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Wanted: Guidance for Bitcoin Tax Compliance

BitcoinOne of the most popular crypto-currencies available today is Bitcoin. Launched in 2009, this digital currency is similar to real currency in that it holds value which can be used to buy goods and services. More noticeable, however, are some of the key differences between Bitcoin and real currency:

Bitcoin operates independent of a central bank;

Bitcoin does not have legal tender status by any government; and

Bitcoins are treated as property by the IRS for tax purposes.

For CPAs, the last item on the list is crucial. As this form of virtual currency grows rapidly, agencies such as the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN), the New York State Department of Financial Services (DFS), the IRS and other regulators across the globe are working quickly to develop regulations while issuing public guidance so Bitcoin users can comply with newly released rules.

In March 2014, the IRS issued Notice 2014-21, where some essential questions surrounding the U.S. tax treatment of virtual currency transactions were answered in the form of a FAQ. For federal tax purposes, the IRS said that virtual currency is treated as property. The growing population of Bitcoin investors greeted this determination favorably, as it meant long-term investors of the currency-those holding bitcoin investments for longer than a year-would be subject to capital gains tax rates, which are lower than income rates. The tax rate on most net capital gains is no higher than 15% for most taxpayers, while some or all net capital gains may not be taxed at all if individuals are in the 10% or 15% ordinary income tax brackets

With a more favorable tax rate comes the flip side of Bitcoin: taxpayers are now responsible for a new process of complex and extensive recordkeeping for transactions and “mining” activities. Mining is the process by which new virtual currency transactions are verified and released into the market. Think of it as digitally mining for gold. Tax preparers now need to know whether clients mine, own, or use virtual currency.

Immediately after the IRS released its 16 FAQs, the AICPA Tax Advocacy Team began developing a list of additional guidance that taxpayers and tax preparers needed from regulatory agencies. The AICPA’s volunteer Individual and Self-Employed Tax Technical Resource Panel has been monitoring the tax treatment of Bitcoin since it first came on the radar, and some of the questions it has developed include the following:

-          With different virtual currency websites posting varying exchange rates throughout the day, what is a “reasonable approach” for determining the fair market value of virtual currency?

-          How are the costs of mining and acquiring virtual currency treated?  Should these amounts ever be capitalized?

-          Will taxpayers be required to identify the basis and fair market value for every single virtual currency transaction so that the gain or loss can be calculated, rather than using a system such as first-in-first-out (FIFO)?

-          Would virtual currency continue to be treated as property if a merchant holds the currency to pay employees and suppliers rather than choosing to hold the currency as an investment?

-          Will donations of virtual currency valued above $5,000 need a qualified appraisal or is there another type of proof of value that can be used?

-          Can virtual currency be considered a “commodity” subject to mark-to-market accounting?

-          Is it permissible to hold virtual currency in a retirement account?

-          Will virtual currency be reportable on the Foreign Bank and Financial Accounts form in future years?

The AICPA panel believes it is essential to advocate for taxpayers to have the answers to the questions listed above. Our Tax Advocacy Team is actively working to request the IRS promptly consider and provide clearer guidance on these issues.

AICPA members serve taxpayers across the country not only by preparing tax returns, but also by offering guidance on significant personal and business decisions. The virtual currency transactions in which taxpayers engage add another layer of complexity to the analysis of a client’s tax year. Being knowledgeable about tax clients’ assets and investments is a crucial responsibility for CPAs.

Amy Wang, CPA, Senior Technical Manager-American Institute of CPAs.

Bitcoins courtesy of Shutterstock.

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