This time last year, hardly anyone bothered to Google “Bitcoin”. Today it is one of the hot topics on search engines. Stories about wildly increasing Bitcoin value fuels hope for quick profits. We are not far from speculators of gold rush times. Stories abound of those who got Bitcoin worth pennies, now reportedly worth thousands. Where are the wagons and the picks?
The IRS gets very edgy when it does not understand something that doesn’t fit existing categories. A virtual item, not under control of a single person…can be used as a store of wealth or medium for payment…no paper trail. A taxman’s nightmare.
In a way, it’s somewhat akin to recent medicinal marijuana operations. There is the potential to accumulate significant income. The IRS response there? Aggressive auditing.
This is my list of concerns: One can receive or make payments with little or no trace or evidence of ownership; no (US) currency reporting requirements, hard to detect taxable events (earning Bitcoin by “mining”, gains by sale of appreciated Bitcoin, by bartering it away or earning Bitcoin by providing goods or services).
It is important to understand that the IRS considers Bitcoin as property. When given away or exchanged, it can give rise to tax liability. Recordkeeping is very important, since Bitcoin may have been acquired at various values and disposed later at yet other values. Anyone who buys or sells stock is familiar with the kind of extensive recordkeeping requirements needed to show basis on a sold stock. Sold for $100, bought at $50 (its tax basis), tax gain of $50. If you can’t prove basis, the IRS will say it was all gain. That’s why recordkeeping is important.
At any given time you may have gains or losses, simply by using Bitcoin you may have acquired. That’s a disadvantage over using a dollar note, one you spend without worry about its worth when you got it.
I’ve written earlier about how the IRS succeeded in getting Bitcoin records from one provider, Coinbase, so it may not be too anonymous. Possession of Bitcoin may not require you to do anything; but using Bitcoin may give rise to federal and state liabilities, and perhaps elsewhere too.
There is precious little guidance on how to stay tax compliant with Bitcoin, and it will definitely require meticulous record keeping. Another challenge: tax professionals are just beginning to wrap their hands around Bitcoin. How will return preparer advise effectively if they themselves do not fully understand? IRS auditors may fare no better. Prepare!