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Bitcoin tax uncertainty

By Kay Bell ·
Tuesday, January 28, 2014
Posted: 4 pm ET

Do you own any Bitcoin? Do you know how it is taxed?

Don't worry. Neither does the Internal Revenue Service.

In an emailed statement about the tax treatment of Bitcoin, the agency said, "The IRS continues to study virtual currencies and intends to provide some guidance on the tax consequences of transactions involving them. The agency is also aware of the potential tax compliance risks posed by virtual currencies."

I understand that it's a new, complicated matter. But the IRS needs to decide, and soon.

Bitcoin pros, cons

In December 2013, the Congressional Research Service's report Bitcoin: Questions, Answers, and Analysis of Legal Issues" highlighted the currency's pros and cons.

"Bitcoin offers users the advantages of lower transaction costs, increased privacy, and long term protection of loss of purchasing power from inflation," wrote CRS analysts. "However, there are also a number of disadvantages that could hinder wider use. These include sizable volatility of the price of Bitcoins, uncertain security from theft and fraud, and a long term deflationary bias that encourages the hoarding of Bitcoins."

When it comes to government involvement, CRS noted that the virtual currency "raises a number of legal and regulatory concerns, including its potential for facilitating money laundering, its treatment under federal securities law, and its status in the regulation of foreign exchange trading."

Bitcoin tax implications

And there are, of course, the tax implications. When the IRS finally decides, the determination of whether Bitcoin should be treated as a currency, commodity or asset will establish the ultimate reporting requirements and how much tax its owners will owe.

It's obviously not going to be an issue for the 2013 tax year. Even if the IRS came up with a Bitcoin tax plan soon, implementing it in the midst of an already delayed tax filing season would be a practical and public relations headache of major proportions.

But the agency, and taxpayers, can't afford to wait much longer.

Individuals who own and use Bitcoin need some certainty. So do the businesses that already accept it.

Financial institutions also are demanding guidance on their responsibilities in dealing with Bitcoin owners. A group of finance executives, virtual currency experts and government representatives met earlier this month at a Bitcoin summit to discuss the matter.

Tax treatment certainty urged

Heck, even the U.S. Treasury could use the taxes that Bitcoin transactions could produce.

But exactly how Uncle Sam would get his hands on Bitcoin taxes is still up in the air.

That uncertainty is unacceptable, says the National Taxpayer Advocate Nina Olson, who included the issue in her latest list of most serious problems for taxpayers. Coming in at number 24 (of 25), it was the second time that Olson had urged the IRS to address virtual currencies. She also addressed the topic in 2008.

In her 2013 report to Congress, Olson chided the IRS for delaying action as Bitcoin usage has skyrocketed. The market value of Bitcoins in circulation increased during the last half of 2013 more than tenfold, said Olson, going from about $1.1 billion to $12.6 billion.

"However, the IRS has yet to issue specific guidance addressing the tax treatment or reporting requirements applicable to digital currency transactions. People who are trying to comply with these rules have complained that they are unsure about them. Thus, IRS-issued guidance would promote tax compliance, particularly among those who want to report digital currency transactions properly, and it would reduce the risk that users of digital currencies will face tax consequences that they did not anticipate," wrote Olson.

And everybody knows that the only thing worse than tax consequences are unanticipated tax consequences.

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Veteran contributing editor Kay Bell is the author of the book "The Truth About Paying Fewer Taxes" and co-author of the e-book "Future Millionaires' Guidebook."

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