Bitcoin and Taxes - Not that complicated

[evoorhees]

The fact that we posted about taxes may be somewhat controversial, but we felt it was important that the powers that be not get frightened by the weird new Bitcoin thing. By posting, hopefully we can help sculpt the dialogue in a proactive way.

http://blog.bitinstant.com/blog/2012/11/12/bitcoin-and-taxes-not-that-complicated.html

[evoorhees]

One thing is wrong with your analogy, your keep comparing the income in the amount of other "Currencies". Bitcoins has yet to be recognized as a currency by the government, so it is a commodity, not legal tender. So it would be more correct and better to compare it to lets say casino tokens. If you have $10,000 in casino tokens do you report that winnings to IRS, of course not, but as soon as that is converted to a recognized currency, then you report the winnings. That is how Bitcoins is treated and the only way it can be treated. Lets say I have BTC1000 obviously you can report bitcoins as bitcoins, so another area is the value is always changing so lets say one year I file on those BTC1000 and the mt gox price is $10 so I keep the bitcoins as bitcoins and pay taxes on $10,000. But next year those same coins are only worth $5, can i report I took a lost $5,000. Obvious answer is no but it should be yes cause it is commodity and having it's value determined by outside forces, of the market.

Good points gweedo and perhaps a real accountant is needed to clarify this. You're correct that until Bitcoin is recognized as a "Currency" (let's use the capital "C" version of the word) it is more like poker chips or pounds of rice or bars of gold.

Any accountants here? If I'm given $100,000 worth of gold or oil or rice, do I report that or wait until it's been sold for a currency?

(In truth, of course, Bitcoin is a commodity-money or commodity-currency, just as gold or silver coinage. This is what Bitcoin properly is by nature, but how the law observes and treats it may be different.)

[DeathAndTaxes]

One thing is wrong with your analogy, your keep comparing the income in the amount of other "Currencies". Bitcoins has yet to be recognized as a currency by the government, so it is a commodity, not legal tender. So it would be more correct and better to compare it to lets say casino tokens. If you have $10,000 in casino tokens do you report that winnings to IRS, of course not, but as soon as that is converted to a recognized currency, then you report the winnings. That is how Bitcoins is treated and the only way it can be treated. Lets say I have BTC1000 obviously you can report bitcoins as bitcoins, so another area is the value is always changing so lets say one year I file on those BTC1000 and the mt gox price is $10 so I keep the bitcoins as bitcoins and pay taxes on $10,000. But next year those same coins are only worth $5, can i report I took a lost $5,000. Obvious answer is no but it should be yes cause it is commodity and having it's value determined by outside forces, of the market.

That isn't even close to true in the US.  If you earn income in ANYTHING it is taxable when the income is earned.

For example lets say you make a website for me and I pay you in a 1 oz gold coin (hypothetical value at time of transaction $1,700)? What is your tax liability?  By your logic nothing until you sell the coins.  The reality is you have gained income (by IRS definition) of $1,700 at the point I give you the coins.   When you sell the coins you may also incur a capital gain (or loss) but that is independent of the income.    What about unique items?  You build a luxury house for me and I pay you with a Rembrandt original valued at $2.8 million.   Your tax liability?  $2.8 million in income.  It doesn't matter how you get paid, it is income, and it is taxable.


How about pure barter of services?  Your make a website for your dentist and he fills in your cavity.  Once again both of you gained taxable income.  The amount taxed is the "fair market value" of the services.   Income is always taxed at the point it is earned.  It doesn't need to be paid in dollars.  If you receive anything of value for just about any reason it is taxable.  For example say you win a car in a sweepstakes.  Yup you owe taxes on the income value of the car.  $50K car = $50K in income seen by the IRS; have your checkbook ready.   Obviously your casino chip claim is false.  One could simply use casino chips as a proxy (i.e. live in Vegas and pay all your bills by casino chips) and never incur any taxes on casino winnings for life.

More on IRS & Barter:
http://www.forbes.com/2009/11/11/irs-tax-barter-exchange-income-personal-finance-wood.html

The IRS starts with a down-home definition. Bartering is trading one product or service for another, whether informally and one-on-one or with multiple parties in a commercial setting. It has a storied, even ancient tradition. "Our ancestors may have exchanged eggs for corn," explains the IRS, but "today you can barter computer services for auto repair." The IRS also lists plumbing services for dental work. You name the swap, the IRS wants to tax it.

Wherever it [barter] arises, it is income to both sides, just like cash, according to the IRS. That means each side must report the fair market value of the item or services received on their tax returns.

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Bartering-Tax-Center

For a second think about it this way.  If income wasn't taxed until converted to dollars it would be trivially easy to never pay any taxes ever for your entire life by never converting to USD.   i.e. I trade you 1000 shares of xyz inc for 20 oz of gold.  I then take the 20 oz of gold and trade them for a years worth of dedicated server hosting.  The webhosting company trades the 20oz of gold for food at the local grocer to feed his family for the next two years.  Nobody has any income?  Nobody has any taxes?  Really does it even seem plausible the IRS didn't notice this massive loophole.



The only time that taxable events are limited to the time of sale is on capital gains.   So if you purchase a gold coin (or oil futures, or home, etc) for $1,700, and the price of gold goes up to $1,800 how much taxes are due?  That's right; none.  The event is a capital gain and only becomes taxable when the asset is sold.  5 years later you sell the gold coin for $2,000 and incur a $300 capital gain which is taxed based on the year you sold the coin.

Note the two can be combined.  Going back to the website.  Say gold was worth $1,700 at the time the site was made.  You incur $1,700 taxable income.  You pay your taxes, and decide not to sell the coin.  You keep it for a couple years and sell it for $2,000.   You incur a $300 capital gain.  Why $300 and not $2,000.  The $1,700 becomes your basis because it was treated at income at the time you acquired the coin.  On the otherhand say gold tanks to $1,200.  You would have $1,700 income when paid in gold and a $500 tax deductible capital loss on the year you sold the coin.  It is possible both events could occur in the same year but they are independent events.

[DeathAndTaxes]

Any accountants here? If I'm given $100,000 worth of gold or oil or rice, do I report that or wait until it's been sold for a currency?

Income is always taxed when it is earned.

If someone paid you:
$100,000 in dollars,
$100,000 in Euros,
$100,000 in gold,
$100,000 in oil,
$100,000 in BTC

it doesn't matter in all four events you incurred an income of $100,000 (or equivalent) and owe taxes on the income.  Failure to include that income on current year's income tax return would be considered tax evasion.

Now if someone gifts it to you (or it is an inheritance) there will be no taxes due (w/ certain limitations) but once again the IRS would see that as a gift of $100K regardless of the form the gift occurred in. 

[ArticMine]

One thing is wrong with your analogy, your keep comparing the income in the amount of other "Currencies". Bitcoins has yet to be recognized as a currency by the government, so it is a commodity, not legal tender. So it would be more correct and better to compare it to lets say casino tokens. If you have $10,000 in casino tokens do you report that winnings to IRS, of course not, but as soon as that is converted to a recognized currency, then you report the winnings. That is how Bitcoins is treated and the only way it can be treated. Lets say I have BTC1000 obviously you can report bitcoins as bitcoins, so another area is the value is always changing so lets say one year I file on those BTC1000 and the mt gox price is $10 so I keep the bitcoins as bitcoins and pay taxes on $10,000. But next year those same coins are only worth $5, can i report I took a lost $5,000. Obvious answer is no but it should be yes cause it is commodity and having it's value determined by outside forces, of the market.

That isn't even close to true in the US.  If you earn income in ANYTHING it is taxable when the income is earned.

For example you make a website for me and I pay you in 1 oz gold coin? What is your tax liability?  By your logic nothing until you sell the coins.  Try doing that and watch the IRS seize everything you own.  You incur a tax liability of income = USD value of 1 oz gold at the time I paid for the site.  You build a luxury house for me and I pay you with a Rembrandt original valued at $2.8 million.   Your tax liability?  $2.8 million in income.  It doesn't matter how you get paid, it is income, and it is taxable.   


How about pure barter of services?  Your make a website for your dentist and he fills in your cavity.  Once gain income.  The amount taxed is the value of the services.   Income is always taxed at the point it is paid.  It doesn't need to be paid in dollars.  If you receive anything of value for just about any reason it is taxable.  For example say you win a car in a sweepstakes.  Yup you owe taxes on the income value of the car.  $50K = $50K in income seen by the IRS have your checkbook ready.   Obviously your casino chip claim is false.  One could simply use casino chips as a proxy (i.e. live in Vegas and pay all your bills by casino chips and thus never incur any taxes on casino winnings.

More on IRS & Barter:
http://www.forbes.com/2009/11/11/irs-tax-barter-exchange-income-personal-finance-wood.html

The IRS starts with a down-home definition. Bartering is trading one product or service for another, whether informally and one-on-one or with multiple parties in a commercial setting. It has a storied, even ancient tradition. "Our ancestors may have exchanged eggs for corn," explains the IRS, but "today you can barter computer services for auto repair." The IRS also lists plumbing services for dental work. You name the swap, the IRS wants to tax it.

Wherever it arises, it is income to both sides, just like cash, according to the IRS. That means each side must report the fair market value of the item or services received on their tax returns.

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Bartering-Tax-Center

For a second think about it this way.  If income wasn't taxed until converted to dollars it would be trivially easy to never pay any taxes ever for your entire life by never converting to USD.   i.e. I trade you 1000 shares of xyz inc for 20 oz of gold.  I then take the 20 oz of gold and trade them for a years worth of dedicated server hosting.  The webhosting company trades the 20oz of gold for food at the local grocer to feed his family for the next two years.  Nobody has any income?  Nobody has any taxes?  Really does it even seem plausible the IRS didn't notice this massive loophole.



The only time that taxable events are limited to the time of sale is on capital gains. i.e. you BUY (using USD or other income which has already been taxed) 1 gold coin (1oz) for $1,700 the price of gold goes up to $1,800 how much taxes are due?  None.  The event is a capital gain and only occurs when the asset is sold.  5 years later you sell the gold coin for $2,000 and incur a $300 capital gain which is taxed based on the year you sold the coin.

Note the two can be combined.  Going back to the website.  Say gold was worth $1,700 at the time the site was made.  You incur $1,700 taxable income.  You pay your taxes, and decide not to sell the coin.  You keep it for a couple years and sell it for $2,000.   You incur a $300 capital gain.  Why $300 and not $2,000.  The $1,700 becomes your basis because it was treated at income at the time you acquired the coin.

Any accountants here? If I'm given $100,000 worth of gold or oil or rice, do I report that or wait until it's been sold for a currency?

Income is always taxed when it is earned.

If someone paid you:
$100,000 in dollars,
$100,000 in Euros,
$100,000 in gold,
$100,000 in oil,
$100,000 in BTC

it doesn't matter in all four events you incurred an income of $100,000 (or equivalent) and owe taxes on the income.  Failure to include that income on current year's income tax return would be considered tax evasion.

Now if someone gifts it to you (or it is an inheritance) there will be no taxes due (w/ certain limitations) but once again the IRS would see that as a gift of $100K regardless of the form the gift occurred in. 

This is actually the same in Canada. in fact I would be interested to see if there is a jurisdiction where this is not the case.

[TTBit]

What about someone who generated 10,000 btc a few years ago and paid tax on the $600 he made. Can he spend the 10,000 btc as if it is tax free? (Of course not, but what is the answer?) What if coins go to $0.00. Can he get back the tax he paid on the $600?

[ArticMine]

What about someone who generated 10,000 btc a few years ago and paid tax on the $600 he made. Can he spend the 10,000 btc as if it is tax free? (Of course not, but what is the answer?) What if coins go to $0.00. Can he get back the tax he paid on the $600?

The difference is taxable, very likely as a capital gain or loss. It is basically the same as if one obtained the fair market value of the coins in the national currency and then immediately purchased the coins.

[DeathAndTaxes]

What about someone who generated 10,000 btc a few years ago and paid tax on the $600 he made. Can he spend the 10,000 btc as if it is tax free? (Of course not, but what is the answer?) What if coins go to $0.00. Can he get back the tax he paid on the $600?

No because there is income tax and there is also capital gains taxes (don't you love the IRS they tax you coming and going).  

So hypothetical situation (for educational purposes only consult a tax adviser for detailed tax advice):
In 2010 someone generated 10,000 BTC.
Value at the time of production was $0.06
Miner's costs were $500
Today (2012) miner sells 10,000 BTC for $10 ea.

So in 2009 the miner incurred an income of $600 (10K * $0.06).  If the miner was operating a business he could deduct his $500 costs and have a taxable income of $100.   Regardless the coins acquired now have a BASIS of $0.06.

If miner sells today for $10.00 ea he has a capital gain of ($10.00 - $0.06)* 10,000 = $99,400.  Now IF BTC went to $0.01 and the miner sold he would have a capital loss of ($0.01 - $0.06) * 10,000 = $-500.  The capital gain or loss would be recorded on the capital gains worksheet.

Note in this case the value of the coins at production were so low value that while taxes were due if not paid it is unlikely to result in a penalty.  If no taxes were paid then the basis would be $0.00 and thus if sold for $10.00 ea the entire amount ($100,000) would be a capital gain.

[BlackHeartFund]

Great contribution. I've been saying this all along. Those of us who are operating legally pay taxes on BTC gains the exact same way we would with any other currency. Certainly a lot of people use BTC to avoid taxes, but for legitimate corporations operating within the confines of the laws and regulations of a state, there is nothing complicated about paying taxes on BTC.

Our accountant had never heard of bitcoin, but was able to work with it in about two minutes. Smart BTC financial services companies, and anyone who makes a profit from BTC, will pay their taxes to the penny. No doubt at some point our industry will have a lot of government scrutiny... if it doesn't already. Everyone who will survive long term will have complete records of all transactions, and tax returns to prove everything was paid.

[Epoch]

I agree with the contributors here. Specifically, even if one views their BTC-generating activity as 'just a hobby', it is technically considered as business income and must be reported. For Canadians:

http://sbinfocanada.about.com/cs/taxinfo/f/hobbybiz.htm

One side-effect benefit of reporting BTC income (beyond the obvious legal requirement) is that legitimate business deductions can be made against that income. The main ones being hardware depreciation and electricity costs.

[Rudd-O]

The fact that we posted about taxes may be somewhat controversial, but we felt it was important that the powers that be not get frightened by the weird new Bitcoin thing. By posting, hopefully we can help sculpt the dialogue in a proactive way.

http://blog.bitinstant.com/blog/2012/11/12/bitcoin-and-taxes-not-that-complicated.html

The powers that be will be angry with Bitcoiners either way because it's going to remove the ability they have to underhandedly tax you through inflation

[max in montreal]

I agree with the contributors here. Specifically, even if one views their BTC-generating activity as 'just a hobby', it is technically considered as business income and must be reported. For Canadians:

http://sbinfocanada.about.com/cs/taxinfo/f/hobbybiz.htm

One side-effect benefit of reporting BTC income (beyond the obvious legal requirement) is that legitimate business deductions can be made against that income. The main ones being hardware depreciation and electricity costs.

I am not sure if I agree with this...what happens if we lose money with our hobby, then the reverse shoulf be true...in any case, take a look at this interesting story...

http://www.canada.com/ottawacitizen/news/story.html?id=74e47320-ecf5-496d-a23f-e6440ece5134

[DannyHamilton]

. . .I am not sure if I agree with this...what happens if we lose money with our hobby, then the reverse should be true...

You'd have to talk to a tax accountant to be sure, but I believe that in the U.S. the IRS sees the difference between a "hobby" and a "business" as a matter of profit motive.  If you can demonstrate to the satisfaction of the IRS that you are engaging in the activity with a profit motive, then it can be considered a business and you can deduct any losses from other income you earn.  If you can't demonstrate to the satisfaction of the IRS that you are engaging in the activity with a profit motive, then the IRS considers is a hobby, and you can only deduct losses up to the total of your hobby income (losses incurred with the hobby offset income from the hobby, but not other income).

[DeathAndTaxes]

. . .I am not sure if I agree with this...what happens if we lose money with our hobby, then the reverse should be true...

You'd have to talk to a tax accountant to be sure, but I believe that in the U.S. the IRS sees the difference between a "hobby" and a "business" as a matter of profit motive.  If you can demonstrate to the satisfaction of the IRS that you are engaging in the activity with a profit motive, then it can be considered a business and you can deduct any losses from other income you earn.  If you can't demonstrate to the satisfaction of the IRS that you are engaging in the activity with a profit motive, then the IRS considers is a hobby, and you can only deduct losses up to the total of your hobby income (losses incurred with the hobby offset income from the hobby, but not other income).

Correct and in either case the NET profits are taxable.  For some strange reason some people in the US think a "hobby" profit isn't taxable.  Both business income and hobby income are equally taxed as regular income (unless the biz is incorporated).   The only difference is the IRS doesn't see losing money in a hobby as a taxable event.  Essentially the worst of both worlds: taxes on net profits, no deductions on net losses.

The same applies to gambling.
Gambling as a hobby
 - taxes on net profits.
 - no deduction on net losses.

Gambling as a biz (yes it is possible a professional poker player for example)
- taxes on net profits.
- deductions on net losses.

[JoelKatz]

I agree with the contributors here. Specifically, even if one views their BTC-generating activity as 'just a hobby', it is technically considered as business income and must be reported. For Canadians:

http://sbinfocanada.about.com/cs/taxinfo/f/hobbybiz.htm

One side-effect benefit of reporting BTC income (beyond the obvious legal requirement) is that legitimate business deductions can be made against that income. The main ones being hardware depreciation and electricity costs.

I am not sure if I agree with this...what happens if we lose money with our hobby, then the reverse shoulf be true...in any case, take a look at this interesting story...

http://www.canada.com/ottawacitizen/news/story.html?id=74e47320-ecf5-496d-a23f-e6440ece5134

In the United States, at least, the reverse is true. You can use hobby losses to offset hobby profits. Of course, you can't just deduct hobby losses. Otherwise, my hobby would be driving expensive cars and eating expensive food and every car I bought or meal I ate at a nice restaurant would be tax deductible.

For example, if you raise prize cows as a hobby, and then you sell one of those cows for $8,000, that is a hobby profit. It is taxable. However, if you spent $4,500 on feed and supplies to raise the cow, you can deduct those hobby losses against the hobby profit.

If you mine Bitcoins as a hobby, you can file your hobby losses so that if you do make a profit when you sell those Bitcoins, you can offset some of those profits with carried over losses.

[evoorhees]

Great responses here, thanks you guys!

[sunnankar]

The fact that we posted about taxes may be somewhat controversial

Not so much controversial as just flat out wrong. Additionally, a professional financial planner is not credentialed in this area. If you want advice you can legally rely on then seek out a tax attorney who retains a CPA.

Those of us who are operating legally pay taxes on BTC gains the exact same way we would with any other currency. Certainly a lot of people use BTC to avoid taxes, but for legitimate corporations operating within the confines of the laws and regulations of a state, there is nothing complicated about paying taxes on BTC.

Our accountant had never heard of bitcoin, but was able to work with it in about two minutes. Smart BTC financial services companies, and anyone who makes a profit from BTC, will pay their taxes to the penny. No doubt at some point our industry will have a lot of government scrutiny... if it doesn't already. Everyone who will survive long term will have complete records of all transactions, and tax returns to prove everything was paid.

BlackHeartFund, I think this is a very conservative way to operate and would recommend it. Unfortunately, your accountant likely did not thoroughly research the topic because Bitcoin and taxes results in some pretty thorny legal and tax issues. However, the result is likely that you will only be slightly overpaying taxes due so I doubt it is that big of an issue.

For those who want to operate extremely conservatively Bill Rounds, a practicing CA attorney, put together A Lawyer's Take On Bitcoin And Taxes which is a 31 page primer and has 108 legal citations. And really it is just a basic guide to save you about $2,000 worth of research from your accountant/tax attorney.

Additionally, it makes several extremely conservative assumptions, which would be legal conclusions and are not currently found in the law, that result in several reasonable ways to treat BTC. In almost all cases, the result is a slight overpayment of taxes due, having an extremely defensible position and the legal reasoning backed up by plenty of sources.

If you wanted to be particularly aggressive with your taxes then you could challenge some of those presumed assumptions. Ironically, one particularly aggressive approach is actually one most likely to be chosen by a tax court because then the court would not have to decide a legal issue which is a presumption of several other methods.

Currently, there are lots of unsettled issues with regards to Bitcoin and taxation and there are several extremely conservative approaches to take.

[sunnankar]

Found a fun court's quote that is quite applicable to Bitcoin and bitcoins:

For instance, assume an ordinance taxes the keeping of pet dogs. Jo is assessed a tax for keeping Fido, and Jo appeals. The question “Is Fido a dog?” may be factual or it may be legal.  If Jo claims only that Fido is a really a cat, then the issue is factual.  No one argues that the legal definition of dog includes cats; the only dispute is regarding the actual nature of Fido.  On the other hand, if both parties agree that Fido is a prairie dog, the question “Is Fido a dog?” is a purely legal one.  There is no dispute about the nature of Fido; the only dispute involves what the legal meaning of “dog” is.  Of course if the city says Fido is a schnauzer while Jo says that Fido is actually a prairie dog, the question “Is Fido a dog” is mixed if both legal and factual aspects of the seemingly single question are in dispute.

Indmar Products Co v Commissioner, 444 F.3d 771 (6th Cir. 2006).

[ArticMine]

Found a fun court's quote that is quite applicable to Bitcoin and bitcoins:

For instance, assume an ordinance taxes the keeping of pet dogs. Jo is assessed a tax for keeping Fido, and Jo appeals. The question “Is Fido a dog?” may be factual or it may be legal.  If Jo claims only that Fido is a really a cat, then the issue is factual.  No one argues that the legal definition of dog includes cats; the only dispute is regarding the actual nature of Fido.  On the other hand, if both parties agree that Fido is a prairie dog, the question “Is Fido a dog?” is a purely legal one.  There is no dispute about the nature of Fido; the only dispute involves what the legal meaning of “dog” is.  Of course if the city says Fido is a schnauzer while Jo says that Fido is actually a prairie dog, the question “Is Fido a dog” is mixed if both legal and factual aspects of the seemingly single question are in dispute.

Indmar Products Co v Commissioner, 444 F.3d 771 (6th Cir. 2006).

The trouble with this analogy is that the ordinance in question covers all sorts of pets from fish to snakes to elephants. So arguing if the dog is a dog or a prairie dog becomes moot. Arguing whether Bitcoin is a "commodity" or a "currency" or a "foreign virtual currency"  or "money" or even a "security" does not change the fact that income earned in Bitcoin is taxable.

[DoomDumas]

So, If I've mined some coins in the past years, I should declare a value gain euqals to the value in $ when coins have been mined, and pay taxes on it, sold or not ?
Someone posted something here, that bring me a question : As the bitcoin block chain includes all transactions, can any of those transactions be linked to me ?  Is there any IP adresses in the blockchain that could lead to someone ?

If someone mine on TOR, and mined coins are stored on a wallet that does'nt exist as a file, this someone can earn bitcoin and not have to fear to pay taxes on it !  is it true ?

I can't imagine the Canadian taxman comming to me, ordering to pay X$ for BTC I've mined in the past years !  This sounds really bad to me..