In the past, Bitcoin resembled Schrodinger’s money. It could claim to be both money and property at the same time in the absence of regulatory observers.
Now that the Internal Revenue Service has opened the package, the condition of the virtual currency has been determined—at least for the purposes of federal taxes.
The IRS recently released guidelines on how it will handle stateless electronic competitors like bitcoin. The gist of it is: as possessions rather than money. The majority of the time, Bitcoin and other digital currencies that can be converted into fiat money will now be regarded as capital assets, with some exceptions treating them as inventory. Capital gains tax will be applied to value increases for Bitcoin owners who are not dealers. Bitcoin “miners,” who unlock the currency’s algorithms, will need to report their finds as income, just as other miners do when extracting more traditional resources.
Although there won’t likely be much upheaval as a result of this choice, it is important to note. The IRS’s decision now allows investors and bitcoin enthusiasts to proceed with a better understanding of what they are (virtually) holding. An owner of bitcoin now has the knowledge necessary to comply with the law rather than evade it.
I believe that the IRS is correct in saying that bitcoin is not money. A form of currency cannot realistically be called bitcoin or other similar virtual currencies because of their extreme value volatility. As a result of floating exchange rates, it is true that the value of almost all currencies fluctuates from week to week or year to year in relation to any given benchmark, be it the dollar or a barrel of oil. But the ability to act as a store of value is a fundamental characteristic of money. The value of the money itself shouldn’t vary significantly from day to day or hour to hour.
This is where Bitcoin fails miserably. Investing in a bitcoin is speculative. It is not a place to keep your available, idle funds. Aside from that, none of the major financial institutions that I am aware of will pay interest on bitcoin deposits in the form of additional bitcoins. A change in the value of a bitcoin is the only source of any profit from a holding.
Whether the IRS’s decision will benefit or harm current bitcoin owners depends on their initial motivation. This is good news for those hoping to directly profit from bitcoin’s value fluctuations because the rules for capital gains and losses are generally friendly to taxpayers. This description also supports how some well-known bitcoin enthusiasts, such as the Winklevoss twins, have disclosed their earnings in the absence of explicit guidance. (While the new treatment of bitcoin is applicable to prior years, taxpayers who can show a valid reason for their positions may be eligible for penalty relief.)
Spending bitcoin is regarded as a taxable form of barter, which complicates the choice for those hoping to use it to pay their rent or purchase coffee. Both parties involved in a bitcoin transaction—the person spending the currency and the person receiving it as payment—must record the currency’s fair market value on the day the transaction takes place. Both the spender’s capital gains or losses and the recipient’s basis for potential future gains or losses will be determined using this.
Even though the transaction is the trigger, it can be difficult to determine a specific bitcoin’s basis or holding period in order to determine whether short-term or long-term capital gains tax rates apply. That might be a tolerable inconvenience for an investor. However, the simplicity of the latter is likely to prevail when choosing between using a bitcoin or simply taking $5 out of your wallet to pay for your latte. The IRS guidance merely confirms what was already true: Bitcoin is not a new type of money. Different advantages and disadvantages apply to it.
Several other issues have also been clarified by the IRS. Virtual currency payments made by an employer to employees are considered wages for the purposes of employment taxes. Additionally, businesses must file Forms 1099 just like they would if they paid independent contractors in cash if they use bitcoin to pay them in the amount of $600 or more.
Clearer regulations may add to some users’ administrative burdens, but they could secure bitcoin’s future at a time when investors have good reason to be wary. “[Bitcoin is] getting legitimacy, which it didn’t have previously,” The New York Times was informed by Ajay Vinze, associate dean at Arizona State University’s business school. He said the IRS decision “puts Bitcoin is headed toward becoming a legitimate financial asset.” (1)
That outcome is more likely to occur once everyone who uses bitcoin can identify and concur on the type of asset it is.
A small percentage of bitcoin users considered its prior lack of regulation to be a benefit rather than a disadvantage. For ideological reasons, some of them oppose governmental regulation, while others believe that using bitcoin to engage in illegal commerce is a useful tool. However, the recent failure of well-known bitcoin exchange Mt. Gox showed that an unregulated bitcoin exchange can result in catastrophic losses without a safety net. Some users might have believed they were protecting themselves by switching to bitcoin in order to avoid the heavily regulated banking sector, but there shouldn’t be any regulation at all.
Bitcoin should be considered property, as the IRS rightly claims. Even though it doesn’t make good currency, this certainty might secure the future of an asset that could be valuable to those who want to own it as property for speculative or commercial purposes.
Source:
1) The New York Times, “I.R.S. Takes a Position on Bitcoin: It’s Property”