You may have heard of the virtual currency bitcoin. More and more companies now accept it as payment, and third-party payment processors - such as Stripe - are now offering bitcoin as a payment option. We'll tell you what bitcoin is, how the IRS looks at bitcoin transactions, and the pros and cons of bitcoin so that you can figure out if it is a good or bad idea for your business.
What Is Bitcoin?
Virtual currencies, such as bitcoin, are digital constructions that function as a way to both exchange and store economic value. Virtual currencies aren't official legal tender in any country, but you can use them in some countries as if they were legal tender. You can buy and sell bitcoins digitally and also exchange them for actual currency, like U.S. dollars or euros. As such, bitcoin is a "convertible" virtual currency.
Taxation of Bitcoin Transactions
Bitcoin and other convertible virtual currencies are property for federal tax purposes.(1)
A virtual currency is not an actual currency and does not generate foreign currency gain or loss.(2)
Since bitcoins are property, the taxation of a bitcoin transaction is the same as the sale or exchange of property. Here is how that applies to you generally:
- If you receive bitcoins in exchange for your services, then your income is the fair market value of the bitcoins received.(3) Your basis in the bitcoins is their fair market value at the time of receipt plus any transaction fees incurred.(4)
- If you receive bitcoins in exchange for your property, then your gain or loss is the fair market value of the bitcoins received less the adjusted basis of your property given up.(5) Your basis in the bitcoins is their fair market value at the time of receipt plus any transaction fees incurred.(6)
- If you give bitcoins in exchange for services, then the value of the expense is the fair market value of the bitcoins given.(7) Also, the value of the services received less the adjusted basis of the bitcoins is a gain or loss to you.(8)
- If you give bitcoins in exchange for someone's property, then your gain or loss is the fair market value of the property you received less the adjusted basis of your bitcoins.(9)
Bitcoins are a capital asset (provided you are not a trader in bitcoins).(10) Therefore,
- you pay tax on any gain at reduced rates,(11) and
- losses are subject to capital loss limitation rules.(12)
Pros and Cons
Pro: Capital losses deductible. If you recognize a loss on a bitcoin transaction, then it is deductible from your other income subject to the limitations applicable to capital losses. And if you are a noncorporate taxpayer, then you can carry forward any losses that you can't use in the current year.(16)
Pro: Taxable capital gains. Your bitcoins can appreciate in value, causing you to both gain extra income and pay taxes on that income. If you recognize a gain on a bitcoin transaction, then you have a short- or long-term capital gain on which you have to pay taxes. You may also have to pay the 3.8 percent net investment income tax on this gain. In cash transactions, you don't have the possibility for profit or the complications of paying taxes.
Pro: Lower transaction fees. Stripe, a large third-party payment processor, processes bitcoin transactions for 0.8 percent of the gross amount up to a maximum of $8 per transaction, compared with 2.9 percent plus $0.30 for credit card transactions (with no maximum).(17)
If you receive a $2,000 payment for services rendered, your potential transaction costs are
- $8.00 for a bitcoin transaction, or
- $53.80 for a credit card payment.
Con: Basis tracking. Cash is cash and requires no special tracking. With bitcoin, you need to track the adjusted basis in your bitcoins and account for basis changes due to fractional sales.
Con: Liquidity. Once you get bitcoins, you may find it difficult to find others to transact with to use your bitcoins for goods and/or services.
Avoid Capital Gains or Losses: Sell It!
If you sell bitcoins immediately after you acquire them, you'll minimize any capital gain or loss realization. Plus, you won't have an ongoing requirement to track their basis, and you'll immediately realize their cash value.
For IRS reporting purposes, transacting in bitcoins is the same as cash: you report payments that you make on Form W-2 or Form 1099 as appropriate for the activity.(18)
More and more businesses are using bitcoin. Since the IRS views bitcoins as property and not currency, they have unique tax issues compared with cash:
- You have to track your adjusted basis in your bitcoins.
- You may have a capital gain or loss when you give bitcoins in exchange for property and/or services.
While bitcoin transaction fees are generally much lower than those on credit card transactions, bitcoins aren't as liquid as good old cash. But if you sell bitcoins as soon as you buy them, you minimize the gain or loss recognition issues while enjoying the lower potential transaction fees. The decision to accept bitcoins in your business will ultimately come down to whether you have customers demanding use of bitcoin and, if so, whether the cons outweigh the benefits.
1 IRS Notice 2014-21, Section 4, Q&A 1.
2 IRS Notice 2014-21, Section 4, Q&A 2.
3 IRC Section 83(a); IRS Notice 2014-21, Section 4, Q&A 3.
4 IRS Notice 2014-21, Section 4, Q&A 4.
5 IRC Section 1001(a).
6 IRS Notice 2014-21, Section 4, Q&A 4.
7 IRC Section 83(h).
8 Reg. Section 1.83-6(b ).
9 IRC Section 1001(a); IRS Notice 2014-21, Section 4, Q&A 6.
10 IRC Section 1221(a); IRS Notice 2014-21, Section 4, Q&A 7.
11 IRC Section 1(h).
12 IRC Section 1211.
13 IRS Notice 2014-21, Section 4, Q&A 10.
14 IRS Notice 2014-21, Section 4, Q&A 1; Reg. Section 1.1012-1.
15 IRC Section 1222(3).
16 IRC Section 1211(b).
18 IRS Notice 2014-21, Section 4, Q&As 11, 12, and 13.