Menus Subscribe Search

Follow us


The Future of Money

irs-building-dc

IRS Building in Washington, D.C. (Photo: Joshua Doubek/Wikimedia Commons)

What the IRS’s Taxation Ruling Means for Bitcoin and Other Digital Currencies

• April 09, 2014 • 8:00 AM

IRS Building in Washington, D.C. (Photo: Joshua Doubek/Wikimedia Commons)

The recent notice is a surreal step that brings what was once an anarchist’s dream come true closer to being a tool of the state.

Where does the value of money come from? Is it from the bill or coin in your wallet, attached to a physical object? Or is money valuable mostly because of its transactionary nature, its ability to be swapped with like-minded people for other, more immediately usable goods?

The United States Internal Revenue Service recently ruled (PDF) that the value of digital currencies like Bitcoin comes more from the former option than the latter. Over the past few years, as Bitcoin’s value, along with those of other alternative currencies like Litecoin and Dogecoin, has multiplied exponentially, the biggest unanswered question was how the government would choose to deal with them. They weren’t outlawed outright, as some may have expected, but those Bitcoin holders hoping to get rich overnight with non-governmental money might be disappointed—they still have to pay their taxes.

An IRS notice released March 25 makes clear that transactions using virtual currencies count as “property transactions” under current tax law. “Virtual currency operates like ‘real’ currency,” it reads. “But it does not have legal tender status in any jurisdiction.” Rather than a legitimate foreign currency like the Chinese Renminbi, Bitcoin is actually a commodity with its own fluctuating value, like a stock or bond. That designation makes things a lot more complicated when it comes to tax time (less than a week away, for those counting).

All digital currency users now essentially work for themselves, running small businesses that just happen to function in a brand-new kind of money. Bitcoin is a cottage industry.

Digital currency miners—the people using their computers to solve complex math problems in order to release new money into the economy—have to track the value of their coins when first mined as well as when they use or sell them. If a miner mined one Bitcoin on January 1, 2013, when it was worth $13, then they must report $13 in direct income. Then, if they sold the Bitcoin on December 31, 2013, when it was worth roughly $1,000, they would be subject to capital gains tax on the $987 difference.

The IRS’s designation means that, at least when it comes to taxes, Bitcoin doesn’t really function as a currency at all. Even transactions carried out purely in Bitcoin without switching into U.S. dollars at any point are taxable as capital gains. So if our hypothetical miner spent $500 worth of Bitcoin to buy a couch, he is still liable for that full $987 in capital gains, since the value has accrued regardless—it just ended up in the form of a couch rather than digital currency.

In some ways, this is a good thing for digital currency holders. It means that gains in Bitcoin value aren’t taxed at a higher level as direct income. Capital-gains tax rates are lower than income tax, hence the appeal of getting paid in stock rather than salary. Ordinary income tax rates and tax on capital gains from the sale of assets held less than a year can go as high as 35 percent, but long-term capital gains tax rates for assets held longer are just 15 percent. For less wealthy investors, short-term rates can be as low as 15 percent (with long-term rates falling to 10 percent). The longer you hold your Bitcoin, the less tax you’ll pay on them.

Capital losses can also be reported on tax filings. So if you bought Bitcoin at its height of $1,000 and sold it after it decreased in value, that loss is deductible. Up to $3,000 in losses can be taken off other forms of income. (Those losses might be more relevant during this year’s tax due date in 2015; Bitcoin’s value has now fallen to around $450.)

THE FACT THAT THE IRS has decided how it wants to regulate digital currencies should come as something of a relief to users who feared they might be decimated entirely. But the sudden profusion of rules also dashes the hopes that Bitcoin would become the world’s first totally decentralized, untaxed, anonymous currency. It’s now less anonymous and more structured than ever before.

In order to properly report taxes, miners must now closely track when they successfully mine coins to determine their original value. Those buying Bitcoins must note the price they bought in at, creating a de-facto timeline of participation in digital currency markets. Getting paid over $600 in Bitcoin for a service is just like getting a job that pays U.S. dollars—employees must fill out W-9s and use their social security numbers. But the value of their salary also fluctuates, and then they’re subject to capital gains taxes if they cash out of Bitcoin at a later date.

On Reddit, one tax attorney also points out that digital currency exchanges could act as a warning system for those trying to dodge their taxes. With wire transfers of over $5,000, especially across international borders, banks are required to file suspicious activity reports, which could trigger investigation by the IRS. So there’s little chance of getting large amounts of money out of the Bitcoin system and into a U.S. bank account without at least one authority being alerted.

It’s a surreal step that brings what was once an anarchist’s dream come true closer to being a tool of the state. All digital currency users now essentially work for themselves, running small businesses that just happen to function in a brand-new kind of money. Bitcoin is a cottage industry.

Yet as Alex Hern points out in The Guardian, the taxes are still going to be difficult to enforce. While individual Bitcoins are identifiable by their numerical addresses, they run together like a herd of zebras. Within one user’s digital-currency wallet, there might be fractions of thousands of different Bitcoins, all bought and sold at different prices. So how do we determine which ones are transacted at which prices?

Hern suggests that an average price could be used, but also warns that Bitcoin “tumblers” that mix together many different Bitcoins into a single wallet before passing them on could complicate things further. At this juncture, it’s up to users to self-report and risk investigation if they don’t.

As Bitcoin prices increased dramatically over 2013, what most wallet-holders will be reporting are capital gains, not losses, and the federal government will benefit from an inrush of tax money from a market it did nothing to create or encourage—a net gain that should elicit few complaints, even if not every Bitcoin user reports their earnings.

Many questions remain. What happens when deductible capital losses in digital currencies start functioning as a form of money laundering? Will the IRS pursue Bitcoin millionaires—and there are many—who try to move their wealth into the real world without proper reporting? Will users selling off Bitcoins to pay for taxes dampen the digital currency market further?

One thing is clear: Though the tax structure forces it into more of a commodity than currency role, Bitcoin is sticking around.

Kyle Chayka
Kyle Chayka is a freelance technology and culture writer living in Brooklyn. Follow him on Twitter @chaykak.

More From Kyle Chayka

A weekly roundup of the best of Pacific Standard and PSmag.com, delivered straight to your inbox.

Recent Posts

October 31 • 4:00 PM

Should the Victims of the War on Drugs Receive Reparations?

A drug war Truth and Reconciliation Commission along the lines of post-apartheid South Africa is a radical idea proposed by the Green Party. Substance.com asks their candidates for New York State’s gubernatorial election to tell us more.


October 31 • 2:00 PM

India’s Struggle to Get Reliable Power to Hundreds of Millions of People

India’s new Prime Minister Narendra Modi is known as a “big thinker” when it comes to energy. But in his country’s case, could thinking big be a huge mistake?


October 31 • 12:00 PM

In the Picture: SNAP Food Benefits, Birthday Cake, and Walmart

In every issue, we fix our gaze on an everyday photograph and chase down facts about details in the frame.


October 31 • 10:15 AM

Levels of Depression Could Be Evaluated Through Measurements of Acoustic Speech

Engineers find tell-tale signs in speech patterns of the depressed.


October 31 • 8:00 AM

Who Wants a Cute Congressman?

You probably do—even if you won’t admit it. In politics, looks aren’t everything, but they’re definitely something.


October 31 • 7:00 AM

Why Scientists Make Promises They Can’t Keep

A research proposal that is totally upfront about the uncertainty of the scientific process and its potential benefits might never pass governmental muster.


October 31 • 6:12 AM

The Psychology of a Horror Movie Fan

Scientists have tried to figure out the appeal of axe murderers and creepy dolls, but it mostly remains a spooky mystery.


October 31 • 4:00 AM

The Power of Third Person Plural on Support for Public Policies

Researchers find citizens react differently to policy proposals when they’re framed as impacting “people,” as opposed to “you.”


October 30 • 4:00 PM

I Should Have Told My High School Students About My Struggle With Drinking

As a teacher, my students confided in me about many harrowing aspects of their lives. I never crossed the line and shared my biggest problem with them—but now I wish I had.


October 30 • 2:00 PM

How Dark Money Got a Mining Company Everything It Wanted

An accidentally released court filing reveals how one company secretly gave money to a non-profit that helped get favorable mining legislation passed.


October 30 • 12:00 PM

The Halloween Industrial Complex

The scariest thing about Halloween might be just how seriously we take it. For this week’s holiday, Americans of all ages will spend more than $5 billion on disposable costumes and bite-size candy.


October 30 • 10:00 AM

Sky’s the Limit: The Case for Selling Air Rights

Lower taxes and debt, increased revenue for the city, and a much better use of space in already dense environments: Selling air rights and encouraging upward growth seem like no-brainers, but NIMBY resistance and philosophical barriers remain.


October 30 • 9:00 AM

Cycles of Fear and Bias in the Criminal Justice System

Exploring the psychological roots of racial disparity in U.S. prisons.


October 30 • 8:00 AM

How Do You Make a Living, Email Newsletter Writer?

Noah Davis talks to Wait But Why writer Tim Urban about the newsletter concept, the research process, and escaping “money-flushing toilet” status.



October 30 • 6:00 AM

Dreamers of the Carbon-Free Dream

Can California go full-renewable?


October 30 • 5:08 AM

We’re Not So Great at Rejecting Each Other

And it’s probably something we should work on.


October 30 • 4:00 AM

He’s Definitely a Liberal—Just Check Out His Brain Scan

New research finds political ideology can be easily determined by examining how one’s brain reacts to disgusting images.


October 29 • 4:00 PM

Should We Prosecute Climate Change Protesters Who Break the Law?

A conversation with Bristol County, Massachusetts, District Attorney Sam Sutter, who dropped steep charges against two climate change protesters.


October 29 • 2:23 PM

Innovation Geography: The Beginning of the End for Silicon Valley

Will a lack of affordable housing hinder the growth of creative start-ups?


October 29 • 2:00 PM

Trapped in the Tobacco Debt Trap

A refinance of Niagara County, New York’s tobacco bonds was good news—but for investors, not taxpayers.


October 29 • 12:00 PM

Purity and Self-Mutilation in Thailand

During the nine-day Phuket Vegetarian Festival, a group of chosen ones known as the mah song torture themselves in order to redirect bad luck and misfortune away from their communities and ensure a year of prosperity.


October 29 • 10:00 AM

Can Proposition 47 Solve California’s Problem With Mass Incarceration?

Reducing penalties for low-level felonies could be the next step in rolling back draconian sentencing laws and addressing the criminal justice system’s long legacy of racism.


October 29 • 9:00 AM

Chronic Fatigue Syndrome and the Brain

Neuroscientists find less—but potentially stronger—white matter in the brains of patients with CFS.


October 29 • 8:00 AM

America’s Bathrooms Are a Total Failure

No matter which American bathroom is crowned in this year’s America’s Best Restroom contest, it will still have a host of terrible flaws.


Follow us


Levels of Depression Could Be Evaluated Through Measurements of Acoustic Speech

Engineers find tell-tale signs in speech patterns of the depressed.

We’re Not So Great at Rejecting Each Other

And it's probably something we should work on.

Chronic Fatigue Syndrome and the Brain

Neuroscientists find less—but potentially stronger—white matter in the brains of patients with CFS.

Incumbents, Pray for Rain

Come next Tuesday, rain could push voters toward safer, more predictable candidates.

Could Economics Benefit From Computer Science Thinking?

Computational complexity could offer new insight into old ideas in biology and, yes, even the dismal science.

The Big One

One town, Champlain, New York, was the source of nearly half the scams targeting small businesses in the United States last year. November/December 2014

Copyright © 2014 by Pacific Standard and The Miller-McCune Center for Research, Media, and Public Policy. All Rights Reserved.