Bitcoin accounting and taxes

[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?