Bitcoin Tax Attorney
For many, Bitcoin and similar digital currencies like Etherium, Lite Coin, and others present significant promise. For many individuals interested in the technology, digital currency is merely the first application of the “blockchain.” Digital currency and blockchain evangelists predict that in time similar technologies will be used in an array of applications potentially ranging from the recording of deeds and property rights to smart contracts. While this technology presents significant opportunities, it is still subject to regulation and taxation by the IRS. Taxpayers who fail to recognize that Bitcoin can result in tax obligations risk fines, penalties, interest, and additional tax consequences.
How Does Bitcoin and Digital Currency Work?
Bitcoin represents the first foray into digital currencies. It emerged onto the scene in November 2008 with the online publication of bitcoin: A Peer-to-Peer Electronic Cash System by an anonymous author who used the pseudonym Satoshi Nakamoto. In January 2009, the peer-to-peer Bitcoin network first came online.
Bitcoin works on the basis of what is known as the “blockchain.” The blockchain is a digital public ledger where every Bitcoin transaction that has ever occurred and ever will occur is recorded. The blockchain is the fundamental basis for Bitcoin and users of the technology have the option to contribute computing resources towards maintaining the public ledger. Individuals who contribute resources are said to be “mining” for blocks of bitcoins. When certain conditions are met, Bitcoin miners can be compensated through the award of new Bitcoins.
Is Bitcoin Considered Taxable Income?
While the exact circumstances and use of the digital currency will determine whether Bitcoin is considered income in that specific scenario, it certainly is possible and reasonably common for Bitcoin to be considered income. Some scenarios where transfers or payments of Bitcoin may be considered taxable income include:
- You contributed computing resources and successfully mined a full or partial Bitcoin.
- You performed work as an employee and received compensation in the form of Bitcoin.
- You worked as an independent contractor who was paid in Bitcoin.
- You run a retail store or an online business and accept Bitcoin as payment for goods or services.
The above sets forth only some of the more basic and common scenarios where Bitcoin is considered taxable income. Please remember that all income is subject to income tax even if your employer fails to issue a W-2, 1099, or other informational tax documents.
What Tax Treatment Does Bitcoin Receive?
In Notice 2014-21, the IRS announced the tax treatment that Bitcoin would receive. While many people would expect for Bitcoin to be treated like other types of currency for tax purposes, it is not. Rather, Bitcoin and similar digital currencies should be treated as property for tax purposes. The IRS bases this determination on the fact that, unlike traditional currencies, Bitcoin is not regulated or governed by a national government or a central bank. Furthermore, Bitcoin does not have legal tender status in any nation or jurisdiction.
As such, Bitcoin and other similar digital currencies are treated as property. When assets receive tax treatment as property, it means that parties must consider and account for gain that occurs. The failure to account for capital gains can result in significant tax penalties. Meanwhile, the failure to account for capital losses may mean that you are paying more in tax than is required.
How Should I Account for Bitcoin Capital Gains?
At a minimum, U.S. taxpayers who hold and transfer Bitcoin should record the value of Bitcoins when they are obtained. They should also record the value of Bitcoins when the digital currency is sold, traded, transferred, or otherwise disposed of. The difference is value is the capital gain or loss.
Typically, the gain or loss is recognized at the time of the transfer. The capital gain or loss should be reported by completing Schedule D of the taxpayer’s income tax return. Once computed, this information should be transferred to line 13 of the individual’s tax return. Taxpayers should be sure to account for all capital gain and loss associated with Bitcoin transactions. The failure to do so can result in tax penalties and interest.
Improper Use of Bitcoin Can Result in Employment Taxes or Self-Employment Tax Problems
Some employers may choose to pay employees or independent contractors in Bitcoin. While payment via Bitcoin is probably more likely in independent contractor relationships, employers and employees always need to ensure that all employment and self-employment tax obligations are handled. Unfortunately, and for a variety of reasons, employers and workers alike sometimes mistakenly think that the form the income takes insulates or excuses them from satisfying certain payroll tax obligations. Employers must withhold employment taxes for employees. Similarly, independent contractors must ensure that their self-employment taxes are paid. The failure to do so can lead to significant fines and penalties. In the case of unpaid employment taxes, both the business and “responsible parties” can be held jointly liable. “Responsible parties” subject to personal liability for unpaid employment taxes can include the business owner, certain managers, and bookkeepers.
Do I Need to Make FBAR Disclosures When Holding Bitcoin?
The most recent IRS guidance on Bitcoin as it relates to FBAR was issued in 2014. During an online seminar Rod Lundquist, a Senior Program Analyst for the IRS Small Business/Self-Employed Division indicated that “At this time, FinCEN has said bitcoin is not reportable on the FBAR, at least for this filing season.” (emphasis added) Thus, we can conclude that taxpayers did not have an obligation to disclose foreign Bitcoin assets for, at least, the 2014 obligation. However, qualifying language does seem to suggest that the IRS may eventually require these disclosures.
Should the IRS re-open this issue, it is important to note that it is highly likely that the method through which you hold your Bitcoin will become highly relevant. Consider the fact that in U.S. vs. John C. Hom, the federal courts determined that money kept in online poker accounts met the definition of “…a financial interest in, or signature or other authority over, a bank, securities, or another financial account in a foreign country….” 31 CFR 1010.350. Thus, the account should have been reported via FBAR. While certain distinctions exist between online poker accounts and Bitcoin wallets, the Hom decision does seem to suggest a framework that could result in Bitcoin wallets being reportable on FBAR. By contrast, much like physical assets held directly in a foreign country, Bitcoin held directly on a hard drive or printed onto a paper wallet is significantly less likely to fall under FBAR disclosure requirements. However, users of Bitcoin should, ideally, engage in an inquiry into whether these reporting requirements have changed annually.
Can Trading, Selling, or Using Bitcoin Trigger an IRS Audit?
The IRS appears to have recognized the fact that Bitcoin and other digital currencies present a potential means for abuse and tax evasion. The belief that at least some taxpayers are using Bitcoin and similar technologies to avoid income and other tax payments is evidenced in recent IRS enforcement actions against Coinbase, a popular Bitcoin wallet, and exchange.
In late 2016, the IRS petitioned a federal court to permit it to serve John Doe summons on Coinbase. A John Doe summons can be used by prosecutors and regulators when they generally believe that violations of the law are occurring, but are unable to specifically identify the parties who are committing the alleged acts. Thus, they file the summons to compel the release of account information to identify potentially involved parties.
On November 30, 2016, a federal court granted the IRS’s motion to serve Coinbase. While Coinbase and individual users have vowed to fight to prevent the release of their information, it is highly likely that the IRS will obtain the information. The IRS has previously used this tactic to compel the release of account records and data concerning offshore credit cards and foreign bank and financial accounts. Thus, taxpayers who failed to satisfy some aspect of their tax obligations should immediately consult with a tax lawyer to determine a path forward.
Will Bitcoin Keep Me Anonymous if I Didn’t Pay Capital Gains, Income Tax or other Taxes?
At least some people started using Bitcoin because they heard that digital currency is “anonymous.” Thus, they may believe that the use of Bitcoin will conceal their identity even in light of the IRS’s John Doe summons. Unfortunately, this belief is based on a fundamental misunderstand regarding how Bitcoin works.
As described above, the defining feature of Bitcoin and similar technologies is the “block chain.” The block chain ensures that transactions are authentic and valid because all transactions are publicly published in the online ledger and “hashed,” or verified, by peers who contribute computing resources to the decentralized network. Thus, all Bitcoin transactions are publicly posted and available for scrutiny. However, one’s real world identity is obfuscated behind a unique identifier. This is the basis for claims that Bitcoin is anonymous.
However, when one uses a Bitcoin wallet or exchange or engages in a transaction with a third-party, the nature of the transactional relationship often means that one’s real world identity is revealed. Therefore, if a single party decides to reveal your identity or is compelled to do so, your entire Bitcoin transaction history can be reconstructed from the public ledger. For individuals who may have elected to use digital currency because they believed it would ensure privacy, this mistaken assumption could lead to serious tax problems.
Am I at Risk of Facing a Tax Audit or Assessment Only if I Held Bitcoin at Coinbase?
While one can only speculate regarding what the IRS will do with the Coinbase account data and other information, there is a theoretical risk to all Bitcoin and other virtual currency users who have engaged in transactions with Coinbase users. As with many other types of potential tax fraud, all it takes is a for the auditor or examiner to pull at a single thread to cause the entire scheme to unravel.
Once again, this is due to the fact that all it takes is a single third-party to whom you provided account information to reveal your identity. For many individuals who used a Bitcoin wallet or Bitcoin exchange, once the IRS can identify a Bitcoin account as belonging to a specific individual, they can extract every transaction from the blockchain. For taxpayers used Bitcoin to commit tax crimes because they thought it was anonymous or that the technology would render their actions opaque, there is a real risk of identification and prosecution.
Of course, this risk is contingent on the IRS’s ability to devise and engage in efficient data analysis and processing. However, the IRS has shown the technical ability to engage in large-scale data processing through its DIF and UDIF scores, offshore tax enforcement programs, and other efforts requiring synthesis of the taxpayer and financial data. Furthermore, there is the potential for tech-minded tax whistleblowers who have engaged in numerous Bitcoin transactions to provide the government with data. Tax whistleblowers can be compensated with a whistleblower informant award. Thus, the motivation for individuals to provide the IRS information is present.
What Steps Should I Take if I Failed to Pay Bitcoin Taxes?
If you have failed to pay Bitcoin taxes, you could face consequences ranging from penalties and fines to allegations of tax evasion. The exact risk you face is dependent upon your actions, surrounding circumstances, and an array of factors considered by IRS agents and auditors. An experienced tax attorney can help you assess whether tax obligations went unfulfilled and potential means to address and correct the noncompliance that mitigates the penalties you face.
However, if you are worried that you may have committed a tax crime, it is essential that you only seek out a tax attorney. If it does appear that your actions violated a criminal tax law, only the attorney-client privilege can protect the disclosures you may make when seeking legal advice. If you make disclosures to an accountant or CPA, the government can and probably will subpoena the accountant to testify against you.
Work with an Experienced Dually Certified Tax Attorney and CPA
At the Tax Law Offices of David W. Klasing, our tax lawyers and tax professionals can help you address tax problems that may exist due to the use of Bitcoin or other digital currencies. If necessary, our tax attorneys can even extend existing attorney-client privilege to CPAs and other tax professionals through the use of a Kovel letter. To schedule a confidential, reduced rate consultation at our Los Angeles or Orange County law offices, call 800-681-1295 today.
Common Bitcoin Tax Questions
Can They Tax Bitcoin?
As the bitcoin cryptocurrency has grown in use, the IRS has issued very generalized guidance on how to handle taxation on its gains and losses.
Rather than treating bitcoin as a currency, the IRS treats bitcoin as an asset/intangible property for taxation purposes. This means that U.S. taxpayers must keep track of any transactions they make regarding bitcoin, no matter how small. Through these records, you can determine the profit or loss you’ve made on your bitcoins and determine the tax you should pay accordingly.
Because bitcoin valuation bounces up and down so frequently, the IRS asks you to select a consistent means of valuing your bitcoins and use it for all transactions.
How Do I Report Bitcoin Tax?
If you have good records of your transactions, reporting your taxable income from the sale of your bitcoins will be an easier process. You need to keep track of every transaction you make with bitcoins, whether you’re purchasing an asset, exchanging the bitcoins outright for U.S. dollars or getting paid for services rendered.
Under current IRS regulations, gains on the sale or use of bitcoins acquired for investment are treated as capital gains for tax calculation purposes.
If you’ve held the bitcoins for less than one year, you’ll pay a short-term capital gains tax, which is equivalent to the tax rate you’re paying for your ordinary income. If you’ve held the bitcoins for more than one year, you’ll pay long-term capital gains. The long-term capital gains tax rate varies, depending on your adjusted gross income, from 0% to 20%.
Is Bitcoin Tax Evasion?
Because using bitcoin is legal, the single act of using it is not in itself considered tax evasion. However, if you don’t report the gains you’re making on the use of bitcoins, you will be committing tax evasion.
Many cryptocurrency users believe their transactions are anonymous. However, the IRS recently began using a software tracking program that analyzes cryptocurrency transactions, including those involving bitcoins. At this time, the IRS expects to be able to track down the people involved with unreported cryptocurrency transactions, including about half of bitcoin transactions to date through this software.
More Questions and Answers About Bitcoin
- What to Do When IRS Wants My Bitcoin Trade History
- Bitcoin Tax Record Keeping
- Can I Appeal a Bitcoin Tax Determination by the IRS?
- Why does BitCoin and other types of Virtual Currency draw so much attention from the Taxing Authorities and the Federal Government?
- Where is the most current IRS guidance on Virtual Currency found?
- Should You Report Bitcoin on Your Taxes?
- What Is Bitcoin?
- How does the IRS treat Bitcoin?
- Can I Face Tax Penalties for Mistakes Made with Bitcoin?
- How Does a Business Determine Its Taxes When Paid in Bitcoin?
- Who Pays the Taxes in a Bitcoin “Mining Pool?”
- Are Bitcoin Miners Required to Pay Self-Employment Tax?
- Can Bitcoin Trading Create an Obligation to Pay Capital Gains Taxes?
- What Is Bitcoin Digital Currency and Why Does it Matter for Tax Purposes?
- What Happens if the IRS Thinks I’m Using Bitcoin to Commit Tax Evasion?
See our Bitcoin and Cryptocurrency Q and A Library