Some are quick to predict the death knell of Bitcoin as the IRS intends to treat it as an accounting line item that’s subject to taxation. But Bitcoin’s fundamental components may very well hold the key to its longevity…
In my ongoing coverage of Bitcoin’s brief voyage to date, we’ve seen some historical events that could’ve easily wiped out lesser rivals.
The clamp down on the infamous Silk Road black market website last October sunk the value of bitcoins by 20% in one day, but the digital currency quickly rebounded, going on to reach historic highs in early December.
A few months later, however, the vice chairman of the Bitcoin Foundation was charged with conspiring to commit money laundering through said Silk Road site. Bitcoin suffered another setback… and this time we began to see a gradual decent in prices.
Then there was Japan’s Mt. Gox – once the world’s largest Bitcoin exchange – declared bankruptcy due to a hacking scandal in late February, and was subsequently shutdown with hundreds of thousands of bitcoins having mysteriously “disappeared”.
Then in what’s perhaps the most devastating blow to the Bitcoin momentum so far, Chinese banks cracked down on bitcoin use by issuing notices to local bitcoin exchanges that their accounts will be frozen come April 15th.
According to the Wall Street Journal, the Chinese account for a large portion of global bitcoin trading. And Huobi, now the largest Bitcoin exchange in the world, accounts for more than half of all bitcoins traded daily.
Huobi stated that it received a notice from ICBC bank – itself the largest bank in the world measured by assets – effectively barring them from accepting yuan-denominated assets.
With all these headwinds, Bitcoin prices have officially fallen below $500 for the first time since November 2013.
But a lesser-known situation brewing within our own Internal Revenue Service (IRS) is widely feared to be the straw that’s truly set to break the camel’s back.
Throwing Down The Tax Gauntlet
The IRS released a notice on March 25th stipulating that the use of virtual currencies like Bitcoin count as “property transactions” under current tax law, rather than conventional currency.
Virtual currencies may operate like real currency, says the IRS, but it does not have legal tender status in any jurisdiction.
In other words, Bitcoin and others are being designated as a commodity with its own fluctuating value, like a stock or bond — and will be taxed accordingly.
As a result, this is expected to be a real headache for businesses that accept bitcoins for their products and services – especially now that it’s tax time.
Companies must include the fair value at the time of receipt for gross income reporting purposes. And if they pay their employees in bitcoins, they’re required to withhold payroll and federal income taxes and file a W-2 Form.
Furthermore, if you pay contractors in Bitcoin for a job that’s worth more than $600, a Form 1099-MISC (Miscellaneous Income) must be filed.
The people who mine for bitcoins aren’t immune from the taxman either, as it’s considered a form of self-employment.
Miners must track the value of their coins when they were first extracted from the Bitcoin algorithm as well as when they are used or sold.
For example, if a miner mined one Bitcoin on January 1, 2013, when it was worth $13, then they must report $13 in direct income. If the Bitcoin was later sold on December 31, 2013, when it was worth roughly $1,000, they would be subject to capital gains tax on the $987 difference.
So does this mean that Bitcoin loyalists should think about throwing up a white flag?
Not so fast. And here’s why…
IRS Ruling Legitimizes Bitcoin
Despite government regulation essentially silencing the overarching mantra of creating an anonymous, decentralized (and non-taxable) currency — it is itself an acknowledgement that Bitcoin is legitimate and is here to stay.
Sure, you will no longer be able to transfer your bitcoins into cash without a paper trail, so it’s wise not to try and dodge the IRS. However, Bitcoin investors shouldn’t be discouraged by the new, seemingly complicated tax rules.
For one thing, the universal Bitcoin public ledger (aka blockchain) already tracks every single Bitcoin transaction that’s ever been conducted since the digital currency was launched.
So while there’s yet to be any official program developed, it’s likely only a matter of time before a tech enthusiast designs one to match Bitcoin transactions associated with each user’s wallet.
That same tool (or another one) could in turn track a Bitcoin’s value whenever they’re deposited or withdrawn, thus allowing users to keep a log of gains and losses — similar to the way an equity brokerage account keeps track of your profit/losses when you trade stock.
On the bookkeeping side of things, by undertaking transactions via Bitcoin, any gains the businesses generate won’t be taxed as high as direct income.
Like many out there who avoid paying more taxes by issuing stock instead of salaries, Bitcoin can prove to be just as advantageous for companies when declaring income from the sale of assets.
By the same token, any capital losses in Bitcoin can be reported as a deductible…and with the way prices have fallen, it can be a good thing as well.
In light of all this, the original incarnation of Bitcoin and all that it stands for is bending to the might of governments and central banks, but there clearly are merits to making Bitcoin less rogue and more mainstream.
The usual heightened risks still exist, but Bitcoin just moved one step closer to becoming legitimate.