US Rules On Recording Bitcoin Transactions Are A Nightmare

The American Internal Revenue Service (IRS) has issued an FAQ sheet to provide guidance on how US taxpayers should report their transactions in Bitcoin, in accordance with the government's recent decision to treat the cryptocurrency as property instead of money.

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US Rules On Recording Bitcoin Transactions Are A Nightmare
The American Internal Revenue Service (IRS) has issued an FAQ sheet to provide guidance on how US taxpayers should report their transactions in Bitcoin, in accordance with the government's recent decision to treat the cryptocurrency as property instead of money.

As could probably be expected, what the US government expects for its Bitcoin-using taxpayers to remain strictly legal is an absolute bookkeeping nightmare.

Here's a breakdown of the information provided in the report, creatively and memorably titled Notice 2014-21:

Bitcoin transactions will be taxed as property transactions.

In the eyes of the US government, Bitcoin is property, so trades in “virtual currencies” like Bitcoin will have “immediate tax consequences” that wouldn't apply if it was considered a currency.

To report Bitcoin transactions, you have to convert the BTC value of each transaction to US dollars according to the exchange rate on that date.

Taxpayers buying and selling Bitcoin have to note the “fair market value of the virtual currency...measured in US dollars as of the date the virtual currency was received.”

That means that legally, if you buy a cup of coffee with Bitcoin, you have to keep a record of that transaction plus the BTC/USD exchange rate on that day. Obviously, everyone familiar with Bitcoin's sometimes-wildly fluctuating value will realize how much of a massive pain this will be.

“[It] would obviously create an accounting nightmare for taxpayers and may cause taxpayers to avoid using virtual currency,” American tax lawyer Jeffrey Hochberg told CNN.

Capital gains taxes apply if Bitcoin is an investment for the taxpayer.

“If the virtual currency is held as inventory...for sale to customers in a trade or business, gain or loss on its disposition will be ordinary gain or loss,” Notice 2014-21 tells us. “If the virtual currency is held as an investment, gain or loss on its disposition will be capital in nature.”

So: buying said cup of coffee for $2 with bitcoins that YOU bought for $1 means you need to report $1 in capital gains and the coffee shop needs to report $2 in gross income.

Mining bitcoins counts as income.

US taxpayers who earn money from mining bitcoins have to count that money as gross income for tax purposes (taking into account, of course, the market value of bitcoins as of that date).

Report, report, report.

People who get paid by their employers in Bitcoin have to report it and pay taxes on it. Employers paying their employees in Bitcoin have to report it and pay taxes on it. Self-employed and independent contractor reporting rules and taxes also apply.

If you don't do it, you'll get in trouble.

“Taxpayers who fail to report their income from virtual currency may potentially be subject to tax penalties,” the notice warns.

Past transactions, back before Bitcoin was A Thing, count too. Taxpayers who treated Bitcoin trades in a way inconsistent with Notice2014-21 even before it was issued will not receive penalty relief if they fail to report and pay taxes on their past transactions.

“This will require many businesses and individuals to go back and determine the existence of gain or loss on transactions that occurred in the past, perhaps several years in the past,” the notice says.

Don't have the receipt for that cup of coffee you bought with Bitcoin last year, before this IRS policy was even established? That's tough. 

In reality, the IRS will have a hell of a time tracking Bitcoin transactions down to this level of detail. But how much they're willing to crack down on tax-avoiding Bitcoin users remains to be seen.

Read the full IRS FAQ here.
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