The Impact of Bitcoin on Your Taxes

It's tax filing date and if you own Bitcoin, you may be subject to tax reporting

Getty Images

The dreaded date of April 16 is upon us.

Yes, it’s tax prep time. It’s that glorious time of year when we happily fork over all that we owe to our country to support all of its activities, and debt!

Although most of us don’t like to see money leave our pockets and go to the ever diligent and efficient agencies of our government (yes, that was sarcasm), what all of us hate is the entire process of reporting our taxes each year.

  It’s painful, often costly and worst of all, we have no choice (unless you feel that you’ll look good in orange and are interested in some away time from the family for awhile).

Many people tout the lack of government control regarding Bitcoin as one of its benefits.  The fact that it’s a currency that’s not controlled by a central agency can be viewed as a libertarian benefit of Bitcoin, but that doesn’t mean that the government doesn’t have some say over it.

In May 2014, the US Internal Revenue Service released guidance that defined Bitcoin as property and therefore subject to tax in much the same manner as stocks can result in taxable capital gains. 

As I wrote in a column at the end of last year, “Because the government classifies bitcoin as property and not currency, it will actually benefit those who are “miners” and investors because their accrued long-term gains and losses will be taxed at the taxpayer's applicable capital gains rate (15% for most consumers) rather than ordinary income rates (25% for most consumers).

Ryan Selkis wrote a detailed and informative piece that comprehensively outlines the tax guide for Bitcoin on Investopedia and you can access it here

Among the areas that he covers is related to those who trade in the digital currency when he writes, “The IRS limits the amount of property losses (net capital losses, to be specific) that can be claimed on personal tax returns to $3,000 per year for both married and single filers, a limit that hasn't been raised since 1978. For these unfortunate folks, large short-term trading losses will need to be carried forward, in some cases for many years. Trading losers would have been much better off if they could have written off "foreign currency" losses against their ordinary income.”

A recent post on Bitcoinist.net provided some further direction for Bitcoin investors from one of the most knowledgeable accountants in the area of Bitcoin, Daniel Winters

Winters points out that due to the guidance of Bitcoin as property, the sale and exchange of the digital currency is treated similarly to that of stocks and other capital assets, “When you buy Bitcoin, then later sell or exchange the Bitcoin, you will have a gain or loss on the transaction. For individuals, Bitcoin which is sold after being held for more than 1 year is taxed at long-term capital gains rates, usually 15%, but a 20% rate applies to taxpayers in the top tax bracket. For individuals, Bitcoin which is sold after being held for 1 year or less is taxed at ordinary income tax rates up to 39.6%.”

Winters points out the backbreaker for most of us involved with Bitcoin, whether trading it or exchanging it for goods and services – “unfortunately, there is NO minimum threshold for reporting Bitcoin transactions. This is consistent with stock sales – brokerage firms frequently report sales for under $1.

Don’t worry, the government has made it easy for Americans to report this as there are now new instructions for reporting capital gains and losses on Schedule D specifically mention Bitcoin and virtual currency.

They’ve also included instructions for Form W-2, Wages, to address the treatment of wages paid in Bitcoin.

To further complicate things, you must be aware of any exchange rates related to your Bitcoin transactions as well.  So if you bought something with Bitcoin in another country and there was an increase in the value of the digital currency, you’ll have to take into consideration the exchange rate of that country as well.

Now I must remind everyone that I’m not a tax expert and nothing in this article should be considered the tax advice of anyone knowledgeable about such matters.  I’m just reporting on it.  Please check with your tax advisor on all of these matters.

Although many of us love the libertarian aspects of Bitcoin, are we really surprised that the government was able to find a way to tax it, even though it’s been badmouthed by many officials as a tool for terrorists and a Ponzi scheme?

I guess the important thing is not how it can change a broken financial system, but how the current system can find a way to benefit from it. 

Gotta go, I need to get my tax return in the mail.