IRS, Treasury to Attempt Taxing Bitcoin Transactions

May 6th, 2013

Recently, digital currency bitcoin shocked investors by exploding into the financial mainstream. No longer just the bartering tool of tech-savvy voluntaryists, this digital alternative to the dollar is being embraced by people around the world for its relative strength and unique features, such as its anonymity and the fact that bitcoin transactions leave no paper trail.

Predictably, governments are also taking notice of this rise in value and, in response, are looking at ways to tax digital currency based transactions. The Canada Revenue Agency recently announced plans to tax bitcoin trades, either as a commodity or a barter transaction. Now, Forbes is reporting that the US Treasury and the IRS are formulating a similar plan to begin taxing bitcoins in the United States. Will bureaucrats succeed in their efforts to tax an anonymous, untraceable currency? How will they know who to tax and when?

Treasury’s Financial Crimes Enforcement Network Watching Bitcoin

Apparently, the US Treasury believes that the exchange of bitcoins between free people could in theory amount to a crime if said individuals don’t do an assertive enough job figuring out how to pay some portion of that transaction to the government. The department’s financial crimes division, FinCEN, has asserted that bitcoins are taxable as income, barter transactions, and as a commodity in cases in which an investor realizes gains due to maintaining possession of bitcoins while dollars devalue against them. Also, FinCEN asserts that bitcoin traders must file as Money Service Businesses.

On the other hand, bitcoin itself is untraceable, so there is no transaction-side way for regulators to monitor purchases and apply fees. Self-reporting appears to be the only enforcement mechanism for collecting the tax.

Realistically, businesses are likely to jump out in front of this and begin paying taxes, as it is cheaper for a lucrative business to just pay the IRS than to deal with the legal fees involved in contesting tax rules. In the future, bigger companies will likely issue 1099 forms with bitcoin payouts.

What About Transactions Between Individuals?

While some major companies are starting to participate in the bitcoin currency system, the vast majority of users are individuals. The Treasury wants to consider bitcoins a commodity, yet they are used exclusively as a currency. Gold is a commodity in the sense that it sometimes acts as money, but also at other times acts as a raw material resource for the creation of goods. Bitcoin differs in that it is used as money, but has no real other use as a raw material. Classifying a digital currency as a commodity and not a currency seems to be a stretch, given this distinction. As such, it seems legally questionable that the Treasury would have the authority to simply declare policies regarding bitcoin without there being legislation drafted to establish definitions.

Due to the anonymity factor, individuals using bitcoin as a currency for small-scale transactions between each other are far more difficult to tax. If they’re expected to pay taxes as if it were a barter transaction, they would have to pay a higher fee than they would have had to if the transaction had taken place using US dollars. That moves past taxation and becomes an attempt to interfere with the specific utility of bitcoin as a currency, which isn’t surprising given the fact that it is competing with the government’s own dollar. On the other hand, one-on-one transactions using a peer-to-peer digital currency are virtually untraceable, so government agencies are going to have an extraordinarily difficult time collecting barter or capital gains taxes from bitcoin users.

Long story short, the IRS will soon try to tax bitcoins. 1099-style transactions involving big companies and large dollar values will likely be successfully taxed. However, efforts to tax barter transactions or capital gains on privately-owned bitcoins will face significant technical challenges, due to the digital currency’s lack of a conventional paper trail. That said, any effort to tax bitcoin in such a way that it loses its utility as a currency is a huge mistake. Paying sales taxes on a transaction paid in bitcoins to a major company is one thing, but taxing them for just gaining value against the dollar is the wrong approach to take when the dollar is teetering on the edge of a full collapse. At this point, we need all the currencies we can get — more in fact, and we need them to remain tax-free so that they can continue to be used as currencies. Going further, not only is this move to tax digital currencies bad policy, it’s also probably impossible for technical reasons except in cases where big companies issue 1099s.

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About the Author: Barry Donegan

is a singer for the experimental mathcore band , a writer, a self-described "veteran lifer in the counterculture", a political activist/consultant, and a believer in the non-aggression principle.