Bitcoin was once something such as Schrodinger’s currency. Without regulatory observers, it could claim to be money and property at the same time.
Now the Internal Revenue Service has opened the box, and the virtual currency’s condition is established – at least for federal tax purposes.
The IRS recently issued guidance on how it’ll treat bitcoin, and some other stateless electronic competitor. The short answer: as property, not currency. Bitcoin, as well as other virtual currencies that can be exchanged for legal tender, will now be treated generally as a capital asset, and in a few situations as inventory. Bitcoin holders that are not dealers is going to be subject to capital gains tax on increases in value. Bitcoin “miners,” who unlock the currency’s algorithms, will have to report their finds as income, just as other miners do when extracting more traditional resources.
Though this decision is unlikely to cause much turbulence, it’s worth noting. Since the IRS has made a call, investors and bitcoin enthusiasts can move ahead with a far more accurate understanding of what they’re (virtually) holding. A bitcoin holder who would like to conform to the tax law, as opposed to evade it, now knows how to accomplish so.
I think the IRS is correct in determining that bitcoin is not money. Bitcoin, and other virtual currencies like it, is too unstable in value for it to realistically be called an application of currency. In this era of floating exchange rates, it’s true that the worth of nearly all currencies changes from week to week or year to year in accordance with any particular benchmark, whether it’s the dollar or a barrel of oil. But a vital feature of money is always to serve as a store of value. The worth of the money itself shouldn’t change drastically from day to day or hour to hour.
Bitcoin utterly fails this test. Investing in a bitcoin is really a speculative investment. It’s not a destination for a park your idle, spendable cash bitcoin mixer. Further, to my knowledge, no mainstream financial institution can pay interest on bitcoin deposits in the form of more bitcoins. Any return on a bitcoin holding comes solely from a change in the bitcoin’s value.
Perhaps the IRS’decision will help or hurt current bitcoin holders depends on why they wanted bitcoins in the very first place. For those hoping to profit directly from bitcoin’s fluctuations in value, that is good news, as the guidelines for capital gains and losses are relatively favorable to taxpayers. This characterization also upholds the way in which some high-profile bitcoin enthusiasts, including the Winklevoss twins, have reported their earnings in the lack of clear guidance. (While the brand new treatment of bitcoin is applicable to past years, penalty relief may be offered to taxpayers who will demonstrate reasonable reason for their positions.)
For those hoping to use bitcoin to pay for their rent or buy coffee, your decision adds complexity, since spending bitcoin is treated as a taxable type of barter. People who spend bitcoins, and people who accept them as payment, will both need to see the fair market value of the bitcoin on the date the transaction occurs. This will be used to calculate the spender’s capital gains or losses and the receiver’s basis for future gains or losses.
While the triggering event – the transaction – is simple to recognize, determining a particular bitcoin’s basis, or its holding period to be able to determine whether short-term or long-term capital gains tax rates apply, may prove challenging. For an investor, that could be a suitable hassle. But if you are deciding whether to get your latte with a bitcoin or perhaps pull five dollars from the wallet, the simplicity of the latter probably will win the day. The IRS guidance simply makes clear what had been true: Bitcoin isn’t a fresh type of cash. Its benefits and drawbacks are different.
The IRS in addition has clarified other points. If an employer pays a worker in virtual currency, that payment counts as wages for employment tax purposes. And if businesses make payments worth $600 or maybe more to independent contractors using bitcoin, the businesses is going to be necessary to file Forms 1099, just as they would if they paid the contractors in cash.
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