They could ask you to reveal your public bitcoin address. If they think you owe them a lot of money then I don't see them simply rolling over.


0.02btc

If they don't check (as suggested) then he might have a point but I can see it opening up a can of worms if a lot of people try it, or someone tries it for a large amount. Surely taking it offshore would be safer.

Bitcoins aren't magic, and they don't magically make income explainable.

You could just as easily say that you made the money selling lemonade on the corner, or that a rich guy gave it to you in thanks because you helped change his flat tire.

The IRS can't necessarily prove that those things didn't happen either.

Mostly, the IRS doesn't care how you made the money, as long as you have records to back up your story and you pay the appropriate amount of tax on the income.

Not true.  Perhaps you have a really successful lemonade operation, perhaps you are just really lucky and happen upon rich people who need assistance frequently. (He can give you as much as he wants, it's just that you'll have to pay some taxes on the additional amount).

It is only unverifiable if you choose not to keep records of your transactions.  That is true of any transaction that you choose not to keep records of.  The fact that someone has chosen not to keep records of some sort of transaction type doesn't automatically make all their income explainable by way of that transaction type. Regardless, the IRS will still expect you to pay tax on that income if you can convince them that you earned it trading bitcoin, so it won't really help you deal with an audit discovering unreported cash.

Perhaps, I go to garage sales and purchase items for cash.  Then I hold my own garage sales daily where I resell these items at a profit also for cash.  Does this mean I can rob a bank and claim that I earned all that cash in my garage sales?

In general, as long as I report the income and pay the taxes on it, the IRS isn't going to care whether I was buying and selling garage sale items or bitcoins.  Other government agencies however are going to be a bit more interested in how I suddenly came to acquire so much cash, and aren't going to stop looking just because I say the magic word "bitcoin".  Those other agencies will keep looking until they can either prove that I made the income via bitcoin (removing me from their suspect list), or until they discover the actual source of the cash (the bank robbery).

If you buy hardware for xxx, then sell xxx bitcoins to pay off that hardware that wouldn't count towards income, would it?

Correct, you can deduct your expenses (hardware and electricity) from your revenues.

When you sold these coins, you would owe taxes on the capital gains.

Edit: This is not tax or legal advice

You'd really have to talk to a tax professional to understand all the nuance and possibilities, but in general in the United States capital gains tax can be owed on most things that increase in value.

Some examples are:
bottles of wine, rare stamps, books, coins, antiques, gold and silver bullion

Unless the laws regarding such items have changed since I last looked into it, the short term capital gains tax rate on these times is the same as your personal income tax rate. "Short term" meaning that you held the item for less than a year.  The long term capital gains tax rate on these items was 28% the last I checked.  Note that this is a higher rate than the 15% long term capital gains tax rate for stocks and bonds.  I'm not really sure which rate should be used for long term capital gains on bitcoin.

I'm not sure that the IRS would consider bitcoin a "foreign currency", but if they do, then Publication 525 states the following:

I'm not certain what you are asking, but I think you might be asking about having to pay tax on the increased value of the bitcoin even if you don't sell/exchange it, so that is what I'll answer.

Typically, in the U.S., if an asset increases in value you don't have to pay tax on it until you use it in a transaction.  So, if you buy 100 BTC at $1 each for a total of $100, and then a year later the exchange rate is $100 per BTC, your bitcoin is worth $10,000, but if you just hold on to that bitcoin, you're not likely to owe any tax on it yet.  Now if you exchange 5 BTC at MtGox for $500 and then use an additional 10 BTC to purchase something, you'll have 85 BTC left, and be responsible for capital gains taxes on the $1500 worth of BTC that you have used.

This means that it would be possible for the BTC to be so valuable that if you used all of it in a transaction, you would owe more in taxes that you earn from your other income.  As far as the IRS is concerned, that increase in value of the BTC is income when you use it. So you are responsible for converting enough of it to USD to pay your taxes if you don't have enough left over from your other income to cover the liability.

It's the same for the other items I mentioned earlier.  If you buy a painting from an unknown artist for $100, then 5 years later the artist becomes extremely famous and your painting has an estimated value of $1 Million. You don't owe any taxes on it yet.  If you then exchange the painting for a house that is worth $1 Million, the IRS will want approximately $280 Thousand in taxes.  If you don't have the $280 Thousand from other income, you better not exchange the painting for the house.  Instead you should consider exchanging the painting for a $720 Thousand house, and include a provision in the sale whereby the seller of the house pays you $280 Thousand for the difference between the value of the house and the painting.  Now you have a $720 Thousand house, and an extra $280 Thousand you can use to pay the IRS.

Are we talking about what the law requires here, or are we talking about what people tend to get away with most of the time?

The IRS doesn't let you get away with avoiding income tax by bartering.  As an example lets say I do some work for you (perhaps painting your house?).  When it comes time to pay me for the work I've done, instead of paying me with cash we barter and you agree to give me your dining room set (perhaps you are planning on replacing it?). As far as the IRS is concerned, I earned an income equivalent to the fair market value of that dining room set, and you earned an income equivalent to the fair market value of the house painting that I did.  We are both required to report this income and pay any necessary taxes on it.

So, if you buy 5 BTC for $10 each, and then use the 5 BTC to buy something worth $50, then you don't have any capital gains income.  The value of the BTC hasn't increased between the purchase of the BTC and the exchange for merchandise.  You paid your income tax on the $50 when you earned it, before you bought the BTC.  It is only when you hold those BTC long enough for them to increase in value that the IRS wants you to pay capital gains income tax on the increased value of the BTC.

Also, note that when you make a purchase of a new item from a business that resides in the same state as you (even over eBay), if your state has a sales tax (some states don't) that business is supposed to collect sales tax from you, report it, and pay it to the state.  Not all businesses do this, but that doesn't mean that they aren't legally required to, it just means that they get away with tax evasion.

What surprises a lot of people is that if you purchase something from a business that does not reside in your state (mail order, phone order, internet order), even though that business does not collect the sales tax from you the law still requires that you report the sale and pay a "use tax" directly to the state for the purchase.  A whole lot of people aren't even aware that they are engaging in tax evasion when they don't do this.

A big return just means that you paid too much taxes throughout the year.  Basically you gave the government an interest free loan for a year.  Instead of having that money available to you throughout the year when it might have been useful, you let the government use it free of charge, and then they just pay you back your money that they've been using throughout the year when you file your taxes between January 1 and April 15.

Generally it would be better to have your employer adjust your withholding so that when it comes time to file your tax forms, you neither owe anything nor get a refund.  Then you'll get all that extra money spread out throughout the year ahead of time.  You can then use it (to buy BTC?), put it in an interest bearing account, or loan it to someone who will pay you interest (and who you can rely on paying you back).