IRS Bitcoin Rules Bring U.S. Up to Speed

The recent IRS ruling on how Bitcoin and other virtual currencies are taxed brings the U.S. in line with regulations in Canada, Australia, Finland, Norway and Sweden.

The IRS says digital currencies are property, not currency, for federal tax purposes. This applies whether the currency was received for payment or "mined," a process wherein people receive bitcoins in exchange for validating transactions against the public ledger.

"Nothing surprising here," says Joseph Ballerini, senior director of international tax at Warnaco Inc. "The property is intangible but that isn't of consequence."

While this ruling isn't shocking, the Bitcoin community is still worried about the digital currency being seen as a commodity rather than a currency. If viewed as a commodity, Bitcoin businesses would be overseen by regulatory bodies such as the SEC and Finra. 

But to be labeled as a commodity, "generally [there's] always an underlying physical asset in theory," says Ballerini. "Bitcoin doesn't have it. It's an intangible." 

The Bitcoin Foundation, a trade group, says that it welcomes the clarity the IRS and other government agencies are providing, but that the IRS's stance introduces complications.

"The tax laws currently permit individuals to ignore small gains and losses in foreign currencies," says Marco Santori, chairman of the Bitcoin Foundation's regulatory affairs committee, in a blog post. "Similar treatment for digital currencies would harmonize the law with the way most people actually use digital currencies.  Artificially characterizing this use case as a transaction in property would make one of the most innovative features of this technology hard to use for those who wish to be compliant."

According to the IRS, Bitcoin will be subject to capital gain and loss rules. Taxpayers who sell bitcoins after holding on to them for more than a year will pay a lower tax rate, capped at 23.8%. Those who hold bitcoins for less than a year before selling must pay a maximum rate of 43.4%.  Loss requirements will also be applicable for bitcoin holders, allowing losses of up to $3,000 a year to be subtracted from gains.

Individuals who are paid "in kind" with bitcoins will have taxable income based on what the fair market value is. The IRS has "discussed 'reasonable methods, constantly applied' and noted that if there was an established market that could be used to calculate value," Ballerini says. 

The virtual currency's price has swung dramatically over the past year and currently hovers between $550 and $650 per bitcoin. When the large Bitcoin exchange MtGox halted withdrawals, eventually shutting down and filing for bankruptcy, the price per bitcoin on the exchange dipped below $100. 

Because of these price swings some experts say instituting a value in exchange benchmark for Bitcoin could be a useful in stabilizing the price and calming speculation. The IRS requires taxpayers to report their transactions using an exchange rate established by market supply and demand.

The IRS says taxpayers may be subject to penalties for failure to comply with tax laws even before the ruling was published, and "there isn't too much sympathy for people not paying their taxes," says Ballerini. But usually these people are only civilly prosecuted and if found guilty must pay the taxes they owe with interest and a possible fine, he says. 

"Criminal prosecution is another matter," he says. "I would bet it would only happen if a sophisticated, monied person was viewed as being coy and scamming the government."