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Summary:

The soaring price of bitcoin likely minted many new millionaires last year. They owe the tax man some of their profits, but no one is sure how much.

Update: Sounds like the IRS has finally taken notice – on Tuesday, the agency announced bitcoin will treated as property/capital assets, not as a currency. See the rest of this story for background and implications.

At the start of 2013, one bitcoin sold for around ten bucks but then shot up to well over $1,000 by year’s end. That’s great news for bitcoiners who bought low and sold high, but there’s a small catch: Uncle Sam wants a cut of the profits — and no one is sure how much.

As with many things related to bitcoin, the tax implications are mind-boggling. For instance, the IRS hasn’t even said if it considers the virtual currency to be a currency in the first place, or if bitcoins should instead by classified as a capital asset. Should bitcoins, in other words, be treated like Apple stocks or like euros and other foreign currencies?

The classification matters because foreign currency and capital asset profits are taxed at different rates. (I’m no authority, but the distinction goes something like this: forex earnings are taxed on a 60/40 formula that blends long- and short-term capital gains, while capital assets must be held for a year to be eligible for the long-term rate.)

Meanwhile, the most conservative investors are treating bitcoins as neither of these things. Barry Silbert, the CEO of Second Market who is reputed to be one of the world’s biggest holders of bitcoin, explained why he’s playing it even safer:

“Unless/until my accountant and tax lawyer counsel me otherwise, I am planning to declare any gain on bitcoin sales as ordinary income.  This is obviously the most conservative approach.  Rationale being that I’d rather get a tax return for overpaying once guidance is given, versus paying interest and penalties for underpaying,” Silbert said by email earlier this year.

Can bitcoin hide from the taxman?

What about bitcoin’s reputation as a decentralized, anonymous currency that’s beyond the reach of government? The short answer when it comes to the tax man is forget about it.

“Any opinion that says bitcoin’s not taxable — any attorney will say that’s hogwash. The better question is when and how it will be taxed,” said attorney Tyler Robbins by phone.

According to Robbins, who has published a primer on bitcoin taxation, the use of overseas exchanges doesn’t make any difference given that the IRS taxes Americans on their worldwide income.

“They’re going to find out on a person by person basis. They’ll look at bank records and see $50,000 coming in,” said Robbins, pointing to increased duties on foreign banks to reports overseas accounts belonging to Americans.

Robbins also observed that anti-money laundering agency FINCEN can share information with other parts of the Treasury Department, including the IRS. Bitcoin watchers will recall that FINCEN is the agency that seized millions from bankrupt exchange Mt. Gox last year and presumably obtained customer account information in the process.

The bottom line is that Americans who made a killing by selling bitcoins last year should think about telling the IRS about their windfall by tax day, April 15. But according to Robbins, the debate over what rate won’t always be relevant: “A lot of the bitcoin holders are 20-year-old kids who don’t want to pay in the first place.”

Image by Pond5/artist3d

  1. Bitcoin is taxable precisely like cash transactions are taxable. There is no functional difference.

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    1. Mike Paszkiewicz Tuesday, March 25, 2014

      It’s not a matter of if they’re taxable or not, more or less how to define a protocol to tax an individual.

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  2. If you aren’t putting 33 percent minimum back “just in case” you will be sorry.

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    1. Very true. Depending on the capital gains, 39% could be expected. $100k would require 39% capital gains tax.

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  3. In my estimation bitcoin is an idea whose time has come, and you can’t tax an idea. It isn’t currency; it isn’t property, Regardless of what the IRS says, the reality is that they have no enforcement mechanisms to enforce compliance. They can’t seize your wallet the same way that banks roll over and comply with IRS edicts, but then again what do you expect from a system that was designed by banksters for banksters with the collusion of their wholly owned politicians?
    The whole elaborate system is a scam designed to trap us in unending debt slavery, since debt in the official system IS money. It can never be eliminated, only expanded. The taxation system is merely the enforcement agency for the banks, with slaves unquestioningly accepting their lot hoping for crumbs of “public good” that fall off of massa’s table while he gorges himself with the spoils of tyranny.
    Bitcoin is like an exit on the plantation.
    I’m leaving. See you on the outside.

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