Topic: Time to start thinking about taxes (Read 6241 times)

!!!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.

No, BTC wasn't specifically created for anonymity or tax aversion, and most users are probably not completely anonymous, because being truly anonymous on the Internet is not nearly as easy as you must think it is.  In USA, all income is taxed unless there is a specific rule saying it isn't taxed, so BTC is already taxed, hence the discussion thread about how to properly pay said taxes.  This is probably true in most countries with income taxes.  I'm not a hardcore BTC bull, but expecting its value to drop because it is taxed is pretty funny considering its value didn't drop when silk road was shut down and the public seemed to think "BTC is to remain anonymous and buy illegal goods".

as soon as btc is taxed, the value will sink. The whole point of BTC is to remain anonymous and tax free, correct?

Chris, I can't specifically bless tax returns or strategies I don't look at in specific detail, but what your paragraph sounds generally reasonable.  Among the other things I look at when advising clients include: operating loss carryforwards, eligibility for research credit, use of retirement plans (SEP IRA etc.), full use of self employment business deductions, use of rental income, use of living trusts, interfamily tax strategies, and charitable gifting of appreciated assets. 

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. 

Well, after reading through all of this I'm going to throw out there that I'm going with capital gains (long term in my case) for 2013. The IRS is still "researching cryptocurrencies" so until they provide guidance I'm taking the 'report and be consistent' approach. For me personally the cap gains is essentially tax free because I had losses in a start-up I invested in, so it's going to net to below 0, and had I gone with the bitcoin-as-a-currency classification (income) I would owe a high tax rate and not capture the cap gains netting benefit. If the IRS doesn't like it they can provide guidance or re-calculate it for me I guess.

steverabincpa what do you think?

I would love to see this ^..

I have read all the post and am very appreciative all the informed perspectives. I wish Uncle would step up now and put out some sort of interim guidance at least.

steverabincpa, my use of the term reward refers to the coinbase transaction - and the miner receives this plus the fees.  One could take the position that the coinbase is lottery-like.  I am not particularly inclined to that as outcome is not certain in a number of for-profit activities.  Fishing and crabbing is the first idea that comes to mind. 

Now steverabincpa - just for fun - check out the way the service treats slot-machine play..... with each trip to vegas being a separate 'transaction' that can not be netted with the other trips........ then think how the block-chain works and what a very silly position the service might take if they said each attempt at a block was an independent transaction.  Pretty fun in the abstract....

The transaction fee is another matter.  To the miner I suspect it is income for service - but the amount these days are so small that I doubt anyone cares.......

achillez - if you're still in the thread - the timing for when the coinbase is to be recognized - if you take the position that it is to be recognized when the reward is allocated to the miner - is again pretty interesting - is it the mean value of bitcoin for the day, and we've had $300 day spreads (forget the differences between Mt. Gox and the others) - say you just use the blend CoinBase reports) as would typically be the case for Estate & Gift taxes, with of course special rules for those favorite holidays!  Even more fun, is it when the block is added to the chain, when you are mature at 99 confirmations..... which can span a day.... Who knows without guidance from the IRS.

steverabincpa is probably right in saying pick your poison, be logical and be consistent - and remember pigs get slaughtered.

We ought to encourage the foundation to chime in o this so that we have some support from somewhere other than a forum.

How is the 'reward' different from lottery winnings or a treasure trove (both taxable eg: Cesarini v. United States, 296 F.Supp. 3 (N.D. Ohio 1969)?  In particular, if a US based lottery pool were involved, with the pool as a counterparty, how would the counterparty record (and report) the transaction?

What are the holding periods and how much of a difference are you talking about?
There is a general cost-benefit principle in accounting that we should not spend $10 to accurately measure $1, and in tax enforcement in general the tax authorities spend $1 to collect $10, not the other way around.  Certainly reasonable estimation methods can be used to avoid individual measurement of micro amounts when exchange information is limited.  I encourage you to consult a licensed tax professional about the details of your situation.

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. 

I've been asked (in private) for more technical support for the capital vs. ordinary treatment of bitcoin gain and loss.  I will share my research on this with you all.  Beware, it is somewhat technical.

A) "Is bitcoin a capital asset? ... I don't mind doing some reading "
It depends.  This is a grey area raising a lot of issues depending on the details of the situation.  I don't have a general answer at this time.

If we believe Bitcoin is currency then, since an individual taxpayer's functional currency is the US dollar,  the foreign currency rules IRC988 apply:"Code Sec. 988. Treatment of certain foreign currency transactions
(a) General rule
Notwithstanding any other provision of this chapter -
(1) Treatment as ordinary income or loss
(A) In general. Except as otherwise provided in this section, any foreign currency gain or loss attributable to a section 988 transaction shall be computed separately and treated as ordinary income or loss (as the case may be)."

This is powerful language and "notwithstanding other provisions of this chapter" means that it potentially trumps the IRC1221 rules on capital assets and capital loss.  Section 988 goes on to say:
"(C) Special rules for disposition of nonfunctional currency
(i) In general. In the case of any disposition of any nonfunctional currency -
(I) such disposition shall be treated as a section 988 transaction, and
(II) any gain or loss from such transaction shall be treated as foreign currency gain or loss (as the case may be).
(ii) Nonfunctional currency. For purposes of this section, the term "nonfunctional currency" includes coin or currency, and nonfunctional currency denominated demand or time deposits or similar instruments issued by a bank or other financial institution."

However, see Rev. Rul. 74-7 where traveler foreign currency reconversion gain/loss not associated with a trade or business was determined to be capital gain/loss.

See also (1985) National Standard Company v. Commissioner: Will the Real Character of Foreign Currency Exchange Gains and Losses Connected with the Disposition of Foreign Debt Please Stand Up? John F. Lyons
http://digitalcommons.pace.edu/cgi/viewcontent.cgi?article=1580&context=plr

Section 1221 defines the term "capital asset" as property held by the taxpayer, regardless of whether it is connected with the taxpayer's trade or business, unless the property meets one of eight listed exceptions: (1) inventory; (2) property of a character which is subject to the allowance for depreciation provided in section 167, or real property used in a trade or business; (3) certain intangible property; (4) accounts receivable acquired in the ordinary course of a trade or business; (5) certain publications of the United States Government; (6) certain commodities financial derivatives; (7) certain hedging transactions; and ( 8 ) supplies of a type regularly consumed by the taxpayer in the ordinary course of a trade or business of the taxpayer.

(0) Is bitcoin property?  Perhaps.  "Foreign currency is recognized as "property" as that term is used in the internal revenue laws. Such property meets the literal definition of a capital asset as set forth in section 1221.2" (International Flavors & Fragrances Inc.; 62 T.C. 232 (1974))  

(1) Is bitcoin inventory?   Probably not. "In the manufacturing context, goods subject to inventory are tangible, movable objects." -  Cf. Jim Turin & Sons, Inc. v. Comm’r , 219 F.3d 1103, 1107 (9th Cir. 2000), (although the IRS commissioner has broad power, in the future to require inventory accounting in designated industries; eg see IRS Letter Ruling 9523001 and 9527003).  Also note that property cannot be classified as inventory unless it is held by the taxpayer primarily for sale to customers in the ordinary course of his or her trade or business (Van Suetendael v. Comm'r, 152 F.2d 654 (2d Cir. 1945))

(3) Is bitcoin certain intangible property?  Copyrights, a literary, musical, or artistic compositions, and similar property.  Probably not.

(7) Is bitcoin certain hedging transactions in the course of trade or business.  This is a complex grey area, as hedging in the course of a trade or business is not well defined.   See Lyons cit. above.  However transactions entered into for speculative purposes will not qualify as hedging transactions. See S. Rep. No. 201, 106th Cong., 1st Sess. 24 (1999).

B) Redacted.
C) " prefer to do things right"
I assume that most of us want to do the right thing, not just to avoid penalties and to sleep well at night, but to set a good example to others and to have a functioning society and government that relies on trust not just on enforcement.  Call me an idealist.    As you can see Bitcoin is a grey area in the tax law, and we are best served by not preparing the tax return ourselves, but hiring a (another) licensed professional who will research the specific situation efficiently and accurately and perhaps with less bias than the taxpayer doing it themself.  

When we (tax professionals like me) make mistakes it is perhaps from error or miscommunication vs. from deliberate deceit/fraud, whereas with a self-prepared return the taxpayer is more likely to be considered 100% responsible and perhaps the taxpayer intent is more likely to be questioned.  Having a respected preparer signature on the return is also particularly important if the tax return is to be credible documentation of income for loan or loan refinance.

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.  

For US Tax purposes, would it not be appropriate to divide mining income between the bitcoin 'reward' and the 'transaction fee' associated with the accepted block.  The former involves a very unique economic transaction that we all feel is open for interpretation.  The transaction fee we receive is another matter.  Those generating a transaction either intentionally or there mining software allocates the fee to prompt inclusion in the block when it is constructed. 

thougths?

Well the reason with option1 is a problem is that many of the exchanges (at least altcoins) do not track full history of trades. Many are < 50. For many micro-transfers many traders easily bypass the 50 amount. This is why I think option2 is the only option for most people. Basically track all profits at point of sale - costs, and treat either as a capital gain or income. In this case would declaring it as a capital gain be fair, or taxing as an income be more accurate?

In general, the approach you describe sounds reasonable to me.  I do not think the problem of tracking is quite so "huge".  Eventually when you sell or exchange the coin you will have paid tax on 100% of your realized amount, so the amount recognized at the mining date is just a matter of timing.  Adopt a method that is reasonable and simple to apply and be consistent.  For example you trade primarily on one exchange during a period you might use published trades from that exchange if available to value mined coins in that period (last, w. avg, (high+low)/2 - any would probably be considered reasonable).  Whichever method and periods are appropriate for your situation and volume, write it down and be consistent.  By paying some tax at time of mining you are demonstrating good faith effort to comply in a grey area of tax law.  Where people get in trouble is when they exhibit the attitudes like "I will pay zero tax" or "I will arbitrarily change my methods from day to day or using hindsight to pay the absolutely least amount of tax possible".  Don't do that.  These are the people tax authorities tend to select for enforcement and to set precedents. 

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. 

It's difficult to track profit at time of mining since the price of the coin greatly fluctuates, pools are used, etc..  I figure there's two approaches to take here:

Approach1:
a) at the time of mining any bitcoins acquired should be tax as income at the fair price for those coins at the end of business day (or week - depending on the accuracy of the coins)
b) at the time of selling, any appreciation of the bitcoin capital should be taxed as a capital asset with regular short-/long-term rules applied. This also would apply with any bitcoin that we purchased/sold for a profit
> any equipment costs can be subtracted from the overall profit, I believe this only applies to (1)

Approach2:
a) Only follow (1b) from above, and pay taxes on bitcoin as capital gains when it is converted over to US $
> I don't think you can deduct equipment costs in this case

I'm inclined to follow approach1 but it's going to be a huge problem accurately tracking what was made at the time of mining given the fluctuating prices.
Also an interesting side question is how do we declare taxes on items that we purchased with BTC that were acquired with (1b) ??

Fair enough, not my skin in the game.  I will only add that publication 17 mentions collectibles and they have a higher tax rate.  While I'm not qualified to provide advice, and specific wording may not matter too much when it isn't in a legal document, and multiple people who may or may not be qualified to provide advice say that bitcoin doesn't fall under the collectible category I refer to, I will say that I, personally, would definitely stick with the term asset.

It's fine we agree to disagree, clearly you've got your approach and I have mine. I don't see any taxable event until it's exchanged. At that point you either have to average every payout at the value it was received or come up with some other clever way to establish a cost basis. The value it hits the wallet is cost basis, you don't have a taxable event until it's liquidated, it doesn't exist. I've seen several articles that argue both sides of this too, personally since Uncle isn't telling me explicitly how to handle it then it's going to be treated either like a stock or as a Beanie Baby.

About the pool thing, they only act as a conduit and some charge fees. If they "earn" 25BTC through YOUR equipment doing all the work, and then they payout all 25BTC it's a wash; guess they can report both sides, and technically maybe they should, but there still isn't a gain that I can figure unless they have a fee revenue setup. Now, if they consider the 25BTC payout to miners as a dividend payment it might be different, honestly we can dream these up all day. You need to go with the story that makes the most sense right now, stick with it, and see if we get a clear rule eventually. You might think I'm giving the bad advice, and that's fine, but I'm not putting myself out there as a CPA. I'm just a dude with a kinda cool job and I've been investing and filing my own taxes for 15 years, had to hire a CPA twice actually because I had some complexities... I digress, I'm a regular guy giving my take just a bit surprised at the advice. I have been skimming lately because I'm working on a project, but at a cursory review there were some things that didn't make much sense to me.

I wasn't trying to give the CPA guy a hard time or pretend I'm the expert, apologies if I came off that way, seriously to the guy I originally quoted no disrespect. I just think there is more than one way to handle it right now, and just because someone is a CPA doesn't mean they've filed BTC on a return yet, reasonable doubt- this is the internet afterall... Unless they set clear guidance there's no way I'll be reporting my toy bitcoins on my income taxes, just not gonna happen, at all. I love this shit, seriously, BTC is the coolest and I have a ton of fun setting up my miners, reading about it, chatting about it, the community is great, I truly believe in it: BUT, right now only a small amount of people (most users here) view it as a "currency". Personally, I view it as a collectible right now; and just like all the other collectibles (if) sold at a profit there is a request that you claim it (when/if you SELL it) using purchase price as cost basis and sale proceeds as gross.

Really?!?!  Wow...  If you had an automatic weapon, you wouldn't have any feet.  Even if the "payment" was a "gift," and forgetting the fact that your statements conflict with each other and couldn't possibly be defensible when paired with you quoting a CPA referencing both income possibilities, you are suggesting that the pool had an investment and gave it to you, which would not be a claimable loss, and would make it impossible to legally run a pool.  Pool gets 25 BTC block, it is $25,000 in income, they gift it to miners, they still owe income tax on $25,000 and don't have any money to pay it.  What's next?  Are you going to suggest the pool's receipt of the block was a gift from the miner who found it and pay all taxes on any block your equipment finds for the pool?  Are you going to suggest that the block was a gift from God and the income tax is his responsibility?  Are you seriously going to claim that the basis on the value of the coins at time of receipt without paying income on that basis, or are you suggesting a basis of 0 even though everything referenced by the CPA indicates otherwise?  Just for the record, if it's a video game in January and has 0 value, but you bought it as an investment, there is tax code for disposal of worthless assets to go along with the code for cost basis of assets and paying income tax on assets received.

I am not an accountant or a lawyer, so none of this should be construed as financial or legal advice, but I would read the information he refers to (and certain sections of IRS publication 17) before trying to argue a stance against it.  Also, I probably wouldn't post on a public forum that I won't be paying taxes unless I believed income tax on US citizens wasn't constitutional or legal and believed I could legally defend my position.

I'm impressed you got your certification but I'm puzzled by your position. I mean, most CPAs err on the side of caution so that might explain; and I mean no disrespect by that, it's not a bad thing. My problem with your position is that there is no "taxable event" happening. It's not currency, yet, and we honestly don't know if it ever really will be in the eyes of our Uncle Sam.

I mine with a pool, they pay me a balance in something that can be exchanged for money, but until/unless it is exchanged there is no taxable event to report. Even if someone gifts you a stock there is no taxable event until it is liquidated, and from there you retrieve the original cost basis to determine the realized gain/loss, or step it up to date of death if it's inherited, but the act of receiving is not reportable. If it's not exchanged there's no realized gain or loss. This whole darn thing could become a bad video game at some point, just a worthless "score" not exchangeable for anything. I don't see how you can advise anyone to report a mining payout, the methodology makes almost no sense.

Think about it, say you mine 40 BTC in January and they are worth $40k, but at year end they are worth $4, you expect people to report a $40k taxable event on something that became worthless within the same year? There's nothing to report until it is sold. Damn, this thread has gotten crazy, good luck to everyone hiring a lawyer for their audit defense. I guess we will all take a position and stick with it, pure intent rarely fails and you can always make a case if you had a sound approach. I'm keeping track of expenses, and if I sell BTC I will track that too, but there's no plan to report anything until I can verify a gain or loss. You could say I am treating BTC as a stock, and what I pay on equipment is like my commission fees that are deducted from proceeds; even in a great situation I'll breakeven and wash upon sale with no reportable gain (unless BTC goes to the moon, which in that case I will gladly pay my cap gains tax on the investment IF/WHEN I exchange for USD).

Agreed, it is income at the time of mining.  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 is the 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 to the taxpayer, not when the investment is sold.  And IRC988 requires income to be recognized when foreign currency is received for goods or services.

Regarding depreciation, in general for federal taxes, most miner expenses get deducted immediately not depreciated, because the business sets a $2,500 capitalization threshold, expensing anything below this threshold, and then accelerating depreciation of expenses over $2,500 up to IRC179 limits (often $500K).  For state taxes it is possible that some expenses may need to be capitalized and depreciated.  Don't forget to deduct telecomm expenses, training, reasonable business travel and home office expenses.

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.