Bitcoin is going to be treated like property, not currency, for tax purposes, the Internal Revenue Service said in a notice released today.
While the IRS acknowledged that virtual currencies operate like "real" currencies and can be used to buy and sell goods and services, it also notes that these virtual currencies aren't accepted by any country as "legal tender."
The IRS has been wrangling for months over what to do with virtual currencies as their popularity has soared. Today's decision had been expected by many tax experts and bitcoin enthusiasts, says Tyson Cross, a tax attorney in San Diego who also runs a site called Bitcoin Tax Solutions.
"It's not very surprising," Cross says of the IRS notice. He says it probably would have taken a longer period of proposed regulations and public comments, perhaps even some amendments from Congress, for bitcoin to have been labeled a foreign currency.
Today's notice provides some clarity to those who have been using or accepting virtual currencies, but it also means that bitcoin users will have extensive record-keeping duties to be compliant, Cross says.
"Every transaction is taxable," he says. Cross says that such an onerous burden, combined with the difficulty the IRS would have in tracking bitcoin transactions, could make this difficult to enforce with casual or small-time bitcoin users.
Under the IRS ruling, wages paid to employees using virtual currency must be reported on a Form W-2 and are taxable. A taxpayer receiving bitcoin in exchange for goods or services must include the fair market value of the bitcoin, defined as its U.S. dollar value on the day it was received, in his or her gross income reporting.
Bitcoin miners must include the value of what they mine in their gross income. And if that mining constitutes a trade or business, the miner must also pay self-employment tax.
Cross says that defining virtual currencies as property means that consumers can get long-term capital gains, which they wouldn't have been able to get if it had been labeled a foreign currency.
Cross says the bottom line is that the IRS is just cementing the idea that transactions made with virtual currencies are taxable transactions. "Someone who was an early adopter and is sitting on $5 million in bitcoins and uses them to buy a yacht ... this is a taxable transaction," Cross says.
The IRS' decision goes into effect immediately and includes past transactions made with virtual currencies. However, the IRS says it may offer "penalty relief" to people who are able to show reasonable cause as to why they underfiled or didn't properly file tax returns.
The Treasury Department and the IRS also are soliciting comments about other aspects of virtual currency transactions that should be addressed in future guidances.
What do you think of this IRS notice? And where do you see virtual currencies heading in the next year or two?