Bitcoin accounting and taxes

[bitcoinaccountant]

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.   

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[bitoption]

Thanks, this list generally tallies with my expectations and understanding of US tax treatments.

Question for you; is it possible a miner would consider BTC to be 'inventory?' I ask out of curiosity, some states have an inventory tax.

[SgtSpike]

I believe inventory only applies to tangible goods.  Don't take my word for it though.

[bitcoinaccountant]

SgtSpike is correct.  Inventory cannot be intangible.

[jerfelix]

"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. "

It should be noted, likewise, that this can be a capital loss as well.
Example:  If you mined some at $32 a couple of days ago, the taxable event is that you earned $32 worth of bitcoins, and that is taxed at ordinary income.  This also establishes the "basis" of those coins at $32.
If you sold them today for $26, that is a capital loss of $6, which earns you a tax break.


If you are buying and selling stock, you are supposed to track whether you are selling LIFO or FIFO.  I believe your broker is supposed to ask you this question when you buy the stock.  Not sure if buying currencies is the same, but I would suggest that people keep track of a) the date and price that you paid (or the fair market value of any mined coins at the date they were earned), b) any expenses that you incurred in the mining or purchasing process (purchasing fees are probably deductable), c) the date and price received for any coins sold.   In other words, treat Bitcoins as you would any other asset.  (This also implies tracking whether your gains are "short term" (under a year), or "long term" (over a year).   Long term capital gains typically receive favorable tax treatment.


I think it's best to choose a method (LIFO specific identification or FIFO), and stick with it until I am out of Bitcoins (at which time I can choose to switch methods).  Generally on an asset that rises in value, specific identification using LIFO is the better choice in my opinion, because then the taxpayer is selling the ones that he/she bought for the most money (generally), as this will generate the smallest taxable event.  On the other hand, LIFO may cause more short-term gains, which get less favorable tax treatment.

On the other hand, if the taxpayer's income is small today (and so a low tax bracket) and he/she expects it to be higher in the future, he/she might want to choose FIFO just to incur the tax burden while the other income is small.  Since Bitcoins are fungible, I suspect the IRS would frown on the "I sold the ones with the highest basis" method, although someone might be able to pull it off.

EDIT:  According to another user (bitcoinaccountant) "Also the cost basis of financial instruments is either determined through FIFO or specific identification. LIFO is not an option."   Read his advice below!


I believe that if the US Government wants to stomp out Bitcoins, they will go after a few tax cheats, and make a big deal out of the cases (in the same way that the Recording industry goes after a few file sharers, to try to scare everyone else).  So don't think your transactions won't be monitored by the IRS!   I plan to list them as "BTC" on the tax return just as if they were any other capital good.


Disclaimer:  Everybody's tax situation is different, and I am not a licensed professional - I'm just a guy on the internet... so don't believe me without checking with a professional, and really, don't take this post as any sort of financial, legal, or tax advice.  I am stating it purely as an opinion for others to give feedback to.

 

[kjj]

On the other hand, while shares are totally fungible, bitcoins are not, at least when it comes to LIFO/FIFO.

For each spend transaction, it should be possible, at least in principle, to figure out which of your receive transactions it/they came from.  Whether the IRS would care to enforce this, or deem the LIFO/FIFO question a matter of local policy, is unknown.

[yellowknife]

I don't think (solo) mining itself would be considered taxable income. You are not receiving the bitcoins from someone else, you are creating them yourself. Income is something you receive from another person/business/entity in return for something.  If you make furniture, the creation of the furniture is not a taxable event, the sale of it is. So I would argue that mining bitcoins doesn't generate income or any taxable event, until you sell the bitcoins, or use them to buy something (in which case the transaction would be treated as a barter).

Now if you are in a pool, that is potentially a different story. It probably could be interpreted that you are offering your services to the pool and they are paying you in bitcoins, in which case any payment you receive from the pool would be taxable income based on the FMV of the bitcoins you receive.

[fergalish]

What if you consider mining bitcoins just like mining gold?  Suppose I find gold on my property and start to mine it, and make a tidy profit.  How is that taxed?

[jerfelix]

On the other hand, while shares are totally fungible, bitcoins are not, at least when it comes to LIFO/FIFO.

For each spend transaction, it should be possible, at least in principle, to figure out which of your receive transactions it/they came from.  Whether the IRS would care to enforce this, or deem the LIFO/FIFO question a matter of local policy, is unknown.

I see your point, and don't know the right answer.  Two counter arguments for you::
1)  "Under new Code Sec. 1012(c) that goes into effect for sales on or after January 1, 2011, accounts are treated separately for purposes of determining the basis of stock. For sales prior to that date, accounts are aggregated. "  By analogy, Bitcoins mined last year would all be treated as a pool, even though you can account for them separately.

2)  The Bitcoin Client (supposedly) sells off smallest first, treating all of your money as fungible.  Sure, I suppose you could write your own client, or use two wallets, or whatever.  But it seems like for the standard 1-wallet user, trying to analyze which actual coins were sold would be a nightmare.  (Not to mention that 2 different coins with two different basis dates could be lumped together in a transaction, and change is returned to you... how are you going to account for the basis of the change?  Pro-rate it?  Seems overly complex!)

Good discussion though!

[bitcoinaccountant]

What if you consider mining bitcoins just like mining gold?  Suppose I find gold on my property and start to mine it, and make a tidy profit.  How is that taxed?

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.

 

[bitcoinaccountant]

I don't think (solo) mining itself would be considered taxable income. You are not receiving the bitcoins from someone else, you are creating them yourself. Income is something you receive from another person/business/entity in return for something.

 If you make furniture, the creation of the furniture is not a taxable event, the sale of it is. So I would argue that mining bitcoins doesn't generate income or any taxable event, until you sell the bitcoins, or use them to buy something (in which case the transaction would be treated as a barter).

Now if you are in a pool, that is potentially a different story. It probably could be interpreted that you are offering your services to the pool and they are paying you in bitcoins, in which case any payment you receive from the pool would be taxable income based on the FMV of the bitcoins you receive.

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.

[bitcoinaccountant]

On the other hand, while shares are totally fungible, bitcoins are not, at least when it comes to LIFO/FIFO.

For each spend transaction, it should be possible, at least in principle, to figure out which of your receive transactions it/they came from.  Whether the IRS would care to enforce this, or deem the LIFO/FIFO question a matter of local policy, is unknown.

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

[jerfelix]

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

I edited my original post, above, to reflect this.  Please read it over, and critique it.

[fergalish]

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.

Of course, I understand that the use of the word "mine" in reference to bitcoins is just a convenient analogy.  However, the from a financial point of view, there is more similarity.  There is something of value waiting to be discovered.  I discover it and thereby increase my net personal value.

More correctly, however, I don't actually give myself the coins.  It is the network that gives me the coins by accepting the block I generate.  Right?  The decision to award 50BTC to me is distributed over the whole network.  There are many next blocks "out there" waiting to be discovered, I find one, lay claim to it and the annexed reward, and the network as a whole approves.

Suppose, let me think, that I create music, and sell it.  How is that taxed?  Music is fairly intangible.  Or what if I sell something artistic, like picture - firstly what if it's a real painting on canvas, then what if it's just a digital image stored on computer?  How would that be taxed?

[bitcoinaccountant]

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.

Of course, I understand that the use of the word "mine" in reference to bitcoins is just a convenient analogy.  However, the from a financial point of view, there is more similarity.  There is something of value waiting to be discovered.  I discover it and thereby increase my net personal value.

More correctly, however, I don't actually give myself the coins.  It is the network that gives me the coins by accepting the block I generate.  Right?  The decision to award 50BTC to me is distributed over the whole network.  There are many next blocks "out there" waiting to be discovered, I find one, lay claim to it and the annexed reward, and the network as a whole approves.

Suppose, let me think, that I create music, and sell it.  How is that taxed?  Music is fairly intangible.  Or what if I sell something artistic, like picture - firstly what if it's a real painting on canvas, then what if it's just a digital image stored on computer?  How would that be taxed?

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

[fergalish]

[snip]
... 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

Please continue...

[Stephen Gornick]

Please continue...

FYI, there's now a Bitcoin wiki article addressing taxes:
  - http://en.bitcoin.it/wiki/Tax_compliance

[Nescio]

[snip]
... 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

Please continue...

LOL, IRS, brb?
I can see the Gawker headline: "First Bitcoin heartattack!" (maybe he got the test result?)

Anyway, useful info, thanks. For me it's still not clear though when you're trading on an exchange whether every single transaction is taxable, or only your eventual balance. (I'm kinda assuming the tax office will view this similar to trading on the stock market, so what are the rules there?)

[skittixch]

bumping dead thread because as tax day approaches, I'm sure many other people will be interested in how to deal with money made through exchanges.  Thoughts? Beuller?

[markm]

There is a slippery slope in virtual goods and how difficult they are to "make" and how many (and which instances) of which might turn out to be valuable.

If I run "make" on a Makefile that generates individually distinguishable magic swords or game tokens or orcish slaves or whatever, that might take less resources per item to "make" than if my Makefile fired up a merged mining of all publicly known blockchain currencies plus a few hundred private ones I figure I might as well merge into the merge just because I can, as speculation, on the off chance that someday I might find a buyer for some finite quantity.

Once upon a time a magic sword sold for lots of money.

Years ago legislators were trying to argue that if your character happens somehow upon a magic sword, you maybe ought to be taxed as if it were worth money, because historically once upon a time one magic sword sold for quite a bit of money. (Maybe also, many magic swords have some times sold for some money.)

If my makefile makes MAXLONGINT magic swords just by filling sizeof(MAXLONGINT) bits with 1s instead of 0s, and one player one day buys one for some amount of money, are all the others worth that much each?

So it is very slippery. There are some DeVCoins on sale on an exchange. Suppose no one buys any at the same nanosecond as you find a block. Does that mean they were not saleable at that nanosecond?

What if none sold that week? Month? Fiscal year?

There might be some point where the number of coins minted per fiscal period falls below the amount sold in that fiscal period, which for bitcoins might be in the past by now but for tomorrow's new coin offered on a new exchange might take forever to reach.

As long as less are bought than are made, it surely is unreasonable to claim any that were not sold were or are worth as much as those that did manage to find a buyer.

If I put hundreds of hours of my time into programming something and don't sell it, how much is it "worth"? Can the fact that a very similar in function sequence of bits sold by a competitor sold for lots of money and sells for lots of money regularly indicate that mine is worth just as much?

If the order book has only X number of orders wanting to buy, only that many in total are presumably worth that much. Whose unsold ones will be assumed to have been the ones that could have fetched that price? Who ever does jump in and actually accept that as the value has filled all demand at that price, leaving everyone else's unsaleable at that price.

Such reasonings seem to have led most Canadians I have consulted on the matter to figure if what you make doesn't manage to get to the market and get bought, then it is just hypothetical speculation that some day you or your heirs or assigns might convince someone to buy it.

Thus so far the theory I have been using here in Halifax Nova Scotia Canada is all the many permutations of bits that I crunch in my computers are just bits of data, and only if someone pays me to manipulate those bits or set or unset those bits or transmit or process those bits are they income - and even then they are not income, they are proof of work - proof I performed a service. It is when they pay me actual real tangible goods or real legal tender that I have income...

-MarkM-

(I guess when I give someone bitcoins for something, that thing is income to me; and some day someone will give them something for them, maybe, if anyone still likes them by that time, in which case they get some income, and the net effect is they gave me something in return for someone else giving them something, which might all some day come around in the course of going around...)

P.S. I could argue that the ones *I* make are worth *millions* of dollars thus that is why I have not sold them: lack of a buyer willing to pay that much for them. SO like a novelist making little this year while not having sold the novel, my potential income from creating it is in the future: I am making bitcoin futures for myself, not bitcoins being sold this year... I guess we should compare to futures market instead of today market? Hmm. Thus most folks consulted throw up their hands and suggest if I sell, when I sell, then I'll have something to be taxable... meanwhile I incur research and development and tool and utility expenses like any other author of sequences of letters glyphs bits words stories chapters novels etc... Until I sell I am running at a loss in fact...

[casascius]

There's all this talk about how Bitcoins are intangible.

Stocks are intangible as well...they can be traded on the company books without anything tangible trading hands.  Bitcoin works much like stock, I suppose the only thing that is missing is that the tax laws don't accommodate any concept of stocks that can just materialize out of thin air, rather than being issued.  And on the other hand, anybody can make their Bitcoins tangible (besides buying my coins) simply by printing out a paper wallet and sending their bitcoins to it.

The way I see buying and selling Bitcoins is like capital gains.

The way I see doing work Bitcoins, or selling things for Bitcoins, is like ordinary income.  Since bitcoin transactions are hard to prove and would just be noise in an audit, I see little wrong with using the final sale price of those Bitcoins as the amount of the income.  (Besides, short term capital gains are practically equivalent to income anyway, so trying to account for the value of the BTC when earned versus sold is a moot exercise).

The way I see mining is that it's an activity most similar to earning ordinary income, rather than acquiring capital assets.  There are equipment and energy costs.  It seems senseless to deduct such expenses against acquisition of an asset, it makes much more sense for those expenses to go against creation of something that gets sold for income.

Regardless of what I think, I would love to be a fly on the wall the first time someone sits face to face with a tax auditor and discusses Bitcoins.  Seems to me, an auditor isn't going to want to take a lesson on block chains and hashes during an audit from the subject of his audit.  Imagine the auditor's eyes glazing over as you hand him a stack of printouts off Block Explorer and told him, "this is the best I can do - that's just how Bitcoin works - see, even CBS/CNN/whatever confirms that."  I would guess he would much rather look at bank accounts or what goods and services you might have received as a basis for deciding what tax you might owe, do all the math in USD, and call it a day.

[SgtSpike]

I think that until an official ruling on Bitcoins is made, the best and simplest route to go is to just record income when (and if) Bitcoins are turned into USD.  This is assuming you are accounting for Bitcoins creating through the mining process.

If you make money trading Bitcoins, then that income (loss) should be reported as capital gains (capital losses) when the Bitcoins are sold.

[markm]

I think that until an official ruling on Bitcoins is made, the best and simplest route to go is to just record income when (and if) Bitcoins are turned into USD.  This is assuming you are accounting for Bitcoins creating through the mining process.

...And a corollary, it seems likely, would be once an official ruling *is* made on *Bitcoins* it might turn out to be time to focus more on alternatives on which no official ruling exists... (How far would one need to slip on which slippery slope to achieve that, hmm?)

-MarkM-

[SgtSpike]

I think that until an official ruling on Bitcoins is made, the best and simplest route to go is to just record income when (and if) Bitcoins are turned into USD.  This is assuming you are accounting for Bitcoins creating through the mining process.

...And a corollary, it seems likely, would be once an official ruling *is* made on *Bitcoins* it might turn out to be time to focus more on alternatives on which no official ruling exists... (How far would one need to slip on which slippery slope to achieve that, hmm?)

-MarkM-

Eh, doubtful you could go there.  They'd probably make a new law broad enough to cover all similar "electronic currencies" or something.

[DeathAndTaxes]

I don't think (solo) mining itself would be considered taxable income. You are not receiving the bitcoins from someone else, you are creating them yourself. Income is something you receive from another person/business/entity in return for something.  If you make furniture, the creation of the furniture is not a taxable event, the sale of it is. So I would argue that mining bitcoins doesn't generate income or any taxable event, until you sell the bitcoins, or use them to buy something (in which case the transaction would be treated as a barter).

Now if you are in a pool, that is potentially a different story. It probably could be interpreted that you are offering your services to the pool and they are paying you in bitcoins, in which case any payment you receive from the pool would be taxable income based on the FMV of the bitcoins you receive.

The alternative view (and one expressed for non-tax explanations) is that you aren't mining anything.  Bitcoin always has and always will have exactly 21 million coins.  They all exist.  When you mine a block the network is paying you 50 BTC for your service in securing the network.  So mining is a service and you are being paid a fee of 50 (or whatever current value is) BTC per block

Honestly it will take some legal precedents before anything is known for sure.  What ultimately matters is what the IRS thinks is a taxable event and when the event occurs.  If the person involved in the event disagrees then what matters is who the courts side with.

[Stephen Gornick]

Here's a good question for the accountants.  

If I were to have had 350 bitcoins in my wallet in June when the price was over $30 (and am in the U.S,) would I be required to file an FBAR?

United States persons are required to file an FBAR if: The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.

- http://www.irs.gov/businesses/small/article/0,,id=148849,00.html

[DeathAndTaxes]

Another good one can people who lost funds in mybitcoin.com collapse write that off as a catastrophic loss?

[casascius]

Another good one can people who lost funds in mybitcoin.com collapse write that off as a catastrophic loss?

The sticky part is that one could claim such a loss and there would be no proof of it.

Since there would be no proof, someone could plausibly have bought lots of BTC before they disappeared, and claim a loss.

The best thing one could have done in that case, perhaps, is to have called the police and filed a report just to generate paperwork, even though it's plainly obvious there wouldn't be anything the police could do.  The police report, with a timely date on it, would probably tip the scales in the taxpayer's favor.

[SgtSpike]

Here's a good question for the accountants.  

If I were to have had 350 bitcoins in my wallet in June when the price was over $30 (and am in the U.S,) would I be required to file an FBAR?

United States persons are required to file an FBAR if: The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.

- http://www.irs.gov/businesses/small/article/0,,id=148849,00.html

No.  Not unless/until Bitcoin is considered a foreign currency or foreign account.

Another good one can people who lost funds in mybitcoin.com collapse write that off as a catastrophic loss?

Catastrophic loss?  That's not a term I am familiar with with regards to taxation.  I'd be more inclined to just call it theft.

[DeathAndTaxes]

Catastrophic loss?  That's not a term I am familiar with with regards to taxation.  I'd be more inclined to just call it theft.

Not sure why I said catastrophic I meant casualty loss.  IIRC IRS lumps theft in with other casualty losses.  The IRS sees a bag of money catching on fire and burning to ashes to be the same as someone stealing said bag of money.  Still it would take a big loss to write if off.  I think your deduction is limited to the amount >10% of gross income.

[hanwong]

Giving a bump to an old thread as tax time nears again. There were some excellent points made by the OP. I don't think he is on these boards anymore, but what he has pointed out is still cogent:

1) The IRS still doesn't know what BTC is and has not issued any rulings. There are no former, current, or pending cases involving BTC that I know of in front of tax court. Tax court and subsequent IRS regulations is where the tax treatment of BTC will be codified.

2) Taxation of bitcoin "mining" should be handled in a two stage event: income tax for a service provided on the receipt of the reward at time of blockchain hashing (sorry I'm not a miner so I don't know all the terminology) and then a capital gains event when miner exchanges BTC for USD sometime later on down the road.

3) Speculating in BTC should be treated as capital gains treatment.

4) If you ever get scammed out of BTC, go file a police report and you can claim casualty loss on the scam.


The IRS hasn't promulgated any rulings, nor pursued any audits that I know of, in the BTC world because BTC has up to this point been not worth their time. But with the greater acceptance and knowledge of BTC by the wider populace, and more importantly, and some of you large BTC holders earning significant gains from the most recent run up in BTC/USD, I bet the IRS will soon start to target BTC users and transactions for revenue review aka AUDIT. The IRS is a business. They will spend there resources where they feel they will earn a return. Since 2009, there hasn't been enough money in the BTC econosphere for the IRS to pursue. But this year might be different. Rest assured that if you have unexplained gains of 100K or more in your bank account, the IRS will be very interested in talking to you about your BTC activities. Stick to the current tax rules regarding capital gains, small business taxation, and tax treatment of financial instruments and you should be ok, until the IRS changes the rules to benefit the revenue team. But that's how the IRS works.

This was meant as free information, not advise. You have to pay for professional advise.

[fergalish]

I saw this thread got bumped, and it got me thinking. Well, if you buy & sell bitcoins, or if you trade for bitcoins, the tax implications should be fairly clear. I think in the former case, you declare capital gains when you realise the profit, and in the latter, you declare a dollar-equivalent income at the time of the trade. Right?

The interesting thing is mining. How do you tax wealth that comes "out of nowhere"? Well, let's examine more closely where it does actually come from.

Well, suppose I were to invent a new currency based on... peculiarly shaped stones that only I can find. Well, if no-one accepts my new currency the value is zero. If people start accepting them, then by their very acceptance, they ascribe a value to the stones. So, it's more like a gift than anything. So I might hold up a stone and shout to the masses: "what'll you give me for this?" and everyone shouts back "$100", and someone "gifts" me $100 for my (previously) worthless stone.

Of course, now that bitcoins are somewhat established, and mining is a big business, I suppose calling it a gift wouldn't cut any more. Yeah, it'd have to be income-taxed.

[dchou]

re: mining, the question is:  when is the income recognized?

If I start a mining business, I am expensing the hardware and the electricity, pool management fees, etc.

If I keep all the coins I've mined for two years, there would be no income generated by my mining business until I actually decide to exchange it for fiat.  My business would be showing a loss for those years.  I am recognizing the income when I sell off my BTC.

If I report the current value of BTC when they are generated as income, I would pay tax once, and then once again on any gains if the value of BTC were to appreciate.

What approach is everyone else taking?

[bbulker]

How can I tell how much $ to pay in taxes when I receive a bitcoin and all the exchanges say something different?

What if there's an exchange trading at $0.01 (that nobody sells on lol) and another trading at $100, can I calculate the tax from the $0.01 one?

Why not just pay taxes from the income you made by selling the bitcoin?

[hiima]

Good read, thanks for the info.

[hanwong]

Sorry for the late reply. Tax season and all...

How can I tell how much $ to pay in taxes when I receive a bitcoin and all the exchanges say something different?

What if there's an exchange trading at $0.01 (that nobody sells on lol) and another trading at $100, can I calculate the tax from the $0.01 one?

Why not just pay taxes from the income you made by selling the bitcoin?

The IRS accepts fair market value. The exchange that displays a price quote of $0.01 is neither fair nor market value. The fair value of anything is the value that two knowledgeable and willing counterparties are able to trade without being forced to trade. There have been no IRS precedents on BTC, but I'm sure the first BTC audit, whenever that happens, the IRS will use the MTgox price on the date of your trade as the fair market value of your trade.

re: mining, the question is:  when is the income recognized?

If I start a mining business, I am expensing the hardware and the electricity, pool management fees, etc.

If I keep all the coins I've mined for two years, there would be no income generated by my mining business until I actually decide to exchange it for fiat.  My business would be showing a loss for those years.  I am recognizing the income when I sell off my BTC.

If I report the current value of BTC when they are generated as income, I would pay tax once, and then once again on any gains if the value of BTC were to appreciate.

What approach is everyone else taking?

You are looking for an answer to a question the IRS has not answered. As there are no BTC audit decisions I am aware of, there are currently no IRS precedents to guide BTC mining businesses. In the absence of precedence, IRS rules state you should use a "fair and accurate" reflection of your business income and expenses. My opinion on your situation, albeit with little knowledge of your full situation, is that you must recognize regular business income when you receive BTC from the blockchain at the market price at the time of receipt. Then if you hold your BTC for two years, you must then recognize capital gains/losses from your basis price (the price you received your BTC at time of mining) to your sales price at the time of sale of your BTC. You essentially have two business activities, mining (your regular business where you are able to deduct your ordinary and regular business expenses of hardware, electricity, pool management fees) and your secondary business of BTC investment management (which will have investment expenses of it's own that you may deduct.)

I saw this thread got bumped, and it got me thinking. Well, if you buy & sell bitcoins, or if you trade for bitcoins, the tax implications should be fairly clear. I think in the former case, you declare capital gains when you realise the profit, and in the latter, you declare a dollar-equivalent income at the time of the trade. Right?

The interesting thing is mining. How do you tax wealth that comes "out of nowhere"? Well, let's examine more closely where it does actually come from.

Well, suppose I were to invent a new currency based on... peculiarly shaped stones that only I can find. Well, if no-one accepts my new currency the value is zero. If people start accepting them, then by their very acceptance, they ascribe a value to the stones. So, it's more like a gift than anything. So I might hold up a stone and shout to the masses: "what'll you give me for this?" and everyone shouts back "$100", and someone "gifts" me $100 for my (previously) worthless stone.

Of course, now that bitcoins are somewhat established, and mining is a big business, I suppose calling it a gift wouldn't cut any more. Yeah, it'd have to be income-taxed.

Your mental exercise is interesting involving magical stones, but ultimately fruitless. Anyone, laymen and tax experts alike, can speculate as to the true tax treatment of mining. Tax experts can use their knowledge of existing tax regulations combined with their client's specific business operations and develop a stated opinion. That opinion, however, is not worth the paper it's printed on until the opinion is challenged and ruled upon by the IRS and if necessary, the tax court.  When dealing with the IRS, a good general rule to follow is to be open to negotiations. Eventually a bitcoin business will be audited. When you go in and sit down with the IRS, the most important thing to the IRS will be how much they are going to get out of you. Everything else regarding mining, blockchain, magical stones, is just details. If you go into an audit with the IRS accepting the fact that the IRS will get X% out of your income as tax, then the IRS will deal with you "fairly." If you try to use the intricate details of hash rates, double spend, Mtgox price vs localbitcoins price in order to lower your tax rate, the IRS will start demanding that X% to be significantly higher.

The above is not advice. Seek competent professional advice from a trusted source and from a licensed professional.

[steverabincpa]

Sorry for the late reply. Tax season and all...

How can I tell how much $ to pay in taxes when I receive a bitcoin and all the exchanges say something different?

What if there's an exchange trading at $0.01 (that nobody sells on lol) and another trading at $100, can I calculate the tax from the $0.01 one?

Why not just pay taxes from the income you made by selling the bitcoin?

The IRS accepts fair market value. The exchange that displays a price quote of $0.01 is neither fair nor market value. The fair value of anything is the value that two knowledgeable and willing counterparties are able to trade without being forced to trade. There have been no IRS precedents on BTC, but I'm sure the first BTC audit, whenever that happens, the IRS will use the MTgox price on the date of your trade as the fair market value of your trade.

While the IRS has not given specific guidance on BTC as of today, they likely will do so in the next 6 years, and there may be significant advances in forensic technology in this period.  If a taxpayer gets an audit notice 6 years from now, and has a tax position that is overly aggressive there can be substantial interest and penalties, even exceeding the disputed amount.

I am not convinced that BTC mining is like creating artwork for several reasons.  Artwork does not have active markets that can be used to determine price at the date of creation.  While art involves assembling supplies previously owned by the artist, bitcoin mining involves a point in time when the miner has control over something they did not previously possess.  And, perhaps most telling, there is a matching principle in accounting that income and related expenses should be recognized together.  So I doubt that deducting electric and equipment expenses now while deferring recognition of revenue will be considered to be consistent.  Then there is IRC83 which requires that deferred compensation (such as stock and options) be recognized at the fair market value when title transfers, not when the investment is sold.  And IRC988 requires income to be recognized when foreign currency is received for goods or services. 

Regarding fair market value, I think revenue ruling 59-60 allows consideration of exchanges other than MtGox, as long as the exchange is active, the valuation method is used consistently and satisfies all other applicable rules.

I am a USA CPA licensed in CA and IL, and I can be found on LinkedIn or by Google. Here is my circular 230 disclaimer.  This post is intended to provide generalized tax and valuation information that is only appropriate in certain situations. It is believed accurate at this time, but these rules, alas, are constantly changing.  It is not intended or written to be used, and it cannot be used by the recipient, for the purpose of avoiding tax penalties that may be imposed on any taxpayer. These contents should not be acted upon without specific professional guidance. Our liability, under any circumstances, is limited to the amount paid for our services.  Please contact us if you have questions. 

[bitpop]

Can I sell through a corporation then pay myself a salary to avoid capital gains, giant bracket and se tax?

[hanwong]

Can I sell through a corporation then pay myself a salary to avoid capital gains, giant bracket and se tax?

This is possible, but you would be well advised to retain a tax adviser to help you execute your plans.

[bitpop]

Can I sell through a corporation then pay myself a salary to avoid capital gains, giant bracket and se tax?

This is possible, but you would be well advised to retain a tax adviser to help you execute your plans.

Can I retain you?

[steverabincpa]

Can I sell through a corporation then pay myself a salary to avoid capital gains, giant bracket and se tax?

This is possible, but you would be well advised to retain a tax adviser to help you execute your plans.

Can I retain you?

You are likely better off paying capital gain tax as an individual, rather than income+payroll tax, particularly if the holding period might be over a year and the capital gain is long term.  In general corporations are like lobster traps, it is easy to put stuff in but expect to pay tax when taking it out. 

Try to find a licensed tax advisor in your state (each state has its own tax rules and licensing peculiarities) who is up to speed on virtual currency issues.  I am taking qualified California bitcoin clients this 2013 tax season and am even accepting payment in Bitcoin.  I can be found through google or linkedin.

Here is my circular 230 disclaimer.  This post is intended to provide generalized tax and valuation information that is only appropriate in certain situations. It is believed accurate at this time, but these rules, alas, are constantly changing.  It is not intended or written to be used, and it cannot be used by the recipient, for the purpose of avoiding tax penalties that may be imposed on any taxpayer. These contents should not be acted upon without specific professional guidance. Our liability, under any circumstances, is limited to the amount paid for our services.  Please contact us if you have questions. 

[bitpop]

Can I sell through a corporation then pay myself a salary to avoid capital gains, giant bracket and se tax?

This is possible, but you would be well advised to retain a tax adviser to help you execute your plans.

Can I retain you?

You are likely better off paying capital gain tax as an individual, rather than income+payroll tax, particularly if the holding period might be over a year and the capital gain is long term.  In general corporations are like lobster traps, it is easy to put stuff in but expect to pay tax when taking it out. 

Try to find a licensed tax advisor in your state (each state has its own tax rules and licensing peculiarities) who is up to speed on virtual currency issues.  I am taking qualified California bitcoin clients this 2013 tax season and am even accepting payment in Bitcoin.  I can be found through google or linkedin.

Here is my circular 230 disclaimer.  This post is intended to provide generalized tax and valuation information that is only appropriate in certain situations. It is believed accurate at this time, but these rules, alas, are constantly changing.  It is not intended or written to be used, and it cannot be used by the recipient, for the purpose of avoiding tax penalties that may be imposed on any taxpayer. These contents should not be acted upon without specific professional guidance. Our liability, under any circumstances, is limited to the amount paid for our services.  Please contact us if you have questions. 

Is this because there is no self employment tax on capital gains?

Now what about people running a business accepting btc? They have to pay both income tax and capital gains if they gain anything at all on their btc?

[luqash3]

Thanks for answering all the questions in such a detail and simple English that I have clarified various confusions which were built up in my mind regarding bitcoins. However, I still have one problem. Are these IRS laws applied worldwide or in some specific countries like I am not residing in USA?

[bitpop]

Thanks for answering all the questions in such a detail and simple English that I have clarified various confusions which were built up in my mind regarding bitcoins. However, I still have one problem. Are these IRS laws applied worldwide or in some specific countries like I am not residing in USA?

Irs is usa of course. If you have citizenship it applies, whether living there or not.

[steverabincpa]

!!!ALERT!!!
New IRS guidance on virtual currency (VC) released 3/25/14
http://www.irs.gov/uac/Newsroom/IRS-Virtual-Currency-Guidance

For most purposes, IRS requires a property approach (Schedule D gain/loss) not a foreign currency approach.

VC is taxable when mined by miners.  VC transactions are reportable.  See the IRS document for details and FAQ.  If you have been doing it differently, consult a tax professional. 

Regarding the scope of IRS rules, they only apply to US taxes.  Although the IRS might wish to be the top tax authority in the US they are not.   They are beneath the constitution, the revenue code (written by lawyers in congress and constantly changing), court case law, and the treasury department.  However in the absence of guidance from these other authorities, IRS rules should be followed.

Here is my circular 230 disclaimer.  This post is intended to provide generalized tax and valuation information that is only appropriate in certain situations. It is believed accurate at this time, but these rules, alas, are constantly changing.  It is not intended or written to be used, and it cannot be used by the recipient, for the purpose of avoiding tax penalties that may be imposed on any taxpayer. These contents should not be acted upon without specific professional guidance. Our liability, under any circumstances, is limited to the amount paid for our services.  Please contact us if you have questions. 

[mmortal03]

On the other hand, while shares are totally fungible, bitcoins are not, at least when it comes to LIFO/FIFO.

For each spend transaction, it should be possible, at least in principle, to figure out which of your receive transactions it/they came from.  Whether the IRS would care to enforce this, or deem the LIFO/FIFO question a matter of local policy, is unknown.

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

This was a good discussion back when all of this was up in the air. Is the above still applicable, given that bitcoins are being treated as property? In other words, is LIFO accounting not an option?

[USBitcoinServices.Com]

If I sell tokens earned from bounties, do I have to pay taxes? or are exempted because that was a gift?