Some business, most often online business, accept Bitcoin and other forms of virtual currency as payment for good provided or services rendered. Many businesses feel that offering this method of payment can only help by attracting customers who do not have credit cards, debit cards, or other electronic means of payment. However, Bitcoin and other virtual currencies receive unique tax treatment. In fact, despite frequently being utilized as a medium for exchange, the IRS taxes Bitcoin as property rather than as currency. This results in unique tax treatment that can trip-up even sophisticated business owners.
What Happens When a Customer Makes Bitcoin Purchases?
Since Bitcoin is treated as a type of property, when a customer or client makes a purchase or provides remuneration in the form of bitcoin gain and loss is triggered on both sides. That is, both the business accepting the payment and the business or individual paying in bitcoin are likely to have a reportable tax event as a consequence of this transaction.
This is because the value of a bitcoin will vary over time meaning that most transactions involving Bitcoin will necessarily involve considerations of capital gain and loss. For instance, consider an individual who bought a Bitcoin in the early days, prior to 2014, for $50. When the individual sells that Bitcoin or uses it to pay for a good or service, he or she will be quite happy to learn that 1 Bitcoin is currently worth roughly $700. Thus, in this example, the seller would realize a capital gain of about $650 at the time of the transaction. Tax is due on the realized capital gain.
On the seller’s side, the business has now accepted a Bitcoin currently valued at $700. Thus, the company has realized $700 in gross income subject to costs and expenses. However, it is absolutely essential for the business to keep a record of the Bitcoin’s fair market value at the time of the transfer. When the business engages in a subsequent transfer involving that bitcoin, it will need to determine its capital gains or loss on the basis of the price at the time of the subsequent transfer. The most important takeaways for business owners is to:
Recognize that bitcoin gives rise to additional capital gains tax considerations.
Ensure that adequate records are kept so all tax obligations can be satisfied.
The attorneys and tax professionals of the Tax Law Office of David W. Klasing can assist businesses all aspects of Bitcoin tax compliance.
What Can Happen When You Fail to Keep Records and Pay Taxes on Bitcoin Transfers?
In the most basic sense a failure to properly account for the tax obligations relating to the acceptance of bitcoin can result in significant unsatisfied tax obligations, penalties, and interest. However, the failure to account for this obligation often results in less than optimal business tax planning. Depending on market conditions, the method of basis accounting can have a profound impact on the company’s overall tax liability. Furthermore, in certain scenarios, self-employment income and tax obligations may arise.
The worst-case scenario involving a failure to account and pay all tax on bitcoin transactions involves the IRS interpreting the actions as criminal tax evasion. The IRS is aware that due to pressures applied in the offshore tax enforcement area through FBAR and FATCA, some individuals explored Bitcoin as a means to conceal income and assets. Since Bitcoin is decentralized and not generally subject to government oversight, the IRS recognizes the potential for abuse and proceeds aggressively. Taxpayers who make mistakes regarding Bitcoin risk getting caught up in the IRS dragnet and facing serious tax penalties.