IRS Rules Bitcoins Subject to Capital Gains, Income Tax

The IRS released a ruling on Tuesday that they consider bitcoins a form of property rather than a currency.

Bitcoins are a virtual currency created in 2009.  Unlike standard currency, bitcoins Over the past few years, bitcoins have become a standard form of payment in various illegal activities, because of the ease with which parties can exchange the currency and the anonymity bitcoins provide to the parties involved in transactions.

“Virtual currency is treated as property for federal tax purposes,” read the IRS ruling.  “General tax principles that apply to property transactions apply to transactions using virtual currency.”

The IRS concluded that although bitcoins are often exchanged as a form of payment in a manner similar to real currencies, bitcoins do not have the status as a legally recognized currency in any jurisdiction.  Therefore, bitcoins are a form of property.

“[The IRS ruling] provides clarity for taxpayers who want to ensure that they’re doing the right thing and playing by the rules when utilizing Bitcoin and other digital currencies,” said Senator Tom Carper, Delaware Democrat.

As a result of the ruling, the IRS can apply federal tax regulations to bitcoins and subject the holders of bitcoins to capital gains and income tax.  These rules are similar to those that apply to stocks and other intangible property, which are subject to capital gains tax when held long term as an investment.

In addition, the ruling means the operators that handle bitcoins will have to make the changes necessary to track and report the exchange of bitcoins.  Businesses that pay employees in bitcoins must report those payments as wages on Form W-2.  Businesses that accept bitcoins must pay tax on their value.

Likewise, the IRS will consider individuals in the business of verifying and generating bitcoin transactions using their personal computers as having their own business.  The IRS will require those individuals to abide by self-employment laws.

A single bitcoin is presently worth approximately $587.

Tax on Bitcoins the Latest Attempt to Control Virtual Currencies

The IRS ruling is the latest in a series of moves by governmental agencies to secure and control the Bitcoin exchange infrastructure.

In March 2013, the United States Treasury’s Financial Crimes Enforcement Network announced bitcoins and all other virtual currencies were subject to federal money laundering rules.  The rules require that bodies facilitating the exchange of virtual currencies must report the exchange of significant transfers.

With the IRS ruling, some believe it may signal the end of the growth of bitcoins as a viable currency.

“The IRS tax ruling, combined with extreme daily price movements of up to 10%, makes Bitcoin even less economical and efficient as a transactional currency,” said Mark Williams, a former examiner with the Federal Reserve Bank and a finance professor with Boston University.

Alternatively, there are others, such as Ajay Vinze, a professor of information security with Arizona State University, who believe the IRS ruling has made bitcoins and other virtual currencies a legitimate form of payment.

“What the IRS has done is legitimize Bitcoin as an investment or a property or a store of value,” said Vinze.  “It’s one more step in the currency’s life.”

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by Mark Johnston

Mark has been a contributor to legal web sites related to bankruptcy, tax, and criminal law since 2011. He has an Accounting degree from Texas A&M University.