Paying taxes on Bitcoin, at least in the US, is the one downside to the whole movement to live solely on Bitcoin. Honestly, when you start to scratch the surface and get a good look at the hoops you have to jump through it sounds incredibly daunting. In a Forbes article from 2014, author Kashmir Hill told a story in which she paid taxes on her Bitcoin for the previous year and her accountant muttered, “The government’s going to kill Bitcoin by taxing it to death.” I have to agree, it’s almost as if the regulations are put in place either to slow adoption of Bitcoin or to make it too cumbersome to use. Do you think I’m exaggerating? Let’s take a look.
The Internal Revenue Service has decided that we in America must treat our Bitcoin as stocks for tax purposes. The rules aren’t that hard on the surface. The guidelines state that you have to pay taxes on the capital gains or losses. This is common when dealing with stocks, bonds, commodities, and the like. You keep track of the value at purchase time and the value at sale time and the difference gets taxed. If you made money you pay and if you lost money you get a refund. This seems like it should take a simple spreadsheet and a couple fancy formulas. And this would be correct if you only do a few transactions per month buying, holding, and selling.
If you use Bitcoin as a currency on a regular basis, on the other hand, the record keeping is utterly ridiculous. With the volatility in Bitcoin every transaction you make is a taxable event. Imagine if you had to keep track of these calculations with every incoming and outgoing transaction in your day to day life. Every cup of coffee, every time a friend paid you back for a cab ride, every time you sent a few bits to a busker using a sign in their guitar case, you would have to write it down, calculate how much it was worth when it came into your possession, how much it was worth when it left your possession, how much the difference was between the two, and how much you need to pay for taxes on it. Now track this over hundreds or thousands of transactions every month.
For example: Let’s say I bought $1 worth of Bitcoin. Then that Bitcoin becomes worth $5. If I bought something for $5 worth of Bitcoin I have to pay taxes on the $4 difference. Sounds simple enough in that example, right? But what if I bought $10 worth of Bitcoin. Then the price of Bitcoin goes up. Then I spend $1 worth of it but it’s worth more. Then someone tips an article I write for $3. Later I buy $6 worth of Bitcoin. Then the price of Bitcoin goes down so some is worth more and some worth less. Then I spend $5 more worth of Bitcoin. So I have to figure out how much the Bitcoin from the original $1 purchase are worth, plus how much the Bitcoin from the $3 tip are now worth, plus how much the Bitcoin from the $6 purchase are now worth, how much of each were spent, how much of each went up, how much of each went down, how much the difference was for which ones I owe from each pile, and how much I have to pay in taxes on all of it. What a nightmare! It’s like filing an expense report every day!
I would just like to take a moment to point out the hypocrisy in this. Imagine what it was like for an American to go on holiday in Europe before the Euro. Nobody from America had to keep track of buying Francs with US Dollars, how much they were worth when they bought them when landing at the airport in France, how much they were worth when they spent them in Paris, how much the leftover Francs were worth when they traded them for Lira when going to Italy, how much the Lira were worth when they spent them in Rome, how much the leftover Lira were worth when they traded them for Drachma in Greece, how much the Drachma were worth when they spent them in Athens, how much the leftover Drachma were worth when they sold them again for US Dollars when they got home, and then how much the differences all were so they could pay taxes when it came time for tax season. They just went on holiday, bought a foreign currency, traded between other foreign currencies as necessary, and spent them. End of list. Again, these regulations seem to be put in place less to tax income and more to make Bitcoin harder to use, to reduce the number of transactions, and to slow adoption, if not to outright kill it.
Update: I was recently contacted by a member of BitcoinTaxes, which I talk about below. I need to add some information here based on what they told me. In my example above, if the currency price fluctuated enough and caused someone to make more than $200 off the gain they would, indeed, have to pay taxes on the gains. And there is no long-term deduction. Also, one benefit of Bitcoin being taxed the way it is, it benefits from long-term reduced tax rates, despite the much more complicated record-keeping.
Fortunately there are a couple groups that have stepped in to make this process easier. But I will warn you that some concessions have to be made. Because I’m not a tax professional I’m not going to give you advice here on which methods to choose, how to track, how much to pay or claim, which forms to fill out and how, or any other tax advice. The IRS are notoriously prickly and intimidating. Either find a tax lawyer or CPA in your area that can give you advice, and backup if needed, or look to one of the following services for direction.
Libra Tax has a very impressive lineup of accounting professionals and finance experts, some of whom worked at the IRS. They mixed them with technology experts and digital asset professionals, many of whom worked at some of the biggest names in the Bitcoin ecosystem, names like Blockchain.info, ChangeTip, ZeroBlock, and Bitcoin.org. They offer an impressive line of tools. You can import data from many of the large exchanges, brokers, and other Bitcoin services. They will do the calculations for you using that data and then give you the proper tax forms. They offer services to individuals, businesses, and CPAs. They also offer their own professional CPA help, if you need it.
A challenger to Libra Tax is BitcoinTaxes and their service looks very similar. They offer a directory to locate a tax professional that can assist you with tax preparation if you’re active in the digital currency ecosystem. They offer similar tools to Libra Tax with which you can import your data, have it calculate your gains and losses, and then have it deliver the proper tax forms to you to put with your forms you send to the IRS. Whereas Libra Tax leads with tax prep tools, BitcoinTaxes leads with an offer to refer you to tax professionals who can assist you in using their tax calculation tools.
But, if you’re scared to death of all this, want someone to figure it all out for you and just tell you what you should pay, you’re in luck. Cross Law based in Nevada and California is a firm focused on cryptocurrencies. They offer tax consultation, do tax preparation in all 50 states, tax planning, record keeping, Anti-Money Laundering compliance, and they specialize in Bitcoin. They also offer a free consultation from their website.
In my first Educational post I mentioned that I’m not in the Bitcoin space to launder money, hide income, or avoid taxes. I’m a proponent for paying taxes and, as much as I complain about the regulations placed on Bitcoin right now, I really do recommend keeping good records and choosing one of the above options. Nobody likes dealing with taxes, it’s true. But nobody wants to go through an audit either. So let’s all learn to play nice for the time being. If you want to buck the system, instead of setting yourself up to be a martyr, for audits, and tax court, let’s all take the time to contact our representatives in government and tell them that we want the laws changed. Hopefully one day the government recognizes Bitcoin for what it really is: just another foreign currency, albeit one with no state.