014-R001.pdf
http://www.fincen.gov/news_room/rp/rulings/pdf/FIN-2014-R002.pdf
memorandum http://www.fincen.gov/news_room/nr/pdf/20140130.pdf
Internal Revenue Bulletin: http://www.irs.gov/pub/irs-irbs/irb14-36.pdf
