Posts Tagged ‘Bitcoins’

Exchanging One Cryptocurrency for Another Is a Taxable Event

Saturday, May 27th, 2017

Let’s assume I own some Bitcoins and you own some Ethereum; these are two cryptocurrencies. We think they’re each worth $5,000 and we agree to swap them. Do we have a taxable event?

The IRS consideres cryptocurrencies to be akin to stocks and bonds. That means any time I sell or otherwise dispose of cryptocurrency I have a realized capital gain or loss. A client was told by a cryptocurrency trader that exchanging one cryptocurrency for another is not a taxable event. That individual is mistaken.

Let’s look at an analogous situation: You and I each own $5,000 worth of a stock (say General Motors and Ford). We swap stocks. I no longer own Ford, so I have a gain (or loss) on my Ford stock; you have a gain or loss on your General Motors stock. No one can successfully argue that this swap doesn’t result in a taxable event for each of us.

As I said swapping one cryptocurrency for another is analogous. Is a Bitcoin identical to an Ethereum? No; they’re each different cryptocurrencies. If you sell or dispose of a cryptocurrency, you have a taxable event. It’s very clear that such swaps absolutely must be reported on Schedule D.

Do You Need a License to Sell Bitcoins?

Monday, May 15th, 2017

Let’s say I own some Bitcoins. I want to sell them to a friend. Do I need a license to do that? This question came up after I was informed that a Missouri man pleaded guilty to operating an illegal money transmitting business.

First, a disclaimer: I am not an attorney. For legal advice, go speak to an attorney specializing in money transmittal law. I am not that person.

If you are in the business of exchanging currency for currency, you need a money transmittal license. Let’s say you open a check cashing store; you may need that license. These licenses are generally on the state level and possibly also from FINCEN (the Financial Crimes Enforcement Network). So clearly Bitcoins, which are property for tax purposes, aren’t a currency, right?

Not so fast. Bitcoins are property in the world of the IRS, but in the view of FINCEN they’re a currency. Bitcoin advocates consider Bitcoins to be a digital currency (or a cyrptocurrency). So two different units of the same government agency (the IRS and FINCEN both fall under the Department of the Treasury) treat the same thing quite differently.

So let’s say I have lots of Bitcoins, and I trade them with a US Bitcoin exchange such as Coinbase. Do I need a money transmittal license? My thinking is no: Coinbase is a licensed money transmittal business, so my selling to them is part of their business.

Let’s say my Aunt Rose gave me five Bitcoins and I sell them to my friend Scott. It’s the only transaction I have in Bitcoins. It’s hard to see how I’m in the business of selling Bitcoins.

On the other hand, suppose I’m a poker player who does quite well on a poker site such as Ignition, and every month I receive some Bitcoins. Rather than selling them to an Exchange I decide to start selling them to others and make more money. That sounds like a business to me, and it might to the US government, too. In that case you should consider speaking with an attorney immediately to determine if what you’re thinking of doing complies with federal, state, and local laws.

Back in the days when Neteller was serving US poker players one of my clients considered going into business facilitating other poker players being able to move money from poker site to poker site. He had a lot of money on Neteller so he was able to deposit money onto (say) Absolute Poker and, in exchange, take money from PokerStars. When he spoke with me I mentioned to him that this might run afoul of the money transmittal laws and strongly suggested he speak with an attorney. The attorney he consulted advised him that my instincts were accurate. I suspect if someone were facilitating such Bitcoin transfers today this, too, would also run afoul of the money transmittal laws.

Getting back to my original question: Do I need a license to sell Bitcoins to a friend? The answer is likely no. But if I go into the business of selling Bitcoins the answer appears to be yes.

IRS: Bitcoins Are Property

Tuesday, March 25th, 2014

The IRS finally released guidance on Bitcoins and other virtual currency today. The IRS’s notice states that Bitcoins should be treated as property. What does this mean?

1. Bitcoins held as investments are generally treated under capital gain rules. If you buy a bitcoin today and sell it in less than a year and a day, it will be a short-term capital gain or loss. Hold it longer, and it’s a long-term gain or loss. (There are exceptions to the capital gain treatment for other situations of Bitcoin use, though.)

2. Every time you spend a Bitcoin (or any part thereof) you have a gain or loss of income based on the change in fair market value of the Bitcoin. If you use Bitcoins regularly, you have lots of paperwork (or spreadsheet work) in your future.

3. If you mine a Bitcoin (for those not familiar with this term, it’s basically the creation of a Bitcoin), you have increased your income. It’s reportable; Congress hasn’t exempted Bitcoin mining from income.

4. Similarly, if you pay people in Bitcoins, it’s reportable as salary (or nonemployee compensation or whatever else). You need to use a “reasonable consistent method” for determining the valuation as you will need to file a W-2 or 1099 based on US dollars. There isn’t any exception for Bitcoins in information reporting rules.

For those who are active in Bitcoins, I strongly suggest you read the IRS notice. It’s fairly straightforward (and there’s plenty more I haven’t covered). Do note this is not the last word on Bitcoin regulations, though. The IRS is looking for comments on the notice.

The Treasury Department and the IRS recognize that there may be other questions regarding the tax consequences of virtual currency not addressed in this notice that warrant consideration. Therefore, the Treasury Department and the IRS request comments from the public regarding other types or aspects of virtual currency transactions that should be addressed in future guidance. Comments should be addressed to:

Internal Revenue Service
Attn: CC:PA:LPD:PR (Notice 2014-21)
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

Alternatively, taxpayers may submit comment electronically via e-mail to the following address: Taxpayers should include “Notice 2014-21” in the subject line. All comments submitted by the public will be available for public inspection and copying in their entirety.

The Trouble With Bitcoins: Taxation

Sunday, January 19th, 2014

National Taxpayer Advocate Nina Olson noted in her recent report that the IRS needs to issue specific guidance around digital currency:

The use of digital currencies, such as bitcoin, is growing. Between July and December, 2013, bitcoin usage increased by over 75% – from about 1,700 transactions per hour to over 3,000. In the same period, the market value of bitcoins in circulation rose from about $1.1 billion to $12.6 billion. However, the IRS has yet to issue specific guidance addressing the tax treatment or reporting requirements applicable to digital currency transactions. Unanswered questions may include:

1. When will receiving or using digital currency trigger gains and losses?
2. When will these gains and losses be taxed as ordinary income or capital gains?
3. What information reporting, withholding, backup withholding, and recordkeeping requirements apply to digital currency transactions?
4. When should digital currency holdings be reported on a Report of Foreign Bank and Financial Accounts (FBAR), or Form 8938, Statement of Specified Foreign Financial Assets?

Taxpayers are speculating on the Internet about the answers to these questions. Some of this speculation is incorrect, incomplete, or misleading. It is the government’s responsibility to inform taxpayers about the rules they are required to follow. The IRS should issue guidance that addresses the tax treatment and information reporting required in connection with digital currency transactions, including answers to the basic questions listed above.

So let’s look at the two basic questions regarding Bitcoins: How are they taxed, and what reporting is required when using them.

Let’s cover the very first issue: If you make money with Bitcoins, it is absolutely taxable. The US Tax Code is quite simple in that respect: Everything is taxable unless Congress exempts it, and nothing is deductible unless Congress allows it. If you make money with Bitcoins, it is absolutely taxable.

The next question is how are gains taxed, and here is the major issue that the IRS and the courts have yet to decide. Are Bitcoins going to be regulated as a foreign currency or will they be treated like a capital asset? The problem for the IRS is that Bitcoins share features of both but also lack features of both.

Foreign currencies (such as the Euro and the British Pound Sterling) are defined in the US Tax Code; generally, income from foreign currencies is ordinary income under Section 988 of the Tax Code. The problem is that there’s nothing foreign about Bitcoins; they haven’t been issued by any government.

So maybe they should be taxed as a capital asset? But most capital assets can be held, and there’s nothing tangible about Bitcoins. A Bitcoin is ethereal but it has real value. If a Bitcoin is a capital asset, every time you sell a Bitcoin you have a capital gain or loss, and Bitcoins would follow capital gain rules and gains would be preferentially taxed.

Unfortunately, how Bitcoins are taxed is a major question that needs to be answered. Until the IRS comes out with guidance, tax professionals must make guesses.

The best tax summary I’ve found on Bitcoin and taxes is from Tyson Cross, a tax attorney in San Diego. A few of the points he makes that I agree with:

1. Gains are taxable when realized. This is absolutely clear under the US Tax Code. If you accumulate Bitcoins and sell them, use them to buy stuff, or trade them for things, you have gains.

2. The basis for a Bitcoin when it is “mined” is unclear.

3. If you keep Bitcoins on a foreign exchange, you may have to report your Bitcoins on an FBAR (Report of Foreign Bank Account, Form 114 (formerly Form TD F 90-22.1)).

Mr. Cross gets into quite a bit of detail on these issues, and his reasoning. If you are active in Bitcoins, I strongly advise reading the article.

One thing that he notes repeatedly (and I agree with) is that every time you use a Bitcoin, you have a taxable transaction and a gain or loss on that Bitcoin. It’s one thing to buy and hold Bitcoins; it’s quite another to be accumulating and using them actively. If you do so, your recordkeeping for your tax returns will need to be quite extensive.

Something that Mr. Cross does not cover (except for the FBAR) but is mentioned by Nina Olson are information reporting requirements with Bitcoin. I expect the IRS to mandate reporting of Bitcoin transactions similar to how dollar transactions are reported. It would not surprise me to see a heightened requirement for Bitcoin reporting (the IRS might consider Bitcoins as a means around the US financial system).

So how and when will the IRS rule on Bitcoins? It’s the government, so the ruling will come…eventually. I could only guess as to how they’ll rule. My instinct is that they’ll rule that it’s a foreign currency because that would tend to increase tax collection (Bitcoins would be taxed as ordinary income rather than as capital gains). Unfortunately, that’s only a guess.