Bitcoin has been in the news frequently lately, particularly since the collapse of the Japanese-based Bitcoin exchange, Mt. Gox. Bitcoin is a digital currency and peer-to-peer payment system created in 2009. Since 2009, the use of bitcoins has expanded significantly. Bitcoins can be bought and sold for various currencies, generally through a series of online exchanges where participants can bid on bitcoins from individuals or buy them at market price from companies.
The unique characteristics of Bitcoin as a digital currency left many questions about tax reporting requirements, such as whether users of Bitcoin must file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). U.S. taxpayers who have an interest in, or signatory or other authority over a foreign financial account, such as a bank account, securities or other similar foreign accounts must file an FBAR if the aggregate value of the foreign accounts exceeds $10,000 at any time during the calendar year. As of October 1, 2013 the FBAR form must be filed through the Financial Crimes Enforcement Network’s (FinCEN’s) Bank Secrecy Act E-Filing System on or before June 30th of the year following the calendar year being reported. For example, to report foreign accounts held open in 2013, the taxpayer must file the FBAR by June 30, 2014.
Prior to the Internal Revenue Service’s release of Notice 2014-21 on March 25, 2014, we did not know whether the IRS would treat a virtual currency as currency or property. The IRS has now said – treat it as property. [IRS Information Release IR-2014-36 and Notice 2014-21]. I think that is a good answer. After all, Bitcoin is not used as the currency of any government and generally, are convertible to a currency of a government. For example, you can buy Bitcoin with U.S. dollars and convert it back to U.S. dollars.
So, what does it mean that Bitcoin is property? Here are a few tax examples.
• If you mine Bitcoin, you generate income equal to the value of the Bitcoin when mined. And if you are doing this as a business, you’ll also owe self-employment tax. [See Q&A 8 and 9 of Notice 2014-21].
• If you buy Bitcoin so you can use it instead of dollars, you’ll have some extra recordkeeping to handle. For example, you bought 1 Bitcoin (BTC) when it was worth $700. You later use half of that BTC to buy goods and at that time, 1 BTC is worth $800. You have a $50 gain. A few months later, you use the remaining .5 BTC to buy goods and at the time, 1 BTC is worth $1,000, you will report a gain of $150. The tax principle here is that if your wealth has increased and you cash out that wealth (realize it), you have income. When you can use something you paid $700 for to buy $900 of goods, you have income of $200. This is the same result you’d have if you had converted the Bitcoin back to dollars right before making the purchase of the goods in dollars. [See Q&A 6 and 7 of Notice 2014-21]
• Your employer pays you in Bitcoin. You’ll have income equal to the value of the Bitcoin on the day you receive it. And, yes, the employer will include this income in your W-2. Same answer if you are instead a contractor; it will be included in the Form 1099 your employer gives you. [See Q&A 10-14 of Notice 2014-21]
Federal tax law requires U.S. taxpayers to pay taxes on all income earned worldwide. The knowing omission of such income can result in a minimum fine of $10,000 and/or potential incarceration of at least 1 year besides the standard civil penalties associated with the increase in tax and interest thereon. U.S. taxpayers must also report foreign financial accounts if the total value of the accounts exceeds $10,000 at any time during the calendar year. Willful failure to report a foreign account can result in a fine of up to 50% of the amount in the account at the time of the violation and may even result in the IRS filing criminal charges.
U.S. taxpayers who have bitcoins would benefit from the experienced tax attorneys of the Law Office Of Jeffrey B. Kahn, P.C. representing you to avoid the pitfalls associated with failure to comply with the reporting requirements associated with owing bitcoins.
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