Compliance

12:31 PM
Kirk Phillips
Kirk Phillips
Commentary
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Bitcoin Taxation: A Gift From the IRS & the Coffee Problem

Every bitcoin transaction requires a gain or loss calculation between acquired cost basis and the amount it was sold for. This is no problem for large blocks, but on everyday purchases, a gain or loss calculation on every $1.79 cup of coffee is a lot of calculating.

I heard about bitcoin at the end of 2013 when a friend asked me for advice on buying a computer to mine bitcoin. I had never heard of such a thing and I naturally thought they mixed up information and didn't know what they were talking about. My perpetual knowledge-seeking genes kicked in to find out more about the mysterious mining which has turned into the journey of a lifetime.

A knowledge-seeking journey
I'm a CPA, entrepreneur, and Certified Fraud Examiner who loves technology and challenging the status quo, so it didn't take long to find out that bitcoin and I were like long lost friends. A few years earlier, I founded invizibiz.biz, an accounting and business process outsourcing subscription service, bringing together the best technology to provide businesses with a 100% paperless, all-in-the-cloud, transparent, and accessible back office solution. My fascination with Bitcoin is a natural extension of my passion for technology and business. 

It's important to think of Bitcoin more as a technology with a first successful use case that happened to be a digital currency. Bitcoin is simultaneously a network, a protocol, and a medium of exchange where the capitalized version refers to the technology and the lower case version refers to the currency. This is worth repeating although it has been explained in many other articles. Bitcoin, the digital currency, is already disrupting the business and financial world and Bitcoin, the technology, will completely transform the way business is done in the next 20 years as it gets adapted to many other uses. 

The IRS speaks
In the meantime, bitcoin has been defined very differently by many regulatory authorities around the world. The IRS issued Notice 2014-21 in March 2014 declaring that bitcoin is property; therefore, the rules for the taxation of property apply. This probably seems like a strange conclusion for something that's used to buy things the same as dollar bills. Only US bills and coins have legal tender status in the United States so bitcoin simply defaults to property status because it's not legal tender. It's ironic that bitcoin is used as a currency but taxed like property. These rules are like a blessing to some and a burden to others depending the type of business activity and whether or not they're owned by an individual or business.

Bitcoin blessings
Bitcoins are intangible and therefore considered property called a capital asset in the hands of either an individual or business. They can't be placed in service and depreciated like a computer or a work van. Capital assets held longer than one year are entitled to the favorable long-term capital gains rate of 20% which is the Holy Grail for taxable income. Taxpayers in the highest tax bracket pay 39.6% tax on their income therefore long-term capital gains are a slam dunk at a 50% discount. Anyone who acquired bitcoin prior to early 2013 has nearly a 100% potential taxable gain and loves the IRS for declaring bitcoin property. 

Bitcoin burdens
On the other hand, capital assets held for less than one year are taxed at short-term capital gains rates, which is essentially the tax rate of your tax bracket. Lower income taxpayers may have a short-term rate that matches their long-term rate creating an indifference to the benefit of the long-term rate. High income taxpayers would have to pay a short-term capital gains rate of 39.6%. Every capital asset and therefore every bitcoin transaction requires a gain or loss calculation between acquired cost basis and the amount it was sold for. When it comes to large blocks of bitcoin this is no problem but when it comes to everyday purchases, a gain or loss calculation on every $1.79 cup of coffee is a lot of calculating. Both individuals and businesses are subject to these rules. Therefore, whether you use bitcoin as an everyday currency, hold it for the long-term as a portfolio play, accept bitcoin as a merchant, or buy business products or other useful assets, every bitcoin transaction requires basis tracking and a corresponding gain and loss calculation. The good news is several platforms such as coinCPA.com, Libratax.com and Coinreporting.com provide tools to help with these calculations. 

Other tax applications
When contractors or employees are paid in bitcoin or other digital currencies, a US dollar equivalent conversion has to be made on the date of the bitcoin payment. The total of these conversion amounts are still reported on 1099s and W-2s the same old way. The medium of exchange doesn't change the "substance over form test," thereby supporting a logical application by the IRS. Bitcoin miners currently earn 25 bitcoins when they successfully solve a block of transactions which means they get paid for supplying computing power to the Bitcoin network. This revenue, worth about $8,250 at the time of this writing, is considered ordinary income the same as any other business that generates revenue from selling goods or services. 

The wheel of compliance
The taxation of bitcoin is fairly logical based on the IRS property rules even if folks don't like their legal tender property conclusion. Bitcoin taxation may seem like a gift, a compliance burden, or a combination of the two; however, it's just another cog in the overall wheel of compliance. Think of the benefits as a bonus and the extra compliance as another day at the office. Businesses can also accept bitcoin with an instant fiat conversion resulting in no tax liability. The benefits of bitcoin far outweigh the cost of taxation for both individuals and businesses so give yourself the gift of bitcoins to start the New Year.

Kirk Phillips in an entrepreneur and Certified Public Accountant (CPA) passionate about technology and the possibilities for bitcoin to disrupt, decentralize and bring transparency into the business world. He is author of "The Ultimate Bitcoin Business Guide," a first of its ... View Full Bio
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