Managing Partner Freyman CPA P.C.
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What is the True Cost of Bitcoin for Your Clients?

May 24th 2016
Managing Partner Freyman CPA P.C.
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Would you allow a client to pay with money that you can’t hold? Sure, you probably do every day if you accept credit cards. How about payment that isn’t legal tender?

You might begin to get uncomfortable with the idea of accepting intangible “Monopoly money” as payment. As it turns out, this “Monopoly money” isn’t a joke – virtual currency has been on the rise since the introduction of Bitcoin in 2008.

There are a number of different virtual currencies, but for simplicity we’ll call general digital monies “altcoins.” In the simplest sense, virtual currencies, such as Bitcoin or Ethereum, are digital money that is not issued by a government. They can be exchanged for goods, services, or real currency (legal tender).

There is generally no central authority over the digital currency; rather, the altcoins are managed through public distributed ledgers. Virtual currencies are intangible, with no physical location, although they can be “stored” in virtual wallets.

You may think that none of this applies to you: maybe your clients operate in the retail or service space, not in technology sectors. Even retailers are taking the plunge into the world of virtual currency, however. Overstock.com led the charge, accepting Bitcoins as a form of payment beginning in January 2015.

What’s the appeal of accepting or using altcoins as a payment method? If your clients transact business with customers or vendors in other countries, they may be used to the headache of dealing with foreign banks, the high fees for foreign transactions, and the delay in payments. Using altcoins eliminates these issues.

First, altcoins are universal – one Bitcoin in South Korea is equal to one Bitcoin in France. You do not need to worry about foreign exchange rates when your clients transact in altcoins. When altcoins are sent from a buyer to a seller, the altcoins are transferred in nearly real time. Although average transaction times have increased significantly in recent years, they are still substantially lower than for traditional payment methods, such as ACH.

Note that although you do not need to worry about foreign exchange rates when using altcoins, the tax withholding and reporting requirements for payments made to foreign vendors or service providers still apply. This is also true of payments made via altcoins to US citizens, whether to employees or to contractors.

For example, if one of your clients pays an employee in altcoins, they must use the fair market value of the currency on the date of payment as the value for employment tax purposes. If the fair market value of altcoins that a client paid to vendors or contractors exceeds $600 for the year, your client must still report the payments (as applicable) on Form 1099-MISC.

The essential tax question with respect to altcoins is how they are classified. The IRS released guidance in March of 2014 (Notice 2014-21) stating that altcoins are to be treated as property, rather than currency.

When altcoins are exchanged for goods or services, they are treated in the same manner as any other exchange of property for goods or services: when a client pays for services with altcoins, if the fair market value of the goods or services they receive exceeds their basis in the altcoins, they recognize a taxable gain, and vice versa (although they may or may not be able to deduct a loss, depending upon the nature of the transaction).

If you have clients that accept or use altcoins, they need to be aware that each time they send or receive altcoins, they are exchanging property for goods or services. You should encourage the client to keep clear records of each transaction, including the number of altcoins transferred, the date of acquisition/disposition, and the fair market value (including method of determination).

You may be thinking that although using altcoins requires more recordkeeping than using a traditional currency might, it’s still a great alternative. All of your clients should start accepting payment in altcoins!

Slow down – there are some significant drawbacks to using altcoins. The first drawback is inherent in the very nature of altcoins: they are decentralized and are not issued by a government. What does this mean? If your client has an issue with their altcoins, they may not have anyone to turn to. If they forget or lose the password to their virtual wallet, they have no access to their money. How would you account for this loss?

It’s unlikely that it would be considered a casualty loss under §165. Your client could be out of money and luck in this situation. Given that the current tax law does not explicitly discuss virtual currencies, there are many areas that are unclear.

You want to make sure your clients are compliant with all laws and regulations, but how do you ensure compliance when there’s no guidance on the topic? One area of concern is Foreign Bank Account Reporting (FBAR); if a client has $10,000 or more of foreign financial accounts at any point during the year, they must file FinCEN Report 114.

If they have an account at a financial institution that’s physically located in a foreign country, it’s clear that they could have a filing requirement. What about if they have $20,000 worth of altcoins? In previous tax years, the IRS indicated that there would not be a filing requirement for altcoin holdings, but with the increased use of virtual currency and the risk inherent in a (relatively) anonymous financial network, FinCEN may require reporting in future periods.

The world in which we conduct business is constantly changing. Think about it, the idea of credit cards was once unheard of yet customers now expect retailers to accept them as a form of payment.

Although you may not have any clients using altcoins currently, within the next few years you may find your clients entering the world of virtual currency in order to keep up with their competitors, and you’ll need to understand how to handle the related issues.

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