Bitcoin barons face tax dilemma as April 15 deadline looms

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