What is Bitcoin? IRS says it knows

Stock Investors

The IRS ruling means Bitcoin investors will be treated like stock investors. Bitcoins held for more than a year and then sold would face the lower tax rates applicable to capital gains -- a maximum of 23.8 percent compared with the 43.4 percent top rate on property sold within a year of purchase.

“The Internal Revenue Service’s guidance today provides clarity for taxpayers who want to ensure that they’re doing the right thing and playing by the rules when utilizing Bitcoin and other digital currencies,” Senator Thomas Carper, a Delaware Democrat, said in a statement.

For investors with losses, U.S. tax law allows taxpayers to subtract capital losses from any capital gains. They can also subtract as much as $3,000 of capital losses a year from ordinary income.

If Bitcoin were treated as a foreign currency, ordinary -- not capital gains -- tax rates would apply. Losses would be easier to deduct, however.

Capital Gains

As with stocks, Bitcoin dealers will be subject to different rules that wouldn’t allow for capital gains treatment.

Bitcoin miners will have to report their earnings as taxable income with a value equal to the worth on the day it was mined. If they mine as part of a business, they would have to pay payroll taxes as well.

The IRS will require information reporting similar to how the tax agency receives notification of stock transactions and payments to independent contractors.

“The danger is the creation of an electronic black market, similar to the cash economy,” Joshua Blank, a tax law professor at New York University, said in a December interview. “That’s what the IRS wants to avoid.”

The ruling takes effect immediately and covers past and future transactions and tax returns. The IRS said in the notice that it may offer relief from penalties to people who engaged in transactions before today and can show “reasonable cause” for underpayments or failure to file.

The ruling comes fewer than three months after National Taxpayer Advocate Nina Olson said the IRS should issue guidance to taxpayers on digital currency transactions.

“It is the government’s responsibility to inform the public about the rules they are required to follow,” Olson, who runs an independent office within IRS, wrote in her annual report to Congress in January. “The lack of clear answers to basic questions such as when and how taxpayers should report gains and losses on digital currency transactions probably encourages tax avoidance.”

 
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