Six Tips for Paying Taxes on Bitcoin

Physical novelty bitcoins from Utah. (Photo: George Frey/Getty Images)Physical novelty bitcoins from Utah. (Photo: George Frey/Getty Images)

Physical novelty bitcoins from Utah. (Photo: George Frey/Getty Images)

How do people pay taxes on bitcoin and other virtual currencies?

Ask anyone deep in the bitcoin scene and they will say that, to the IRS, it’s just like paying taxes on stock. To which you probably think: uh-huh, thanks, but we’re back where we started. Most of us have never paid taxes on stocks, either.

Wait, though—isn’t bitcoin the Libertarian currency? Isn’t paying taxes on it completely counter to its whole ethos? Maybe, but the stuff has real value in the world. Anyone playing that game does so at their own risk. Taxpayers that want to stay on the right side of John Law should get their books in order and pay Uncle Sam.

The Observer reached out to Daniel Winters of Global Tax, LLC, a New Jersey based accounting company that has made a special effort to serve customers in the Bitcoin sector. Mr. Winters walked us through some of the key points of the new IRS guidance on tax liabilities from bitcoin, released last year. We saw Mr. Winters speak at Blockchain New York, earlier this month.

Here’s some top level tips that Mr. Winters gave us for paying taxes on bitcoin:

  • Use a service that tracks the dollar value of bitcoin at the moment of each trade. Mr. Winters says that very few of bitcoin wallets keep track of the dollar value at the moment of trades, but he pointed to two services that help here. Coinbase keeps track of that information within bitcoin. Libra (which includes Mr. Winters in its referral program) can sort out the value of bitcoin at the moment of trade across all currencies. Tracking this is important because…
  • Bitcoin is property (much like stocks), in the eyes of the IRS. Which means users pay capital gains taxes on it, once the gains (or losses) are realized in a trade, so taxpayers will need to know what their net gain (or loss) is on the digital currency in a given year. So taxpayers will need to be able to compare the value of the bitcoin at the moment of acquisition and at sale. This is across all trades. Anyone that uses bitcoin to buy a slice in Fort Greene has made a trade. Going back and calculating all these values in retrospect would be a giant pain, but these two services will basically have it ready for tax time.
  • Bitcoin is income. The value of bitcoin brought in at the moment it’s acquired effects a taxpayers tax bracket and counts against income taxes.
  • If simplicity is a priority, convert cryptocurrency immediately. To make life simpler, a taxpayer could simply convert bitcoin to dollars as soon as it comes in, and then there would be no capital gains or losses to calculate.
  • More than $10,000 worth in bitcoin. If anyone’s account has that much bitcoin in it, a taxpayer may need to file a foreign bank account form. .
  • New Jersey and New York have both issued guidance on bitcoin and state taxes. Mr. Winters didn’t know of other states that had, but that may not necessarily mean that taxpayers don’t have to pay state taxes. Again, it might make sense to check in with tax advisors. Since the Federal government is, there’s a decent chance that states will also view cryptocurrency as property.

At first this sounded like bitcoin was getting double taxed (income and capital gains), but it isn’t. Think of it like this: imagine both income taxes and capital gains taxes were 10 percent. If someone earns 0.35 bitcoin today, it would be worth $100 at the present exchange rate. That person would owe $10 income tax. Then, six months later, that person converts it to dollars, and gets $110. He or she would then own $1 in capital gains tax.

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The second payment is on the income realized by sitting on the bitcoin for six months, but not on the principal.

Bitcoin’s value has been going up at a reasonable rate since it hit its nadir in August. The value of currency reflects how many people actually want to use it as a medium of exchange. As the use of bitcoin shifts more to actual purchases rather than bitcoin speculation, that could keep going. For example, Overstock accepts bitcoin now.

If this post makes paying taxes on bitcoin sound complicated, the executive summary is this: there’s software that will take care of the most tedious aspects, so taxpayers shouldn’t let the paperwork keep them out of the currency if it fits into their life or business plan.