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Special Tax Season Summary

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Feb 24th 2015
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It's been a special tax season, to say the least. Remember the buzz about virtual currencies, especially Bitcoin, the best-known one? Now and then, discussion peaks, and then seems to wane.

Has it disappeared, or has it become so mainstream that no one discusses it? And are regulators doing anything about it? What are the tax implications? Most intriguing of all, are your clients or employers thinking of using Bitcoin—and what do you say to them?

Bitcoin is alive and well and living around the world. It's gaining increasingly wide acceptance. Indeed, Microsoft is accepting Bitcoin payment in limited circumstances, noting that users can buy apps, games, and other digital content from Windows, Windows Phone, Xbox Games, Xbox Music, or Xbox Video stores. It may eventually almost affect every company, so it pays to get up to speed.

Introduction for the Newbies

If Bitcoin is still some sort of vague science-fiction term for you, don't worry. It's not too late to get up to speed. Bitcoin a "virtual currency" or "cryptocurrency." That is, it's a currency like dollars or euros, except it's not connected to any particular country and there are no printed bills or minted coins—the money exits only electronically.

The system was started by a shadowy individual or group, and now runs by consensus. That is, there is a loose confederation of programmers that decides how it will proceed, and the program itself sets limits on how many Bitcoin units can be created, to prevent runaway inflation. However, wild price swings and instability are possible, and speculators can lose a lot of money very quickly.

One of the clearest explanations of Bitcoin comes from Bitcoin.org. It's not authoritative, but that's the point of Bitcoin—very little is authoritative. However, it gives very clear explanations for the uninitiated, and lists reasons why Bitcoin is catching on. For example, it notes that it's "possible to send and receive any amount of money instantly anywhere in the world at any time. No bank holidays. No borders. No imposed limits. Bitcoin allows its users to be in full control of their money."

Also, the fees are very low. Merchants like Bitcoin because "transactions are secure, irreversible, and do not contain customers’ sensitive or personal information. This protects merchants from losses caused by fraud or fraudulent chargebacks, and there is no need for PCI [payment card industry] compliance."

At the other end, purchasers like Bitcoin because they are fully in control of the transaction—there is no chance of extra charges being slipped into a purchase, says Bitcoin.org. Exchanges are exceptionally transparent and neutral.

Of course, there are risks associated with any new and minimally regulated system, and little protection against wide price swings that can reduce the value of Bitcoin.

Has the IRS Weighed In?

Regulators have not been unaware of what's happening. Although regulation is still ramping up, there is guidance out there.

About a year ago, the IRS addressed Bitcoin and virtual currencies generally. Its guidance noted the following:

  • Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
  • Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.
  • The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
  • A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

Further details are available in Notice 2014-21, which answers questions about the tax treatment of Bitcoin, fair market value, and basis, among other issues.

Other Agencies Are Investigating

Meanwhile, states are getting into the act. New York, long seen as a leader in financial regulation because of New York City's position as a worldwide financial center, has held hearings and issued proposed rules that may require licensing for Bitcoin traders. Such a scheme could bring more predictability and assurance to Bitcoin—but could also limit the reasons people came to use it in the first place.

In a December 2014 speech, Benjamin M. Lawsky, Superintendent of Financial Services for New York, said proposed regulations would be "primarily focused on providing additional flexibility for virtual currency startups to innovate—while at the same time maintaining our commitment to protecting consumers and rooting out illicit activity."

He did seem to accept the idea of that virtual currencies could be important. He noted that

"there are significant, well-founded concerns that financial institutions—and regulators, for that matter—are not keeping up with the expectations of consumers for fast, reliable, digital transactions."

What will happen next—nationally or state-by-state? For now, it's a wait-and-see proposition.

Comment in our Forum section--are you or your client using Bitcoin?

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