The Internal Revenue Service has ruled that it considers Bitcoin a form of property, not a legitimate state-backed currency. The announcement is a big deal for Bitcoin holders nervous about staying on the right side of the law as tax time approaches. What does it mean for your tax return? Below, we'll try and sort out what the IRS statement implies for people who hold — or transact — in bitcoins.
Wait. You're telling me I can be taxed on my bitcoins?
But isn't the whole point of Bitcoin to allow me to escape the clutches of the government?
Within reason. Bitcoin may be free from bank fees and delays that might affect other transactions. Still, the fact that you might be making money from your investments in Bitcoin — or earning your salary in it, as many people who work for Bitcoin-related businesses do — doesn't exempt you from owing taxes.
In that light, it's only natural that Bitcoin transactions would be held to the same expectations.
Bummer. So how will I be taxed?
It depends. It's helpful to think about it more in terms of common stock that you might own as a shareholder in a company, tax experts say. When you sell stock within a year of buying it, the profit is taxed as ordinary income. But if you hold that stock for longer, it is taxed at the capital gains rate.
The same is true for your bitcoins. Spend one at a coffee shop, and depending on the value of a bitcoin at the time, you may have incurred a gain or a loss compared to when you first got it. Regardless of which it is, that's what the IRS would call a taxable "event."
This is potentially really great for people who use Bitcoin mainly as an investment tool. That's because capital gains, as you may know, are taxed at lower rates than ordinary income.
How does this affect businesses and employers?
It's a little early to tell. But some companies, such as Coinbase and the Bitcoin Foundation, pay their employees' salaries in bitcoins. Their examples might be instructive for the future.
Suppose Coinbase employs a woman named Jean. When Jean got hired, her salary was set at $100,000 — in dollars, not bitcoins. Every two weeks, Jean gets paid the equivalent of her bi-weekly paycheck in bitcoins rather than in dollars. What Jean does with those bitcoins is up to her. She can spend them, convert them to dollars or do a mix of both. "Cashing out" immediately safeguards Jean's earnings from the notorious price fluctuations that affect Bitcoin.
Because Jean's salary is set in dollars, Coinbase would generate W-2s just like any other company. That makes it relatively easy for Bitcoin-related employers to perform withholding and to comply with other federal requirements.
What about people who mine bitcoins?
The IRS is treating any new bitcoins generated as a result of mining as a form of income that has to be reported. To do so, miners will need to calculate the dollar value of the generated bitcoins at the time they were mined, and then report that as income on their returns. So if you successfully mine 25 bitcoins in August that are worth $500 each, and then you mine another 25 bitcoins in October that are worth $600 each, you'd report that as $27,500 of gross income.
Freelancers tend to file their taxes quarterly. Is anything changing about that?
Nope. If you earned bitcoins as payment, just make sure you convert the income into dollars before including it in your return.
So if you're just reporting everything as dollars anyway, the IRS won't necessarily know that you've earned any bitcoins?
That's one of the things that's still unclear. But what does the tax man care, so long as he's collecting the right amount?
What if I've already filed?
You can still amend your return. The rules are retroactive, so if you also need to amend last year's return, too, you can do that as well. On the flip side, you're subject to penalties if you don't report your Bitcoin-related income accurately, just as you would be for anything else.