A growing number of individuals and businesses own bitcoin or use it for transactions (perhaps with a third party actually handling the bitcoin to cash exchange). So, more people, including tax practitioners, need to know the federal guidance at
Notice 2014-21.
I was interviewed recently for an article in
Business Insider by Jonathan Marino on the topic. The article is titled:
"Bitcoin will be a big mess for both Bitcoin holders and the IRS." That may be true for some, but it doesn't necessarily have to be.
Certainly, if an individual has been using bitcoin regularly and not doing anything to track the basis and value for each transaction, they have some catching up to do. If someone gets on a system of tracking, they should have the data all ready when it comes time to file their income tax returns. And, there are tools available to assist with this. Your bitcoin wallet should help. And, there is specific software, such as that from
LibraTax (note, I'm on their tax advisory board).
The IRS guidance says that virtual currencies are property (not currency). So, each time you use bitcoin to buy something, you have bartered (exchange of property for property or services). The tax effect with respect to the bitcoin is that you basically sold it for the value of the item you received (clothing, coffee, haricut, etc.). So, you need to know the basis of the bitcoin you used and when you acquired it. So you can determine the amount of the gain or loss and whether long-term (over one year) or short term.
Challenges include though:
- Knowing the basis. You might not easily be able to tell which bitcoin you used. Best to use multiple codes to help. If you really cannot tell, can you default to a FIFO system? The law doesn't provide for that, but if you can't do anything else, perhaps it is better than nothing. This is something the IRS needs to address - and soon.
- If you have a gain, it is taxable.
- If you have a loss, it might not be usable. If all you do with your bitcoin is use it for personal purchases, the bitcoin sounds like a personal use asset and you can't claim such losses (you do have to pay tax on such gains though). Are you holding your bitcoin for investment? Then it is the same rules for when you hold corporate stock. What if you hold it for both? Identify for each transaction, how you held that bitcoin (sounds odd, but that is what the federal tax rules on property call for). You could separate the virtual currency into multiple wallets - one for investment and one for personal use. That would make it all easier.
The IRS sought comments when it released guidance back in March 2014. It doesn't look like they got many so far. A few areas where guidance would be extremely helpful for indviidauls are:
- Allow for FIFO for tracking basis (or perhaps also a LIFO option).
- State what are reasonable methods for identifying the value when used (which exchange rate to use, use of an average for the day or the week, etc.)
- Push Congress to provide a rule similar to that for foreign currency (IRC Section 988(e)) that for a de minimis amount of virtual currency held for personal use ($200 is the Section 988(e) amount), there is no need to deal with gains and losses from using it (so no need to track).
Practitioner tip: Be sure to ask all of your clients if they own or use virtual currency so you don't miss it for their 2014 income tax returns.
And more from my 12/19/14 post on SalesTaxSupport.com on sales tax and bitcoin:
New types of transactions often challenge existing rules
designed without such transactions in mind. The use of virtual currency, such
as bitcoin, may be another example. The IRS has proclaimed that convertible
virtual currency should be treated as property for federal tax purposes (rather
than as a foreign currency) (see Notice 2014-21).
If states take a similar approach (which seems likely), would
obtaining bitcoin from someone for cash be subject to sales or use tax? It
seems like a "sale" of property. However, virtual currency is
intangible and most states (perhaps all) would not include it in the sales tax
base (today).
A few states have issued statements or guidance on virtual
currency. For example, in June 2014, the California Board of Equalization
issued a special notice - Accepting Virtual Currency
as a Payment Method. The BOE points out that
"The measure of tax is the total amount of the sale or lease, whether
received in money or other consideration." Records should be kept that
show the amount charged. For example, to show the price charged for a meal, a
restaurant should keep a copy of the menu. The BOE notes that it does not
accept payment in virtual currency. There was no mention of sales tax on
virtual currency, but California would not tax it as the state has mostly a
tangible personal property base.
In September 2014, the Missouri Department of Revenue
issued LR 7411 (9/12/14).
Here, Taxpayer (T) provides ATMs that enable customers to obtain bitcoin.
Customers insert paper currency and obtain bitcoin on their electronic wallet.
T is not a bitcoin exchanger and does not produce bitcoin. The question
presented to the DOR was whether T is required to collect sales tax when it
transfers bitcoin to customers. The DOR said no because the item transferred it
intangible and not subject to sales tax.
And on December 5, 2014, the New York State Dept. of Revenue and
Taxation issued TSB-M-14(5), (7)I,
17(s)covering sales tax and income tax. For sales tax, the ruling
explains that use of virtual currency to pay for purchases results in a barter
transactions (following the property approach of the IRS notice).
Per the NY ruling: "A barter transaction is actually
comprised of two separate sale transactions. Each party to a barter transaction
gives something of value to the other party in order to receive something of
value in return. In a barter transaction, sales or use tax (sales tax) is due
from each party based on the value of the property or services given in trade
if what is received in exchange is subject to sales tax. Services given in trade
are taxed based upon a party’s normal charge for the service it provides."
An example is provided of a home décor vendor accepting virtual
currency from customers. As a barter transaction, this means that the customer
receiving the décor items owes sales tax (to be collected by the vendor). The
transaction amount is based on the value of the virtual currency at the
time.The vendor received virtual currency, but no sales tax is owed because it
is intangible and not subject to sales tax in New York. The vendor is to record
the sale based on its value in US dollars and remit the sales tax in US
dollars. No guidance is given as to what exchange table to use to determine the
value of the virtual currency in US dollars at the time of the transaction.
If a state imposed sales tax on virtual currency or it fell
within an existing definition of taxable digital goods or a taxable intangible,
there could be double taxation because the merchant is really accepting
the virtual currency as a cash equivalent. Returning to the home décor example
above, each party would owe sales tax on the exchange if the sales tax base
include virtual currency. And, if the vendor converts the virtual currency to
cash (that is, sold it to someone for cash), sales tax would be charged on that
transaction too. That seems a bit odd, but appropriate unless an exception is
provided for the cash to virtual currency conversion. Australia has proposed that double
taxation results with its goods and services tax (VAT).
As states continue to broaden and modernize their sales tax base
for our modern world (the one where some tangible goods are replaced with
digital ones), consideration will need to be given as to whether the exchange
of virtual currency for cash should be exempted, at least for merchants.
What do you think?
