As we approach tax day, many bitcoin fans may be wondering how to handle all of their newfound wealth. Given the recent ruling that BTC are property, not currency, things can get kind of hairy when mining, buying, or trading your BTC. What to do?
Thankfully, folks like Tyson P. Cross are around to help. The owner of BitcoinTaxSolutions, Cross handles tax returns and offers tax planning with a focus on cryptocurrency. That’s right: he’s a bitcoin accountant.
I asked Cross to walk us through the recent ruling and what it means for Satoshi-ites.
TechCrunch: Tell us about yourself. How did you get involved in bitcoin?
Cross: I first learned about cryptocurrencies in early 2012 when I came across a law review article discussing their legal uncertainties. Unfortunately, I didn’t have the foresight to view them as a potential investment opportunity, although I admired their possible application in the banking and finance industries. It wasn’t until spring of 2013 that really took a professional interest in bitcoins from a tax perspective. I spent the next ten months exhaustively researching the proper tax treatment of bitcoins and ended up developing a real passion for this area of the tax law.
TechCrunch: How will the IRS find out about our bitcoin? Can they?
Cross: As a general rule, the IRS only knows what it is told. This means that it has no knowledge of your bitcoin unless someone tells them. Here are four ways that can happen (others may exist). First, your bitcoin exchange may report your transactions to the IRS. This would be done with a Form 1099, which you’ve probably encountered at one time or another in a different context. However, it does not appear that bitcoin exchanges are currently subject to the 1099 reporting requirements (although that will probably change in the future). Thus, unless the exchange voluntarily files a 1099 against you, it is unlikely that the IRS will receive a report of your bitcoin transactions. Note that they would need your Social Security number to file a 1099 in your name, so a request from your bitcoin exchange to provide your Social Security number may be indicative of a 1099 filing.
Second, your bank or bitcoin exchange might file a Suspicious Activity Report (“SAR”). U.S. banks and bitcoin exchanges are required to file SARs for wire transfers that are “suspicious” and larger than $5,000 ($2,000 in the case of bitcoin exchanges). The meaning of “suspicious” is very vague and highly discretionary. Out of an abundance of caution, many banks automatically treat all international transfers as “suspicious.” So, if you’ve sent or received a wire transfer of more than $5,000 to/from an international bitcoin exchange like Mt.Gox or BTC-e, you can be pretty sure that your bank has already filed a SAR against you (although they are prohibited from telling you if they did, so you’ll never know for sure). The larger and/or more frequent you SAR filings, the more likely they will become a legitimate red flag and trigger an investigation. Although FinCEN is generally concerned with money laundering activities, the IRS does have access to FinCEN filings and it is common for IRS special agents to participate in FinCEN investigations.
Third, someone can report you to the IRS, which happens far more often than you might think. The simple fact is that people get jealous, and if they’ve heard that you’ve made lots of tax-free money with bitcoin, they might get tempted to make sure justice is served. There’s also that nice reward the IRS will pay them for their efforts.
Fourth, you voluntarily and accurately report your gains on your tax return. That might sound ridiculous to some people given the inherent anonymity of bitcoin, but there are some very rich people in prison right now who used to think the same thing about their Swiss bank accounts. The fact is that penalties for failing to report income are significant. This includes the possibility of criminal prosecution. You can also add to this the additional penalties for failing to report foreign financial accounts, which can be even more severe.
At the end of the day, you have a decision to make. You can comply with the law and pay taxes just like everyone else, which is admittedly unpleasant. Alternatively, you can violate the law and hope that you don’t get caught. Maybe you will, maybe you won’t. If you are caught, though, the amount of money you’ll be forced to pay in penalties and interest will drastically exceed the amount you saved. That’s not to mention the possibility of a felony criminal conviction and prison sentence. Personally, I have seen the havoc wreaked on people’s lives by tax crimes and I would never want to be in their shoes. Neither should you.
TechCrunch: What do these new laws mean for miners?
Cross: IRS Notice 2014-21 clarifies the tax treatment of bitcoin miners. Specifically, the Notice provides that miners must recognize income for each bitcoin mined during the taxable year. The amount of income is equal to the market price of bitcoin on the day it is awarded on the blockchain. This amount also becomes the miner’s basis in the bitcoin going forward and will be used to calculate gain/loss in the future when the bitcoin is sold.
For example, assume someone mines 1 bitcoin in 2013. On the day it was mined, the market price of bitcoin was $1,000. That person has $1,000 of taxable income in 2013 as a result of his or her mining activity. Going forward, that person’s basis in the bitcoin is $1,000. If he or she later sells the bitcoin for $1,200, he or she will have a taxable gain of $1,200 – $1,000 = $200.
Mining expenses, such as electricity, would be deductible in the taxable year as an expense. The proper method for deducting these expenses will depend on whether the miner’s activity rises to the level of a trade or business, which is a highly factual determination and should be made with the assistance of a tax professional.
This determination also has additional consequences in the form of self-employment taxes, which the IRS notice also confirmed are applicable to miners engaged in a trade or business.
TechCrunch: What do these new laws mean for exchanges?
Cross: Surprisingly, the IRS Notice was silent with regard to bitcoin exchanges (although it did address companies that provide bitcoin settlement services to merchants). However, as bitcoin exchanges continue to open in the U.S., this will likely not be the case for long. At some point, the IRS will have to address bitcoin exchanges. When they do, it’s likely that bitcoin exchanges will be made subject to the same requirements as other financial asset exchanges, which would include reporting bitcoin transactions on Form 1099-B. For now, though, the greatest burden on bitcoin exchanges remains compliance with federal and state anti-money laundering laws.
TC: What do these laws mean for the average Josephine with a few BTC?
Cross: For the average person who bought BTC as an investment and plans to hold it as such, the IRS Notice has little impact. However, for those who plan to use bitcoin as a medium of exchange, the IRS Notice will create some difficulty because of its position that every bitcoin transaction is a taxable event. This means that bitcoin users will have to determine their taxable gain (or loss) each time they use bitcoin to purchase goods or services. That creates a serious burden that will need to be addressed before bitcoin can achieve widespread adoption. The solution might be as simple as a software program that tracks bitcoin transactions automatically. Preferably, though, it would be a recognition by the IRS that bitcoin needs to be classified as a foreign currency for tax purposes (which would render personal transactions non-taxable).
TC: Is there anything special to watch out for? Anything we may miss?
Cross: Going forward from here, it’s vitally important for the bitcoin community to get involved in shaping the tax treatment of cryptocurrencies. The Treasury Department is accepting public comment and I would expect groups like the Bitcoin Foundation to participate in this process. As the saying goes, the power to tax is the power to destroy, and this is no exception.
You can contact Tyson here.