There is similarity, but according to tax law mining specifically refers to extracting natural resources such as oil, coal, gas, etc.

Art or music that is created is not a taxable event.  It would not be taxed until it was sold.  Depending on how widely bitcoins are adopted, it is very possible that they will be treated the same.  However, if bitcoins really take off then mined bitcoins could be taxed upon mining.  This is especially true if they become a 'pseudo-currency'.

Now, in the case of tax treatment of a bitcoin upon discovery, there really isn't a good precedent in my opinion.  It is very possible that your music analogy will be the correct treatment, at least in the beginning, as

I agree with you, there has to be a third party if people want to be able to use bitcoins over the internet and have significant protection against fraud. 

I am just throwing out some ideas on how it could be implemented. 

Escrow services would not work for this type of application, unless merchants want to manually confirm every time they receive a bitcoin.  This is especially true considering that bitcoins cannot be considered 'spent' until they are treated so by the network, which takes a few minutes.

Having a separate registration system where bitcoin wallets are connected to bank accounts or some other form of money which is verifiable online allows instant verification, as 'bad' bitcoins are backed up by the online account, whether that is a credit card, bank account, etc.

Bitcoins are certainly fungible.  Fungible just means that they are a commodity that can be substituted. Just because you can specifically identify the acquisition or disposal of a particular bitcoin doesn't mean that one is any more or less useful or valuable.  I can specifically identify exactly the same information with stocks, bonds, options, etc.  

Also the cost basis of financial instruments is either determined through FIFO or specific identification. LIFO is not an option.

Pub 550 has more details here

http://www.irs.gov/publications/p550/ch04.html

That may be the generic definition of income, but not the tax definition.   You are using a furniture analogy, but that is not valid here, as furniture is tangible personal property, and would be treated as inventory by someone manufacturing them.  Bitcoins are either going to be considered intangible personal property, or most likely some type of financial security.  They cannot be considered inventory, because that has to be tangible.

Really it depends on what happens to bitcoins going forward.  If we assume they become a new type of currency or means of exchange, they will probably be treated more along the lines of a financial instrument.  If they don't become a new type of currency or means of exchange, it probably doesn't matter as their value in that case would probably fall to immaterial levels.

As for the pool analogy, I agree.

Mining gold and mining bitcoins might sound similar because they are both "mined", but from a tax perspective they are not similar at all.  You cannot "mine" intangible personal property.

In the event that you are running a gold mine, the simple answer is you would be taxed on the value of the gold you mined, less the cost to mine it.

 

Exactly.  Tons of people seem unable to get their money into Mt Gox to trade.  Look at some other places where people are able to buy bitcoins easier, such as ebay, where they are selling for ~$40+ each.

Whether bitcoins are successful long term or not is debatable, but it seems clear that there is at least a large amount of pent-up demand at MtGox waiting to buy bitcoins.  Certainly this bodes well for the short term prospects of bitcoins.

I am just spitballing here, throwing out an idea I was tossing around in my head.

Maybe someone could set up a bitcoin registration site, where people could link their bitcoin address and their  credit card, and confirm them somehow.  Im not sure exactly how it would work, but basically you would have an account on the site.  The site would come up with some kind of registration process where they would confirm your credit card and your bitcoin address.

Then, when people wanted to trade with each other , they could trade with other people on the site.  This way they would know they were safely trading bitcoins & credit card numbers with people who were verified by the registration process.

Now, since all transactions are public, they would be able to verify that person A sent bitcoins to person B, in the case of a dispute or chargeback.

The person buying the bitcoins wouldn't  be able to claim it was fraud, because there would be a record of the transfer between the seller to the buyer's bitcoin account.  No one could say their credit card was stolen and the thief sent bitcoins to the victim's bitcoin account!

Now, perhaps this site could also let merchants set up accounts, and the site could then process a customer's credit card payments into bitcoins, or bitcoin payments into cash in the merchant's bank account.

As for paypal, I think that they are probably a lost cause.  According to their TOS, they do not allow these types of transactions, right now they probably consider bitcoin as a potential competitor.  Perhaps if someone higher up in the paypal corporate structure was able to work directly with the bitcoin community, this would change, but otherwise it seems like btc/paypal transactions are going to be much too risky, from a fraud perspective.

Any thoughts on this?  Obviously this would take quite a bit of programming, and there are definitely some legal issues, as far as licensing as a money transferring business, etc. 

The fact that these types of transactions are NOT anonymous will certainly help prevent "conspiracy to engage in money laundering" type charges.

SgtSpike is correct.  Inventory cannot be intangible.

This is my personal attempt to give my best opinions on accounting/tax questions related to bitcoins.  Whether or not you pay any taxes is between you and your own government, this is simply a way to share some information with people who are interested in the bitcoin market and potential US tax implications.  Keep in mind, bitcoins are so new that the IRS has not really released any answers as to how bitcoins are going to be treated in the future, so these answers are my best reasonable assumptions as to their treatment under current tax law. 



As for my qualifications, I am an accountant in the US, and am (hopefully, waiting on a test score)  just about finished completing the requirements for my CPA license.  I am in the early stages of building my own accounting and bookkeeping business, and am working on setting up a website, developing it, etc.

Are bitcoins taxable if I earned them by doing a service for someone else, or received them in exchange for something?

Anything that you receive as payment for goods or services is generally taxable income unless it is specifically exempted.

That means, if you mow your neighbor’s lawn, it doesn’t matter if he pays you $20 in cash, or $20 worth of bitcoins.  (Or $20 worth of tomatoes for that matter)

You are still legally required to report it to the IRS as income.  Now, if you don’t, the IRS will probably never know, but try to mow 10,000 neighbor’s lawns and not report the income,and you will be much more likely to get caught.

Are my bitcoins taxed as income, or as capital gains?

Income that is earned through the exchange of services with another person, whether in the form of bitcoins, dollars, or barter; is included in gross income, and would be subject to income tax at applicable rates.  Also these bitcoins would be subject to self employment tax.

Income earned through the process of buying and selling bitcoins would also be included in gross income, but would be treated as capital gains. 

How are bitcoins that I have mined treated for tax purposes?

This is a tricky question, in that bitcoins are really the first digital currency that was created in this manner and actually have a significant value in USD.  Essentially it is somewhat uncharted territory.  Literally bitcoins, and even digital currencies are so new, that there is little to no precedent for some aspects of bitcoin mining, from a tax perspective.

Since bitcoins are currently traded in various online marketplaces, when someone receives a bitcoin, they can reasonably calculate it’s value in USD.  Because of this, it is possible that the IRS will treat the receipt of a bitcoin through a mining pool, or from an individual mining operation, as a taxable event.  At that time, the taxpayer would be required to estimate the value of the bitcoins in dollars and record that amount.  This would have to be done either daily or weekly depending on the value of the bitcoins if their value keeps fluctuating as much as it has the past few weeks.  These amounts would be recorded as revenue from bitcoin mining operations and would be taxable less allowed expenses.

When selling mined bitcoins, however, you would also be taxed on the increase between the value you recorded them at when you first received them, and the value you sold them for. 

Another possibility is that the government will consider mined bitcoins  ‘intangible personal property’.  As a rule, however, financial instruments are excluded from this particular category.  The question is, are bitcoins a financial instrument, or rather, will the IRS consider them a financial instrument?  We will have to wait and see if bitcoins become popular enough for them to take a position on that.




What expenses can i deduct/expense/itemize if I set up a bitcoin mining operation?

That depends on your situation.  Generally speaking, though, you can deduct business expenses that are ordinary and necessary.  Buying video cards would be both of these, buying a big screen TV to watch while mining would be neither.



Do I need to register as a business/LLC/corporation to mine bitcoins and deduct expenses?

No, regardless of whether you decide to form a corporation, register as an LLC, or simply operate as a private individual, the basic concept of tax treatment for bitcoins is going to remain the same.  For example, you will report gross income, deduct expenses, and have a net taxable income on which you will be required to pay income tax, as well as possibly self employment tax depending on how your mining business is set up.



Here are a few links that contain some basic information from the IRS on tax rules for starting a small business, as well as treatment of income and expenses.

Pub 4591 Small Business Tax Responsibilities
http://www.irs.gov/pub/irs-pdf/p4591.pdf
Pub 525 Taxable and Nontaxable income
http://www.irs.gov/publications/p525/ar02.html#en_US_2010_publink1000229086
Pub 535 Business Expenses
http://www.irs.gov/publications/p535/index.html

Please feel free to ask me any questions about bitcoins (or anything else accounting/tax related) in this thread, and I will do my best to answer.