IRS weighs in on bitcoin taxation

Recent guidance from the Internal Revenue Service establishes that bitcoins and other types of digital money will be taxed as property rather than currency.

What is Bitcoin?

Bitcoin is a digital payment system that was launched in 2009. A key characteristic of bitcoins and similar virtual currencies is that they allow payment transactions to take place on a peer-to-peer basis without the need for a central controlling entity like a bank. For this reason, Bitcoin and similar payment systems are sometimes referred to as a decentralized currency.

Theoretically, at least, bitcoins have a number of potential advantages over traditional currencies like the dollar. One aspect that appeals to many bitcoin users is the fact that, because the digital currency is not issued or controlled by any country or government, it allows international transactions to take place without the need for currency exchanges or fees.

Another potential draw for some users is that its value is not tied to the dollar or any other unit of actual currency, therefore it is not subject to manipulation by the Federal Reserve Bank and thus is theoretically shielded from inflation to some degree.

How bitcoins are taxed

According to the recent IRS notice, bitcoins and other virtual currency will be "treated as property for U.S. federal tax purposes." This means that it will be taxed according to its fair market value, much like other valuable property such as art or antiques.

Thus, the IRS explained, bitcoin traders must pay capital gains taxes if they invest in virtual currency, just as they would when investing in stocks or bonds. Likewise, people who "mine" bitcoins or are paid in virtual currency for their work must report the value of the digital money they receive to the IRS, and employers who compensate workers in bitcoins can be liable for business taxes relating to those payments.

IRS announcement draws mixed reaction

The recent announcement from the IRS regarding the taxation of bitcoins has drawn mixed reaction. For instance, as reported recently by USA Today, some see the policy as a step forward for the virtual currency, increasing its legitimacy in the eyes of the public by formally recognizing its value as an investment worth taxing. This development, they hope, will help spread the perception of bitcoins as a valid form of payment and encourage its increased acceptance and use.

On the other hand, others fear that taxation of digital currency may discourage its use and potentially curb the growth of the new payment system. Because the market value of the Bitcoin is still highly unstable and has been known to fluctuate dramatically from day to day, some say the IRS announcement could discourage people from using and accepting what some already view as a risky and inefficient payment method.

Get legal advice when tax questions arise

Individuals and business owners with questions about their tax liability under state and federal law are encouraged to contact an experienced tax lawyer who can advise them of their rights, responsibilities and legal options with regard to their unique circumstances.