Have you seen this image while shopping online lately? The "Bitcoin Accepted Here" button is popping up across the internet. Some big sites like Overstock.com and many smaller boutique sites are beginning to accept Bitcoins as payment, which makes me wonder - How are these companies accounting for and paying taxes on income made with this new digital "currency"?
What is Bitcoin?
Bitcoin is an online digital currency and is not backed or regulated by any government, central bank or other legal entity. They are created by an open source computer program that began running in 2009. Each bitcoin has a coded internet address that can be stored in an online "wallet" created by its owner. Bitcoins are created through a process called "mining" in which super computers are used to solve complex math problems - like gold mining in the digital world.
To me it seems silly that people would prefer this digital currency over cash but Bitcoin fans like the safety, control and transparency of this currency. For example, all transactions are immediately logged digitally on a transaction log that tracks the time of purchase and the amount, while still allowing the owner to remain anonymous. This log is basically an audit trail that prevents bitcoins from being counterfeit. Also, there are no third parties involved (like a credit card company or bank), so there are no fees associated with transactions for the buyer or the seller.
So are Bitcoins taxable?
While the IRS has not issued any statements on how they will tax Bitcoin transactions - they are paying attention. At this time, they are likely considering how they would classify this digital currency since it could be considered income, property or foreign currency. However, regardless of how the IRS eventually classifies Bitcoin, current IRS rules state that all income from whatever source (and not limited to cash received) is taxable as income.
So if you own Bitcoin as an investment or accept Bitcoin for goods or services you will need to account for it and pay taxes on any income. If owned as an investment, you will need to track the fair market value of the Bitcoin when received and when sold and the difference will be your gain or loss. If you accept Bitcoin for goods or services provided, you will need to value your goods or services against the fair market value of the Bitcoin - the same as if you were bartering for another good or service.