When it comes to virtual currency Bitcoin, there's a lot of confusion about what it really is. Some say it's a commodity. Others think it’s a currency. Now the Internal Revenue Service has weighed in.
Prompted by concerns over how to tax the fledgling virtual currency, on Tuesday the IRS indicated that that Bitcoin isn't currency--at least for tax purposes. Instead, the federal agency declared it property. So if your business accepts payment in Bitcoin, trades it, or sells it, there's a new set of regulations you need to follow.
The IRS is adding its voice to states and municipalities struggling with how to regulate the currency for businesses and consumers, and the ruling may help to legitimize the cryptocurrency for the many businesses rushing to embrace it.
"There are no free rides, and this is similar to how the IRS taxes people on the barter system," says Scott Cheslowitz, a partner at accounting firm Rothenberg & Peters in Great Neck, New York.
How the IRS Sees It
Here are the main points: The IRS has decided that, for tax purposes, it will not treat Bitcoin like currency, which similarly depreciates or increases in value. Instead, the IRS will tax Bitcoin as either a capital asset or tangible asset. Capital assets are things like stocks, bonds, or investment properties. Tangible assets are things like inventory, machinery, or your company's buildings.
While the value of both types of assets can rise and fall, the tax rates are pretty different. Generally speaking, you'd pay the ordinary tax rate on the sale or exchange of Bitcoin held as a tangible asset--say you were paid in it. By contrast, you'd pay the lower capital gains rate of about 15 percent to 20 percent on transactions for Bitcoin held as an investment, for example if you obtained it on an exchange.
The same treatment goes for losses. If your Bitcoin has depreciated since you've held it, you'd get a tax write off.
That's pretty important for owners of Bitcoin, whose value is currently around $600, but which has traded over $1,000 within the past few months.
The Business Perspective
Remember, if your business pays people in Bitcoin, you'll also have to issue a 1099 for any contract work you pay for worth $600 or more.
Similarly, if your business, or part of your business, mines and trades Bitcoin, you'll be liable for self-employment taxes on earnings. And if you're paying your employees in Bitcoin, the IRS says that pay is now subject to withholding taxes based on the virtual currency's fair market value.
The IRS also says its rules are backward looking, so you could be subject to penalties for improper tax treatment of Bitcoin income in prior years.
"The IRS is interested in collecting revenue and regulating and creating rules and laws for people who want to avoid taxes with Bitcoin," says Ed Mendlowitz, a partner at WithumSmith+Brown, an accounting firm in New Brunswick, New Jersey.
Nobody likes the taxman, but for entrepreneurs and consumers eager to validate Bitcoin and bring it into the mainstream, the IRS notice goes a long way toward achieving those goals.
"The IRS is legitimizing and recognizing Bitcoin," Mendlowitz says.