IRS Posts Taxes on Bitcoin

irs tax bitcoin

As U.S. Internal Revenue Service (IRS) officially announced the tax regulation about bitcoin, bitcoin—digital money is regulated as an asset, rather than as a currency for taxation.

The rules were first announced on March 29, as the New York Bitcoin exchange started its first trading day. Investors do not seem to worry about value of bitcoin going down after the regulation.

Investors Buy Bitcoin on Dips

Bitcoin’s value has plunged from $571.23 on Monday to $499.24 on Saturday. New York Bitcoin Exchange organized a seminar to explain the effect from the IRS provisions. Volunteer instructor Mark Anthony explained the provision line by line.

“I don’t think the IRS regulations will last long. If bitcoin becomes a widely accepted currency, then an investor will have about 100 transactions on average. It’s difficult to accurately report each transaction to the IRS, which is why it’s difficult to tax bitcoin as an asset.” Anthony said. Now, the IRS is treating bitcoin investment as gold investment.

Anthony said he did not invest enough in bitcoin to worry about the regulation. He thinks the recent plunge of bitcoin’s prices was related to the Chinese government banning financial institutions handling bitcoin transactions. Also, he took the chance at the price dips and bought some bitcoins, each valued at $490.

“If you’re mining bitcoin in your apartment, would you report the “mining”activitiy to the IRS? Very few people would report a few bitcoin transactions in tax returns.” Investor Tariq Albazzaz frankly said. Bitcoin is a new monetary trend and its unstoppable. Even with the U.S. government’s strict regulation, investors will always find ways to get around it.

However, some investors have reservations toward bitcoin’s value. One investor said, he would not sell his bitcoins, and would not continue buying it. He’s observing the market, “the recent value changes is largely due to the Chinese government regulation.”

The New York Bitcoin exchange trading screen showed that as of 18:00 on March 29th, bitcoin’s trading volume is same as usual.

Is Bitcoin a Currency?

The IRS provision states that individual possession of bitcoin needs to be declared as asset, when the transaction received capital gains. The IRS does not recognize bitcoin as a currency, it views bitcoin as an asset and taxes capital gains from trading.

Entrepreneur Huang Xin, who owns a number of accounting firms in California said:”The current regulation is unclear to people—whether bitcoin is a financial asset or commodity for taxation.”

Bitcoin is taxed as a financial asset, such as stocks. And to encourage long term investment instead of short term speculation, the taxation percentage depends on the length of the bitcoin possession. If an investor holds bitcoins longer than 1 year, it’s considered long term investment capital gains. Based on investor’s income level, one can expect to pay up to 15%-20% on capital gains tax. If one  holds his bitcoins less than one year, then it’s taxed as short term investment, mostly above 28%, up to 39.6%.

If bitcoin is taxed based on commodities such as gold, silver bullion, wine etc, there’s no advantage of long term investment tax rate. No matter how long investors hold their bitcoins, short term investment tax rate is applied.

Of course, even when the IRS doesn’t recognize bitcoin as currency, people still need to pay capital gains tax. Currently, if an individual is buying and selling foreign currencies like the Euro and made some profits, he has to report the gains in tax report too. Since it’s hard to determine the time of possession, so 60% of the gains is taxed based on long term investment rates while 40% of the gains is taxed based on short term investment rates.

Bitcoin is still not recognized as a currency, so whether it’s beneficial for investors in terms of taxing is still unknown. We’re still waiting for IRS’s further clarification. If bitcoin’s taxed based on financial assets rule, it’s advantageous to hold bitcoins longer than 1 year. However for speculators, taxed based on short term investment rates will definitely increase their costs in investing in bitcoin.

Declare bitcoin as capital gains or sell bitcoin

“I’m sure some people will report bitcoins in their tax returns, when they used $1,100 to buy bitcoins, and sold them with $500, in which it’s a loss and can be used to claim tax refunds.”Anthony said.

Mr. Huang from California also said, there were clients lost thousands of dollars in bitcoin investments and asked how to used the losses for some tax relief.

The main impact of the IRS provision is not that whether bitcoin is a currency, but bitcoin investors must declare the bitcoin’s value in dollar, report and record the transactions. Since each bitcoin transaction is permanently stored in the blockchain, in the U.S., investors must record tax information for up to 7 years.

Most bitcoin transactions occur outside of the U.S., even cross border transactions are hard to trace. That’s why very few people have reported bitcoin in their tax return. On March 29th, before the New York bitcoin exchange started operation, there was even an one hour training session, emphasizing the illegality of not reporting bitcoin in tax returns.

“This notification clearly states: if you accept bitcoins as salary or other compensation, it’s considered wages and needs to be reported in tax return in dollar value. That’s why later on April 15th, some bitcoin owners might have to sell some bitcoins to pay for taxes, as the IRS only accepts U.S. dollars.” Huang Xin said.

The similar situation happened in the 2001 tech stock bubble period, when the Nasdaq crash occurred. Employees who received stocks as compensation had to sell stocks before their value dropped to pay for taxes, some even sold all their stocks and had to declare bankruptcy.

For example, if a computer programmer received 20 bitcoins for a project, and those 20 bitcoins were worth $1,200 each, then he has to report these 20 bitcoins as $24,000 in tax report. However as bitcoin’s price drops to $500, his assets suffer a loss of $14,000. That means if his tax bracket is at 30%, this year he still has to pay $6,300 in tax. In the end he has to sell 12.6 bitcoins to pay for his taxes.