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...