Michaela Merz

USA – tax regulation of bitcoins and other crypto currencies

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IRS (internal revenue service), the US tax authority, published this year (March 25, 2014) a clear guidance (Notice 2014-21) on how the tax principles apply to transactions involving bitcoins and other crypto currencies. It is not a new law but just an interpretation of how the existing law should be applied to the new technology. It describes how Bitcoin and other crypto currencies transactions should be taxed. “The sale or exchange of convertible virtual currency or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction has tax consequences that may result in a tax liability”. For federal tax purposes, crypto currency is treated as a property and not as a currency. As such, gains and losses on the disposition of Bitcoins and other crypto currencies can never be exchange gains or losses. This may be frustrating to taxpayers who lost money in Bitcoin investments as these losses cannot be seen as exchange-losses (relevant tax losses).

Payment of $ 600 or more to an independent contractor for the performance of services or goods using crypto currency is subject to information reporting as well as subject to backup withholding to the same extent as any other payment made in property. The payments are subject to backup withholding to the extent the payor is unable to solicit the required tax information from the payee. The current tax system is built on the assumption that parties to a taxable transaction know each other. Bitcoin however allows the exchange of value without the parties to a transaction ever knowing each other. Therefore Bitcoin payors cannot always say whether done payments are made to the same person or to different persons. It is thus difficult to be certain whether the threshold of $600 was reached.

The basis of crypto currency that a taxpayer receives as payment for goods or services, as a salary, rent, wage, premium, annuity or compensation is the fair market value of the virtual currency in dollars as of the date of receipt. Payment in Bitcoins for goods and services is taxable if the value of the Bitcoin used changed since the time when it was acquired. For example if the taxpayer bought 1 Bitcoin for $ 350 and uses the Bitcoin later to buy a service when the market value of Bitcoin increased to $ 400, the taxpayer is obliged to tax the gain of $ 50. Therefore the value of Bitcoin has to be exchanged in US Dollar to calculate the gain or loss. “Fair market value is determined by reference to the BTC/USD price quoted in an online exchange if the exchange rate is established by market supply and demand. The problem with this determination is that there are multiple exchanges, and the BTC/USD spot price may vary significantly among such exchanges”. Theoretically it means that the price of a Bitcoin has to be recorded at every purchase.

Mining activity is taxable

When a taxpayer successfully mines crypto currency, the fair market value of the crypto currency as of the date of receipt has to be taxed as part of the gross income.

For more details see:

http://www.irs.gov/pub/irs-drop/n-14-21.pdf

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