If you’ve paid attention to the news the last few years, then you have probably heard of Bitcoins. In fact, you may even have considered accepting them as payment for services or product sales. Before you do, you’ll want to make sure you have an understanding of how the IRS treats Bitcoin payments.
First, it’s important to be aware of the fact that the IRS does not consider Bitcoins, which are virtual currency, as a legitimate state-backed currency. Instead, they see Bitcoins as property.
How does this affect you as a taxpayer? This means that the tax rules that apply to property transactions will also apply to payments received in Bitcoins. When a person or business acquires property, they are required to record the fair market value of the property. This will become the owner’s basis for the property.
Once the property is sold or exchanged, if the fair market value of the property has increased, then the owner will have a taxable gain. On the other hand, if it has decreased in value, the owner will have a loss.
This means that if a business owner sells a product today and receives Bitcoins worth $100, but then converts them to dollars next week and the value has increased to $120, they will have a gain of $20 that will be taxed as capital gains.
This becomes even more complicated when multiple Bitcoin transactions take place. Each transaction needs to be tracked separately, and each will have its own gain or loss depending on the current valuation of Bitcoins when they are converted to dollars. The amount of paperwork and record-keeping becomes significant.
There are a couple of workarounds for this. First, each transaction can be converted to dollars immediately. Secondly, there are now Bitcoin merchant service providers that will deal with all of the back-end record-keeping that is necessary. This allows businesses to accept Bitcoins without ever actually dealing with them.
The IRS ruling to treat Bitcoins as property turned the Bitcoin world and those who want to accept them on their heads, but technology and even the IRS will eventually catch up to the new reality of virtual currencies. It just may take awhile.
For more information on tax implications associated with Bitcoins, please contact us today!