Bitcoin has moved front and centre into the public eye over the last year. This has led to a variety of use cases with some employees being paid with Bitcoin, a few retailers accept Bitcoin as payment, and others hold the e-currency as a capital asset. Recently, the US Internal Revenue Service (IRS) clarified the tax treatment of Bitcoin and Bitcoin transactions.
Given the difficulty in establishing ownership of Bitcoin assets, different nations are trying different methods to try and claim tax from profits made by Bitcoin investors. The IRS, for example, has tried asking people nicely to declare their tax, however reportedly only 802 people listened and the rest remained silent.
Let’s have a look at how three countries are tackling the issue.
In the US it’s called a convertible virtual currency because it has an equivalent value in real currency. The sale or exchange of a convertible virtual currency—including its use to pay for goods or services—has tax implications. The IRS answered some common questions about the tax treatment of Bitcoin transactions in its recent Notice 2014-21. Tax treatment depends on how Bitcoins are held and used.
Bitcoin used to pay for goods and services taxed as income
If you are an employer paying with Bitcoin, you must report employee earnings to the IRS on W-2 forms.
You must convert the Bitcoin value to U.S. dollars as of the date each payment is made and keep careful records.
Wages paid in virtual currency are subject to withholding to the same extent as dollar wages.
Employees must report their total W-2 wages in dollars, even if earned as Bitcoin. Self-employed individuals with Bitcoin gains or losses from sales transactions also must convert the virtual currency to dollars as of the day received, and report the figures on their tax returns.
Bitcoins held as capital assets are taxed as property
If you hold Bitcoins as a capital asset, you must treat them as property for tax purposes. General tax principles applicable to property transactions apply.
If the Bitcoins are held as a capital asset, like stocks or bonds, any gain or loss from the sale or exchange of the asset is taxed as a capital gain or loss. Otherwise, the investor realizes ordinary gain or loss on an exchange.
Bitcoin miners must report receipt of the virtual currency as income
Some people “mine” Bitcoins by using computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger.
According to the IRS, when a taxpayer successfully “mines” Bitcoins and has earnings from that activity whether in the form of Bitcoins or any other form, he or she must include it in his gross income after determining the fair market dollar value of the virtual currency as of the day he received it. If a bitcoin miner is self-employed, his or her gross earnings minus allowable tax deductions are also subject to the self-employment tax.
Income or capital?
This is a key question that a lot of nations will have to answer, if it is taxed as income, as opposed to capital, it will be at a higher rate. Proving that it was indeed a long-term investment, and thus subject to gains tax, is far more difficult in the fast moving ecosystem that is Bitcoin.
It is the very nature of cryptocurrencies that as they emerge more in the mainstream, they will be subjected to more scrutiny and regulations. While Blockchain and cryptocurrencies are a disruptive force, scaring longstanding institutions such as banks, it is doubtful that they will be able to avoid tax forever. It would be more pertinent for a resolution to be met between tax authorities and crypto investors, lest there be bigger issues down the line.
In Australia, the government has deemed that cryptocurrencies are “a form of property”, and therefore: “Any financial gains made from the selling of Bitcoin will generally be subject to capital gains tax (CGT) and must be reported to the Australian Tax Office,” a spokesperson from the tax office said.
While this is still a grey area, there has been a warning issued. The Australian Tax Office has warned it will be looking out for tell-tale signs of crypto tax dodgers living beyond their means:
“The Australian Tax Office is here to help those that are genuinely trying to meet their tax obligations. However, where people attempt to deliberately avoid these obligations, we will take strong action.”
This includes using “a range of existing powers” which are used to address “unexplained wealth and conspicuous consumption that may arise through profits derived from cryptocurrency investment”.
The South African Revenue Services (SARS) said in December last year that it would be exploring ways in which to track cryptocurrency trades in the hopes of addressing tax avoidance. In the meantime, it is looking to provide its own guidance for citizens on the tax treatment of cryptocurrencies, its first foray into controlling the gains made.
As Asheer Jaywant Ram, senior lecturer in the School of Accountancy at the University of the Witwatersrand, said:
“I think there is enough interest and enough scope for SARS to be looking into this space, but now the question becomes, are they really going to accept taxpayers declaring their gains as capital gains tax or are they going to just say it is all revenue in nature?”
“Those sorts of debates on the nature of Bitcoin – I think those are coming – and I think it would be very interesting to actually see the outcome of those debates”
A useful glossary of terms
Capital asset: Basically anything you own, from a house to furniture to stocks and bonds — and bitcoin.
Basis: The amount you paid to buy bitcoin (including any fees you paid).
Realized capital gain or loss: The profit or loss you made when you sold bitcoin (i.e. the price you sold it for minus your basis). Losses can be deducted from your taxes (more on this below).
Unrealized gain or loss: The profit or loss you have on paper but have not actually cashed in on. You do not pay taxes on unrealized gains until you sell, at which point it becomes a realized gain or loss.
Short-term gain: Realized gain on bitcoin or any other investment held for one year or less before selling it.
Long-term gain: Realized gain on bitcoin or any other investment held for longer than one year before selling it.