It’s time to start to start thinking about the tax and accounting ramifications of digital, virtual currencies.
Bitcoin is virtual currency much in the news these days. It’s peer-to-peer so there’s no central bank or government. But, because it necessarily represents income or asset, it needs to be accounted for and hence will have tax ramifications.
Accountants, the IRS and accounting software developers are starting to take it seriously. But in the absence of IRS rules specific to bitcoin taxability, accountants have to draw upon their knowledge of IRS rules that govern income, assets, capital gains or losses, and stock and bond transactions, and apply that corollary to bitcoin ownership and transactions.
As a bitcoin is (supposed to be) a currency, it has value. How does one acquire or provide value?
You buy bitcoins for cash. In other words, you changed the “form” of your assets from cash to virtual currency. You did not deliver or receive value – just changed form, probably akin to buying stocks. The value of your stock can reduce (capital loss) or increase (capital gains). Similarly, the “value” of your bitcoins, as long as you don’t convert them into cash again or barter them for services / goods, will fluctuate resulting in capital gains or losses.
You barter bitcoins in exchange for services or goods. Say you provided $100 worth of services to someone and she paid you in bitcoins. It’s not cash in your bank account, yet it’s “worth” $100 in income. And income is taxable. You may not report it but sooner or later regulators will find ways to know about your virtual income and tax it as real.
Someone gifts you bitcoins or you inherit them. Inheritance of a very new asset form can be rare as of now but gifts? Yes. People can gift you bitcoins. For the giver, it means they earned or bought bitcoins so they will need to be accounted for. For you as the receiver of gift, you may or may not have tax implications. For example, what if an employer gifts you bitcoins? It is certainly different than your grandpa gifting you bitcoins. Whether or not there will be gift tax or estate tax will all depend on circumstances of the donor and receiver.
What it means for accountants and tax preparers Let’s say one of your clients bought a million dollars worth of bitcoins. Do you know how to account for it? Will you show it as inventory? Inventory can, by nature, not be intangible. Or will you account for it as cash? Will the bitcoin transaction statement or account statement, if there is one issued by an “authorized” entity, be taken as a proof of ownership or net worth? Which line item on a tax return will you show it on as taxable or nontaxable income or capital gains or loss? Like stocks, will you need to do the valuation by “marking to market”? Will it be your professional liability if you fail to account for bitcoin ownership? How does insurance cover it? What if someone offers to pay you in bitcoins for your services?
Just like any new regulation and law sends you scrambling for answers, bitcoins can soon send you on a wild goose hunt. The only difference is that in the former case, you can get answers from regulators. In case of bitcoins, there is no regulator at all.