As a wise man once said, there is no escaping taxes and death once you are born. When Bitcoin was introduced, however, there was a glimmer of hope, most of us thought that we might just be able to escape taxes. Unfortunately, it was short lived, as the IRS decided to impose taxes on virtual currency holdings. Now that Bitcoin is considered as an official asset by various government agencies in the United States, one can do nothing but pay the toll.
How do we know what is taxable and what is not? Well, for that we have a few experts who can help us understand, but it will be easier if you are involved with cryptocurrency and reside in the United States. Laura Shin is one such good Samaritan who has explained how to deal with digital currency and the IRS when it comes to taxes. Her article in Forbes clearly explains about various different sources of bitcoin/digital currency and how to account for it. To begin with, all digital currency holdings are to be treated the same way one treats his/her capital assets like stocks and bonds. Internal Revenue Services in its guidance notice 14-21 refers to cryptocurrency as assets.
There are only so many ways one can come into possession of digital currency or spend it, starting with mining. If you manage to mine some bitcoins, any block reward you might get has to be accounted for along with the number of bitcoins gained and their market value at that time. It is important to have proper records, as Bitcoin value is bound to fluctuate and you will never know what the value will be when you file your taxes. The taxes will be calculated depending upon whether it is long term or short term capital gain.
Are you getting paid in bitcoins? The good news is that your salary may double itself if you manage to save some and the Bitcoin price goes up. The bad news is that you will pay income tax for the value received and capital gains tax for any subsequent gains on those saved bitcoins. However, it is best to keep a record of the actual value in fiat currency at the time of receiving payment for services rendered (including the cost of services).
If your paycheck was in Bitcoin, then you are expected to spend some in the form of Bitcoin itself (applies to others who come to possess Bitcoin through any means). Any expenditure in Bitcoin is equivalent to selling an asset; the gains or loss incurred will also account for the holding period. So, in order to find the holding period, one has to know which bitcoin he is selling and when did he receive that particular bitcoin, and it is virtually impossible to account for that unless you use a fresh wallet for each transaction. A better approach will be to have a set of predefined rules applicable for all income and expenditure in bitcoin. Laura suggests the implementation of last in, first out or first in, first out accounting methods.
What about tips? If you give or receive Bitcoin as tip or gift, it is better to divulge or ask for information about the cost basis and date of acquisition of the digital currency in question. If it is available, then it will be easier to calculate capital gain. Else, in the absence of information, one can always account it under income and get rid of the hassle. If you are making donations to registered charities, then the gains on the digital currency unit donated can be written off and it is not taxable. Laura suggests donating the digital currency with highest appreciation to reduce taxes.
While trading bitcoins, it is advisable to keep records of fair market value against those dates when it was traded. If the trading platform or exchange issues a 1099-B report, it will be helpful to record gains and losses. These pointers will come in handy for those who have started handling Bitcoin and would like to know how to keep track of gains and losses associated with their digital currency stash.