IRS Issues Guidelines for Bitcoin

With the advent of virtual currency, consumers can now conduct entire transactions online without the burden of having to seek a common currency. Bitcoin has spread across the world as a popular form of this currency. In turn, transactions can now take place without switching from one form of currency to another (e.g., conversion from U.S. Dollar to Euro). On March 25, 2014, the Internal Revenue Service (“IRS”) issued guidelines regarding its approach to virtual currency, such as Bitcoin. Under these guidelines, the IRS will treat virtual currency as property, not currency, for federal tax purposes. Accordingly, the tax principles that typically apply to property will now apply to transactions involving virtual currency.

What Is Bitcoin?

Bitcoin is a form of virtual currency.  An unknown individual using the alias Satoshi Nakamoto created Bitcoin in 2009. This virtual currency allows for online transactions without bank issued transactions fees. People store their Bitcoins in a “digital wallet” on a personal computer or on the cloud. This serves as an online bank account, which can send and receive Bitcoins. Then, people use this currency to conduct transactions. However, unlike funds stored in a traditional bank account, the Federal Deposit Insurance Corporation (“FDIC”) does not insure Bitcoin wallets. Furthermore, transactions can now take place entirely anonymously. Online consumers do not have to provide bank accounts or other financial information. Therefore, it becomes nearly impossible to trace transactions using virtual currency. Bitcoin is becoming increasingly popular and more merchants accept this currency for all types of transactions. International transactions can also take place without fees from foreign countries or conversion fees. Consumers can also “mine” Bitcoin, which involves competitions to solve complex computer-based math problems to win additional Bitcoins. Bitcoin is also a valuable investment, with people purchasing Bitcoin to profit from increases in its value.

What Are the Parameters of the New IRS Guidelines?

First, these new IRS guidelines apply to all sales and exchanges involving profits or losses from transaction using virtual currency. This will include, among others, employment wages, payments to independent contractors, and the mining of virtual currency. Indeed, the IRS may also tax the mining of Bitcoin as revenue from self-employment. All Bitcoin users will now have to keep detailed records of every transaction involving this virtual currency to satisfy their obligations under the new guidelines. With the constantly changing value of Bitcoin, users must also conduct calculations to account for such fluctuations. This is especially problematic since the value of Bitcoin often changes. The new IRS rules will tax any increase in Bitcoin’s value. The average Bitcoin users do not typically maintain strict business records. Therefore, this new requirement will be a new practice for virtual currency users. This may pose an additional problem if Bitcoin use declines as consumers seek to avoid having to comply with these guidelines. Nonetheless, the IRS may now issue penalties for failure to report transactions involving virtual currency.

At our law firm, we help businesses and individuals set up and conduct transactions using virtual currency. You may contact us to discuss with an attorney how these new IRS guidelines will affect you.