How Will the IRS Tax Bitcoin?

[Naruto.me]

How can they know you have bitcoin (if U not use it). It is just a file in you PC. 

[maaku]

How can they know you have bitcoin (if U not use it). It is just a file in you PC. 

What's the point of having it if you're never going to use it?

[Raize]

I've engaged an attorney to help me work through compliance.  Thankfully, It's been a long time since my bitcoins have sat on any exchange, let alone a foreign one.  Most of my bitcoins have been sitting still in offline wallets only I control, some for over a year at this point, which will help me make a case for long term capital gains treatment, which is ideal.

Same here, if First In, First Out applies, a lot of us that were around in 2011/2012 are going to be taxed at long term capital gains rates if the IRS does make a ruling.

[Raize]

Well, my accountant is pregnant and due in a month and I also bought a house this year as well so we're probably going to file an extension. She's told me that filing an extension doesn't increase my chance of being audited, but I pretty much think everything about me is going to trigger about fifty "needs to be audited" flags, anyway.

I suspect that the Winklevoss will have figured out what the ETF tax situation is going to be by around June 2013, then we'll probably make modifications as necessary from there.

If for some reason they still haven't made a judgement call, we're going to assume it falls under "Other Income" and get taxed at the highest rates. After that and an expected audit, I might move to Thailand to be your neighbor if you don't mind... I'll probably renounce my US citizenship sometime after that and not sell again till 2015.

This is my first big "test", to see how moronic the feds are going to be regarding Bitcoin and conversion to fiat. If another country makes it easier or is going to let me hold on to more of it, I'm more likely to move there.

I have a few candidates, Ecuador, Chile, Thailand, Singapore, etc. New Zealand and Costa Rica were the first two I looked at, but they are in housing booms that aren't busting, so they kind of fell out of favor. Singapore is where Jim Rogers and Eduardo Saverin are, but housing is expensive there (not necessarily in a bubble, it's just such a small country and has no extra space to expand). I know some Thailand missionaries that need help with a school in Lampang. I know parts of NW Thailand are dangerous, but I still think it'd be cool to set up a nice computer lab and educate kids there about IT stuff for the rest of my life. Chile is attractive because of its libertarian tendencies, but is likely semi-unstable. Ecuador is more free-speech oriented, but I don't know how safe it is from interference in business.

I think it'd be nice to run an email service to compete with US-based Gmail, YahooMail, Hotmail, etc. If those Iceland programmers get a quality encrypted mail services app working, I might just do that somewhere as the NSA has just created the best marketing campaign for external privacy-related email the US has ever seen. I've spoken to a few dozen folks that are willing to spend upwards of $5-15/month for truly private email, but only because they trust me and pretty much me alone for keeping their personal communications truly private. I think it'd be nice to run my own datacenter in SE Asia or Latin America at this point. I have to believe there's a huge need for outside-the-US privacy-oriented emailing services right now. If I could reliably get something like that to integrate with BitMessage, it'd be another benefit as well.

[Bob Derber]

A tip - have your atty./accountant understand the block-chain as a ledger - so they can appreciate FIFO may not by the only option.  If you had multiple wallets and/or processed transactions directly from the block chain addresses - you can trace the coins you sold to the coins you bought right from the block-chian.  This may allow you to use the 'specific identification' method instead of FIFO. 

Help your accountant understanding this and they may steer you away from FIFO so you have more control over what coins you sell in the future both to trigger long term capital gain and/or to minimize the overall gain on the transactions.  How you treat the way you account now will be called a "method of accounting" and you will have to live with it for all future transactions unless the IRS lets you change - which is a real pain.

The bitcoin protocol has an API for raw transactions that allows for specifically identifying your trades but it does not appear to be incorporated into the -Qt wallet.  Never-the-less your block-chain activity will have a specific listing of the source transactions for your bitcoin sales if it was a block-chain transaction (by that I mean off an exchange....). 

Your accountant or atty. may simply not understand how bitcoin works if you don't educate them.  It will be new to them on the accounting side as well as they, like me, will probably look for something similar but, as with all disruptive technologies... it is difficult to fit into existing ruels.

I first referred to the stock and commodity broker/dealer rules in this area for guidance as there is no clear guidance for bitcoin.......  They may find this a fertile area for help as well.  As a bonus, in the area of stocks you can "specifically identify" the stock you sold despite that the stock sold came from an account of commingled groups of the same stock (i.e. stocks that you bought over time in a brokerage account but were never in certificate form or separately kept in journal form).  You might apply the same principals for a bitcoin transaction..... 

IRS hasn't provided guidance yet.... but that doesn't mean you need to take the worst possible position.  If you're afraid of the penalties and interest because they might decide otherwise when they provide us some guidance, ask your accountant about filing the return, then a refund request through an amended return.  If you look for guidance up front through a private letter ruling, it can take months (maybe more) and they don't have to issue any letter ruling if they don't feel it appropriate.

[Raize]

Bob,
Thanks. I appreciate the advice. I'm actually taking the route with my LLC specifically to see how the IRS handles the FIFO designation. I'm going to acknowledge to the IRS that I have other coin owned personally, but sell my LLC-based coin to see what their reaction is.

Part of this is to determine the fungibility of Bitcoin with regards to the IRS. The other part is to determine their concern. My hope is that an audit will help clarify what their position actually is, because whatever it is, it'll be something I can immediately report here, to others that will need the info.

It is worth noting that FIFO is actually beneficial to me from a tax standpoint, but not from an anonymity standpoint. I have no doubt that Coinbase is giving US intelligence agencies information regarding our personal holdings, however it remains to be seen whether or not they are giving details regarding our non-Coinbase assets. Such information will be integral to determining if they are actually able to confiscate our coin, assuming they do so in a manner akin to FDR's confiscation of gold. If they really want this info, we'll know that coin purchased prior to the MtGox confiscation (coin purchased via Gox anyway) is truly anonymous, and can be sold at a premium.

I suspect they do not have such capabilities, and have no special agreement with MtGox, which means several of us are shielded from such possible future confiscation by the fact that they don't actually know what we own if purchased via Dwolla.

Make no mistake, my intentions in this are not necessarily anti-American-intelligence-agency, but I really do want to know if they have such capabilities with IRS audits. The closing and confiscation of the MtGox Dwolla accounts tells me they do NOT yet have this capability. I'll be particularly interested during my audit in what the IRS specifically requests from me to validate the FIFO.

[Bob Derber]

Raize:

FIFO is the default for tax purposes, so absent a strong indication that it distorts your income, and I doubt that would be the case with bitcoin, this is relatively safe method overall.

You can not 'ask' the IRS to come visit you unless you apply for a letter ruling (a kind of guidance ruling along the lines of what Milly Bitcon/Atlantic City did with FinCEN).  Even then the decision is theirs.  I think I recall a prediction on this board that they would provide guidance before April 15th - I'm not holding my breath...

Rather than you test the IRSs position, it would be nice if you chimed in on the foundation to open a dialogue with the IRS or that they take steps to test the waters. 

But if you go it alone be careful what you wish for.  You will find that the government has an incredible number of ways to determine your assets, they are in no hurry, and if they want you, money is quite there for investigative work. You can be a little feisty today and not see it come back to haunt you for years.

There are ways to pressure the IRS to give clarity in the area, which is really what most want.  The virtual world companies have dealt with this for years - and the gamers - Blizzard, Second Life, etc.  I think we need to reach out to them as they have been there for a long time and we don't need to reinvent the wheel..... and by we I really mean we - not you as an individual.  Do not take the IRS on as a personal crusade.  Rather, be a catalyst and help pull a group together to represent us before them.

Hope I interpreted your post correctly......

bob

[Raize]

Well, you did understand what I was saying. I'm not a fan of the federal government. I have much less problems with state government because they are actually using our money domestically. I guess I was just looking for more reasons to be upset.

I am not trying to "take the IRS on" or anything. I just expect an audit due to the massive jump in money I will have this year, and the fact that most of it came from Coinbase. I have a paper trail for everything, so I don't think I'm going to run into any problems anyway. At the worst an audit drains me of every fiat I own and I leave the country to go somewhere more accommodating. The US has a chance to become the place people flee "to" with Bitcoin by forcing the IRS to classify Bitcoin as capital gains at the lowest tax rates or a currency with the 40/60 Forex rules. Or perhaps something new. The more attractive the tax laws, the more likely a country will be the ones Bitcoiners settle into, IMHO.

The problem I suppose I really have is how is stuff like this not settled already? No doubt many of the US-based exchanges have already gotten clarification on how they are taxed on their own Bitcoin holdings (let's be honest, they can't all be converting to fiat entirely), so why is this information not public knowledge at this point?

[Bob Derber]

I doubt US based exchanges have guidance yet - or we would see it as the only guidance they could rely on is a private letter ruling.  IRS private letter rulings are made public.  I can also easily understand why the IRS is not ready to weigh in on this yet - we're still sorting out what bitcoin is ourselves.  From a policy perspective, it is sad that the IRS is in this position.  

Virtual currencies predate bitcoin by over a decade.  The IRS hasn't given any 'safe harbors' for those of us who are willing to do the right thing.  Then again, they have not aggressively pursued the arena that I can see.  I see no court cases or taxpayer challenges.  What a mess for the IRS to have a judge decide how virtual currencies will be taxed.......

It would be nice if the service were to issue  'temporary' guidance while this virtual currency space works itself out.  Many are in for the investment - more like gold.  Many are in it as a currency - to support a consensus based transactional medium.  

As a miner you face, from a cerebral standpoint, the more discrete but interesting judgments..... do you recognize for tax purposes the coinbase when it is awarded or when it is spent - do you recognize it as of the date you become a part of the block-chain, at a safe margin of confirms or at the 100 confirm requirement for spending?  This stuff was pretty inconsequential when it was a $750 issue when this year began.

And since the block time stamp is not an indicator of the time of the coinbase award or its confirmation, tracking will be interesting....

And what do you use for valuation - interday average on Mt. Gox, Bitstamp.... some blend, some running average..... ?

Take heart, though, as your issues are pretty obvious and you have lots of options that are rational and will not be a compliance nightmare once they are made.  I am dealing with a bigger issue right now on those who are determined on using bitcoin for purchasing transactions in a business.  

We are facing some very real compliance issues not only for valuation but also for accounting where bitcoins are regularly used in purchase transactions by a firm...... say you bought your bitcoin for $100, then you used it to buy a portable computer.  The portable may be $800, so there are two transactions here - you made $700 on your bitcoin, you purchased an asset...... Straight forward transaction, but for an individual using Quickbooks (or big boys on an Oracle or SQL solution), it's not easy to track without double entry, and double entry is twice the work.......

All the luck Raize.  Congrats on having the problem you do and I hope you 'ASIC Up' as a friend says, the market only appreciates for bitcoin, and your problem is only worse next year as you pocket some coinbase.......  ditto for you Goat - and I want a ride in that new car.......

[maaku]

I'll probably get an accountant to look this over (anyone know a good one in the SF bay area?), but this is how I'm going to proceed to get an estimate of what I owe and prep the documentation for the c.p.a:

I'm going to do specific identification using the block chain ledger. The block chain records which coins were used in a transaction, and so I can use that to determine the cost basis of coins sent to an exchange or used in a purchase. I did not think ahead enough to plan which coins I used, but I would like that capability in the future and therefore need to establish the specific identification method now. Within an exchange I'm not sure whether to use FIFO accounting or a weighted average since the coins are no longer distinguished. This distinction doesn't really affect me much as I tend not to leave coins on exchanges, but I'd be interested to know what approach is best for the future.

This will probably require a number of custom scripts to gather this information from the blockchain and generate CSV outputs, I'll publish that when it's ready.

I assume that I'll have to start paying quarterly income taxes now that most of my income is not from W-2's...

[maaku]

This wiki says that you can now change your chosen cost-basis method for investment assets:

http://www.bogleheads.org/wiki/Cost_basis_methods

Is this true?

[Bob Derber]

Goat -

First - remember that I am at 7,000 ft. and we love ice and snow.  We're at a 40 inch base here.... and do take a look at how a Tesla handles ice.... you may re-think what you have..... but I digress....

Yes, there are several items surrounding a theft loss that your accountant will sort with you - typically quite quickly but always based upon your own circumstances.  It will depend on whither your bitcoins lost were part of a business, held for the prouction of income, as an investment or as a hobby.... and that it entirely dependent upon your circumstances.

Depending on the above, it may be limited to the basis or fair market value of your bitcoins - so your accountant will likely need both.  

Basis is typically what you purchased the bitcoins for or, if you do pool them, the value under the pooling convention you use (FIFO, Weighted Average, etc.).  For the fair market value of the loss make sure you bring to your accountant some exchange numbers from the likes of Bitstamp, etc. - and a chart works best as the exact 'date' your loss occurred may be as much a guess as anything.  In any event, make sure the exchange price or method you use it is the same exchange you used to value your bitcoin (if you were a miner) in the first place.

Finally, take care to explain the loss clearly.  Your accountant may ask that you file a police report or the like, to help substantiate the loss.  In bitcoin a 'loss' by theft is typically evidenced by little more than a transaction on the block chain.... so you want to think about how this loss can be documented for an agent if you are audited a year or two later who will likely not understand bitcoin. Showing that it was a theft can be a more difficult part of the process.  

As well, determining 'when' the theft occurred is many times interesting.  If you loaned the guy some coins involved in a 'test' - when did it go wrong to the point of being a loss or theft - and when did you discover it.  Did you discover it immediately or did a suspicion ripen into an certainty.  

Also, just fyi - keep in mind a gambling loss is different event than a theft loss, and I am not sure where your loss fits.  You need to be very clear here, as gambling losses are treated quite differently from a theft loss and we're talking about a good deal of money.  It may be critical what you were specifically doing - because if you are 'testing' a gambling site that, to me, is quite different from simply gambling at the site.  Testing implies there is a business going on here - either because you are in the trade or business of gaming as a gambler, or as an owner of a gaming space or location.

This is were one needs to be so cautious and clear.  Let's pretend it was 'gambling.'  The worst of all worlds could arise if the IRS said when you cashed in you effectively 'sold' your bitcoin for its the value of the account you received - a transaction where you have to recognize income and one that you may not be able to net your gambling losses agains.... and then you gambled..... an activity where your losses could be non-deductible... in short, a double whammy.  

Finally, you need to be careful to document in this space the circumstances surrounding the loss to make sure it is not colored as part of an 'illegal' activity.  It's not in the IRS Code, but there are court decisions permitting the IRS to deny the loss deduction simply because it was incurred in an activity that was illegal and 'violated public policy.'

If you want, Goat, email me - you have that info.  I am responding to this depth here so that others who are taken in this space understand that their accountant is critical in dealing with things like this.  I can't tell you where you fall in the spectrum, only the guy who knows your business can.

For that guy, this should be an easy question, they understand your circumstance and your options in how you treat and document the event.  They won't be able to give you certainty, but they will be able to give you a way to report this that is accurate and protects you best should it be questioned later..... if you need someone in the SF bay area - that's where I'm from and I can give you a lead or two......

[TechieCFO]

I was a CPA for over 10 years working in an International Firm
and an NYSE listed bank. I am also a miner. I've been a corporate
CFO and COO over 20 years since then….

For buying on an exchange, the price you pay for a bit coin is your cost.
the price you sell it at is your proceeds. the difference is your gain or loss.
If you hold it over a year, use schedule D, long term capital gain. Else,
use short term capital gain. This is a very reasonable approach. If you do
this offshore, you can probably do it without being found out, but the US policy
is to tax its citizens no matter where they make income. I don't agree with that
but it is what it is. Proceed as you see fit.

If you mine, its less clear. To me, my cost of mining equals
Cost of mining equipment / estimated coins to be mined = $cost per coin mined.
There are some details, but I will leave those to you to ponder...

sales proceeds are realized when sold. Ordinary income rates would apply.

However, if no sale occurs, no dollars go into your bank account. That implies
no gross income (as defined by the IRS). At the same time, your costs associated
with mining those coins probably should not be deducted before they are sold, instead
capitalized…(e.g. not deducted)  some of you may want to deduct the costs before the proceeds arrive,
but the IRS would probably want to ding you on that… Can't say I'd blame you, but
its not what I would do. on the other hand, if its not a lot of exposure, go for it…see what happens :-)

the interesting side is if you buy and sell bit coin for alt coins or something else.
in this case, there is no US dollar realized as cost or proceeds. Take your own approach on that :-)

Barter transactions (bitcoin for bicycles, etc) -- i Think it only matters if its not a one-off transaction.
The IRS really is not in the business of going after a $1000 here or there… just not enough meat on the bone...

JD

[hanwong]

Barter transactions (bitcoin for bicycles, etc) -- i Think it only matters if its not a one-off transaction.
The IRS really is not in the business of going after a $1000 here or there… just not enough meat on the bone...

JD

Thanks for the above post.

But lets say hypothetically an American living in Thailand for years bought mining equipment using Thai Baht, then mined BTC in Thailand, held that BTC for 2 years and then used it to buy a car worth $220,000?

Capital gains taxes should be paid? If not what sort of taxes?  

This is not what happened in real life, as my wife bought the car with her BTC. But I did not use mine becasue I have no idea how to pay taxes on it. She as not being an American does not have to pay US taxes as far as I understand it.

The following is free information for entertainment purposes solely, does not include any specific tax advise, and cannot be used to avoid penalties...

The first thing this hypothetical guy needs to do is get his wife an ITIN (individual tax identification number similar to a SSN but only for tax filing purposes), so that she can be included on his US income tax returns. All US citizens must file income tax returns, and if the US citizen is married, the spouse, even if she is not a US person, must be included in the return. The US citizen must file a return that has an accurate filing status (Married Filing Jointly or Married Filing Separately -- advantages and disadvantages to either) In either case, you must file married and declare your non-US person wife. To file, but to not include your spouse, is incorrect and illegal. Whether her income is included on your tax return depends a many details.

The second thing is, an American living overseas, running a business denominated in a foreign currency does not release the American from his legal obligations to file and pay taxes as a US citizen living and working abroad. You will file your income taxes and denominate your income in USD, converted from Thai Baht based on average annual FX conversion rate.

The third thing is, yes capital gains is the most advantageous method of paying taxes on your bitcoins, but will it hold up in court is another issue up for debate with no definitive answer at the moment.

Lastly, I assume, and I apologize if I am making an incorrect assumption, this hypothetical American has been living abroad for many years and has failed to file income tax returns either because he did not make much income, wanted to give a big F U to Uncle Sam which is probably why he moved abroad in the first place, or just was lazy and Uncle Sam wasn't there to make sure he did the right thing. Whatever the reason might be, not filing and not paying taxes while living abroad is the same as not filing and not paying taxes while living in 'merica, it's illegal. If you do have unfiled tax years, get that taken care of first. Then worry about the correct treatment of your bitcoin gains.

[hanwong]

If there was no income no reason to file correct?

I was not in the USA but I was also not working and had no income of any sort.

So I did not have anything to pay, that I'm sure of. However is there a law saying I must file every year even if no money is owed? I kind of doubt that but I have been wrong before.

The following is free information for entertainment purposes solely, does not include any specific tax advise, and cannot be used to avoid penalties...

Correct, if you made $0 income then you do not need to file. However, very few people actually make $0 income. If you had self-employment income over $400, then you must file (for all you tax geeks out there, he must pay SE tax) Do you really think you can make the argument that you didn't engage in any sort of activity that led to the creation of $400 of profit for yourself in a year? Not even selling pineapples in Bangkok?

[hanwong]

If there was no income no reason to file correct?

I was not in the USA but I was also not working and had no income of any sort.

So I did not have anything to pay, that I'm sure of. However is there a law saying I must file every year even if no money is owed? I kind of doubt that but I have been wrong before.

The following is free information for entertainment purposes solely, does not include any specific tax advise, and cannot be used to avoid penalties...

Correct, if you made $0 income then you do not need to file. However, very few people actually make $0 income. If you had self-employment income over $400, then you must file (for all you tax geeks out there, he must pay SE tax) Do you really think you can make the argument that you didn't engage in any sort of activity that led to the creation of $400 of profit for yourself in a year? Not even selling pineapples in Bangkok?

Yes I can. I lived off of income I had already paid taxes on (I had a business that I sold before) while I was a student. Had I worked I would have been deported and or jailed.

I had no income of any sort at all. If anything the US Govt would owe me money.

Only income I could even think that I might have had was interest in my bank account and if I made any at all it was way less than $400 a year!

The following is free information for entertainment purposes solely, does not include any specific tax advise, and cannot be used to avoid penalties...

I'm just playing agent Smith here...

IRS Agent Smith thinks :I don't like the tone this guy is taking with me. He is not submitting to my authority: "So you had a bank account? Foreign bank account? (go google the penalties for not reporting a foreign bank account)" "So you received interest of less than $400 a year? How did you survive living on less than $400 a year? Possibly some illegal activities?" "Oh you didn't live off of your interest income, you lived off of savings? Let's take a look at those years you earned all that "already taxed income" and see what if we can make some adjustments."

Morphs back into Morpheus...You see how this game goes when you think you didn't do anything wrong? There is nothing wrong in trying to minimize your taxes. But when you take the attitude, that many in this community have, that I am going to use the law to get around the simple fact (but not a law) that the IRS will get a certain percent of what you make, then you will start getting into trouble.

[hanwong]

lol US bank account plus ATM. Only need to report foreign accounts over $10,000. Did not happen.

Thanks for your concern but on this issue I'm not worried.

Trying to get the other issues (real ones) sorted.

tbh

the issues with bitcoin taxation aren't that thorny. any good accountant you can find will be able to sort it out. Just pay your dues to the man and you should be fine.

[maaku]

hanwong, his wife is not a U.S. person, correct? So he has to file "Married, filing separately", and his wife is not required to do anything, correct? I understand why his wife needs a taxpayer identification number (to list on his filing), but why does she need to pay U.S. taxes too?

[hanwong]

hanwong, his wife is not a U.S. person, correct? So he has to file "Married, filing separately", and his wife is not required to do anything, correct? I understand why his wife needs a taxpayer identification number (to list on his filing), but why does she need to pay U.S. taxes too?

The following is free information for entertainment purposes solely, does not include any specific tax advise, and cannot be used to avoid penalties...

To determine whether the spouse is or is not a US person is fairly complicated with a long list of tests. The US citizen has the option to file MFS or MFJ, with many advantages and disadvantages to consider.

If the wife is truly a non US person, and he chooses to file MFS, then her income MAY be kept off of his income tax return. As always the true test if this possible scenario of keeping her income off of his US income tax return, contains many many hoops you must jump through.

If your just asking about what the law is, then the above statement is correct. If you care about how a real life situation where a US citizen hasn't filed or paid any taxes in years, lives abroad, has a wife that can afford a 200K car, but your still asking the IRS to give you the best possible tax treatment of your bitcoins so that you can minimize your pound of flesh you have to give up, well I have no comment there.

[hanwong]

lol she made her money in thailand and paid thai taxes on it. just cuz she married an american does not mean she should pay us taxes. you are now trolling im sure so i will ignore you from now on. thanks for the help

The following is free information for entertainment purposes solely, does not include any specific tax advise, and cannot be used to avoid penalties...

ur welcome.

to be clear, I don't believe I said the non US wife needs to pay US taxes on Thai income. In fact the last post to another poster, I said that if the wife is truly a non US person and the US citizen chooses to file MFS, then the wife's income may be excluded from the US income tax return.

But my overall point in that last post was that, in an audit situation this will be hard to explain, a US citizen not having filed or paid taxes in years, living abroad with no income, with a wife that can buy a 200K car, now you go to the IRS asking for a favorable tax treatment of bitcoin gains. In that type of situation, I do not foresee a favorable encounter with the IRS. Although the rules and the law states one thing, how field agents apply these rules and laws to your specific situation is an entirely different story. In my opinion, if I saw this situation, I know what the field agent would do. He would launch a rectal audit to try to sniff out if you've done anything wrong in the past. Now if you survive that audit because you absolutely haven't done anything wrong in the past, then congrats. It's just like a black kid wearing a hoody walking down the street. He's done nothing wrong, but that doesn't prevent the police from stopping him and asking him questions. Now go and ask how many black kids have been stopped by police having done nothing wrong, but ended up in trouble anyways.

In any event, since I'm ignored , I hope that little story was illustrative and helpful to others who are in delicate tax situations.