Bitcoin: How To Account For Virtual Currency on Your Taxes
If you've been watching the financial news over the past year or so, you may have heard quite a bit about this thing called “bitcoin." You may have also heard that it is a new type of currency, and thought about using it in your business. If you do decide to accept bitcoin, how will it affect your taxes?
What Is Bitcoin?
Bitcoin is virtual currency used around the world, allowing people in different countries to do business without middlemen adding significant cost to the transaction by charging a currency conversion fee. Fees imposed are generally less than the 2.5 to 3 percent charged by a credit card processor. Bitcoin is essentially an app that serves as an online wallet and allows users to send and receive bitcoin with other people who have a wallet too.
What the IRS Says
That being said, is the IRS even interested in bitcoin, since it isn’t really cash? Yes, it is.
The agency just issued Notice 2014-21, which provides answers to frequently asked questions about virtual currencies. Because the virtual currency is used to pay for goods and services in transactions, there is a tax effect that must to be reported to the IRS. However, the agency is only interested in the U.S. federal tax implications of these transactions.
So, you would expect that since it is a virtual currency, the IRS would treat bitcoin as if were cash, right? Not exactly. Virtual currencies are actually treated as property.
This means that you need to keep track of the fair market value of your bitcoin transactions so that you can determine if you have a gain or loss on each one. If you purchase something with virtual currency that has a fair market value greater than the fair market value of the virtual currency, you will have a gain on the transaction, which will need to be reported on your tax return. By the same token, if the fair market value of the virtual property is greater than the item purchased, you will have a loss on the transaction, which also needs to be reported on your tax return.
What To Do When Buying and Selling
Even though it is considered property, the IRS recognizes that virtual currencies are used to buy and sell goods and services. If you receive bitcoins for providing goods or services, you will need to include in your earnings the fair market value of the virtual currency used on the date it was received. Likewise, if you pay for goods and services using bitcoin, you will need to include in your expenses the fair market value in U.S. dollars of the virtual currency as of the date it was paid out.
As you would when paying cash, virtual currencies are subject to the same information reporting requirements. If you make a payment in virtual currency with a fair market value of $600 to a non-exempt person or business, you will need to report these payments to the IRS and the payee on form 1099-MISC.
Dealing with the ins and outs of virtual currencies can get tricky. If you have any questions, be sure to have your accountant walk you through all your options before deciding whether to use bitcoin or other virtual currency.
Chris Peden, CPA, CMA, CFM, is a freelance writer using his 20 years of accounting and tax experience to help individuals and small businesses understand taxes and accounting while organizing and making sense of their financial information.