Posted by Jane Irene Kelly on Friday, March 6, 2015 - 00:00
It can be difficult not to think of the virtual currency bitcoin as “pretend” money, at least at first. Seeing physical bitcoins doesn’t help, as most resemble arcade tokens — or the coins from Nintendo’s “Super Mario Bros.” video game. But bitcoin is definitely real, and despite a rather bumpy 2014, seems to be gaining acceptance as a legitimate form of currency. So accountants — especially tax accountants — will be wise to understand what they’re all about.
Bitcoin is not the only virtual currency (aka “cybercurrency” or “cryptocurrency”) out there. But it is currently the only digital currency that is actively traded for goods and services. There are more than five million holders of bitcoin today, according to the Digital Currency Council. A number of well-known companies, including Dell, Microsoft, and Overstock.com, already accept bitcoin. Even attendees of this year’s World Economic Forum in Davos, Switzerland, were able to use bitcoin to pay for lodging and other services and products.
Where do bitcoins come from?
According to Bitcoin.org, “Bitcoin uses peer-to-peer technology to operate with no central authority or banks; managing transactions and the issuing of bitcoins is carried out collectively by the network. Bitcoin is open-source; its design is public, nobody owns or controls Bitcoin and everyone can take part.”
Users can buy, transfer or “mine” bitcoins. Mining is how new bitcoins are generated; they are rewards for solving complex math problems online using basic hardware and specialized software. The “miner” in the bitcoin network who solves the problem first receives 25 bitcoins (the value of one bitcoin was more than $250 at the time of this writing in late January 2015). Each bitcoin transaction is recorded in a public log, but buyers and sellers remain anonymous. Users are known only by the IDs of the digital wallets used to store their bitcoins.
Bitcoin’s image problems
The practice of anonymity in the bitcoin ecosystem may change in time. Concerns about the use of bitcoins to fund illegal activity have prompted the U.K. government to propose a bill that would end anonymity in bitcoin transactions. Russian telecommunications regulator Roskomnadzor started banning bitcoin websites this year, saying they “contribute to the growth of the shadow economy.” And a bitcoin trader’s deep involvement with the now-defunct Silk Road online black market has not helped to quell critics of the cryptocurrency.
The Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission have both issued alerts in the past year cautioning investors about the risks of buying and using digital currencies like bitcoin.
Tax implications of bitcoin
Controversy and cautions aside, bitcoin is being used by many people for legitimate purposes — including purchasing real estate. Companies like BitPay and Coinbase are making it easy for businesses of all sizes to accept bitcoin as a method of payment. Users of services like Gyft can turn their bitcoins into gift cards that are accepted by many major retailers in-store and online.
In fact, enough people are using bitcoin now that the U.S. government is taking the trend seriously: In March 2014, the Internal Revenue Service made its first major ruling on bitcoin, saying the digital currency will be treated as property for tax purposes. This means that bitcoin investors are viewed, essentially, as stock traders. (This includes taxpayers who receive the digital currency as payment for goods and services.) Bitcoin investors need to report their earnings as taxable income, with taxes based on the value of the bitcoin and the day it was received/mined. If a person mines bitcoins as part of a business, they must pay payroll taxes.
For more details on tax obligations related to virtual currency, see this IRS FAQ.
Resources for accountants
Bitcoin has a long way to go before it can truly be considered a mainstream currency, but that doesn’t mean accounting and finance professionals shouldn’t be prepared to field questions from clients about bitcoin taxes and investments.
If you want to learn more about the basics of digital currency, and even pursue a credential in this emerging area of expertise, the Digital Currency Council provides a training course, certification exam, and continuing education program for accountants and other financial professionals. (Membership in the council is free.)
And if you do need to help a client with bitcoin taxes this year, there are accounting tools for recording, reporting, accounting and estimating taxes for bitcoin transactions. LibraTax, a Software-as-a-Service platform, and online service BitCoinTaxes are perhaps the best known.
Do you have clients coming to you for tax advice on virtual currencies? Share your experience in the comments section.