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Tax implications of bitcoins (and traditional alternative currencies)

BY: THOMAS S. GROTH, ESQ (find Thomas on twitter! @tsgESQ)

I’ve decided that I want to be a Millionaire.  So I am going to buy one bitcent (cBTC), and I’ll be all set.  Sure, a bitcent is worth roughly $1 in U.S. fiat money (and rising my bitcoin ticker app now pegs the bitcoin to 137.90 USD), but that bitcent is worth a cool MILLION in satoshis! Say that with me, one million sa-TOSHE- ees.

(For a our first introductory article on what bitcoin is and one potential regulatory hurdle (the FBAR), please see our article here.)

On a more serious note, I was thinking of asking one of the partners here at IRSMedic HQ if he could start paying me in bitcoins.  Why would I do that?  Mostly because I think there’s a good chance that the BTC is here to stay, and I like the idea of having a store of value that is protected against the whims of a government that can just print more money whenever it is convenient.  So, I want to get paid in bitcoins.  That’s TRILLIONS of satoshis every pay period!  But I’m a Tax Attorney, not a pirate, so I’m not sure if I want to dive head-first into uncharted waters.  The problem is that there isn’t any clear guidance on how I would be required to report my spending if I got paid in bitcoins and used it for my day-to-day purchases.  Let me explain.


First, I’m going to discuss how bitcoins are commonly used, and then I’m going to move on to the scenario I’ve proposed – being paid in bitcoins.


There are two general reasons that people acquire bitcoins: 1) for investment purposes, and 2)  for transactional convenience.  Many people engage in trading bitcoins on exchanges such as Mt. Gox or ICBIT.  They do this for a profit, and as a result, they should usually report this activity on a Schedule D in a similar manner as those who buy and sell stocks, commodities, or foreign currencies.  (The particular treatment of this income will vary depending on whether the particular bitcoin trader is a “mark-to-market” trader, etc).

For those who acquire bitcoins for transactional convenience, there probably aren’t any real tax implications.  Many people are moving towards bitcoins as a more convenient method of transacting business over the internet.  Some claim that the only reason one would do so is because of the anonymity of bitcoins – that is: people who conduct business in bitcoins are the same people who run their businesses in cash because something shady is going on.  While it is true that bitcoins are used in black market activities, or to avoid “the Feds” in other ways, there are legitimate reasons for using bitcoins in normal commercial transactions. 

The major reason for legitimate, legal, taxpaying businesses to take and remit payments with bitcoins is that the transaction costs can actually be much lower than using other methods on electronic payment.

When someone acquires bitcoins for transactional convenience, it usually  won’t have any tax implications.  That’s because the turnaround time is generally pretty quick.  In a normal transaction, Customer sees what he wants to buy from Vendor in bitcoins.  Purchaser buys bitcoins and transmits them to Vendor for the goods.  Vendor (especially if the transaction is legal) will turn around and exchange the bitcoins back into Vendor’s local currency.  In this scenario, bitcoins are being used as a conduit for the transaction, but there is little time for the bitcoin to fluctuate in value to such an extent that it would trigger a taxable event.


But what if I was paid in bitcoins? Can I be taxed when I spend them?

If I was paid in bitcoins would there be tax implications when I went to spend my money?  The answer is yes.  Maybe.

At this point, there has been very little direct guidance from the Internal Revenue Service on this type of transaction, and while the recent guidance from FinCen makes it clear that a bitcoin is not considered “currency” in the traditional sense by that arm of the U.S. Treasury, the common wisdom is that bitcoin transactions should be treated in a way similarly to transactions involving foreign currency.  So let’s dive in to Section 988 of the Internal Revenue Code. 

First what is my functional currency? The general rule, stated in 988(a) is that any “foreign currency gain or loss.. shall be computed separately and treated as ordinary income or loss[.]“  The trick is that I will only have a gain or loss if a transaction involves my “nonfunctional currency.”  So maybe I’m all set then, right?  I mean – here’s the thing.  I don’t want to “function” on U.S. dollars anymore.  I want to “function” on bitcoins.  Unfortunately for me, the Tax Code doesn’t care what I want.  In its infinite wisdom, Congress decided to let the I.R.S. determine who can choose to opt-out of using the greenback as his/her/its functional currency.  And what do you think the I.R.S. decided?

“The dollar shall be the functional currency
(i) A taxpayer that is not a QBU (e.g.,
an individual);” Treas. Reg. § 1.985–1(b)(1)


Oh well, looks like I can’t choose to function without dollars, no matter how desperately I want to. I’m an individual.  And the IRS has decided that my “functional currency” is the Dollar.  So now what?  Well, I’m going to be using my bitcoins for “personal transactions,” does the code have anything to say about that?  988(e)(1) tells me that “the preceding provisions of this section shall not apply to any section 988 transaction entered into by an individual which is a personal transaction.” 

So what am I worrying about?  Apparently 988 doesn’t even apply to me!  And it’s true, section 988 – at least the part that says any gain I have on foreign currencies has to be treated as ordinary income – doesn’t apply to my spending of bitcoins (so long as my spending is not somehow deductible as a business expense.) 

See, Section 988 deals primarily with establishing that when a business benefits from the appreciation of a foreign currency (for example, X billed Y in euros, and by the time X was paid, the EUR/USD had increased).  When a business benefits from fluctuations in currency during a transaction, then the benefit is taxed as ordinary income.  That’s basically what Section 988 is saying.  Treasury Regulation 1.988-2(a) clarifies that normally, foreign currency gains are treated the same way as disposition of any other property is treated by the Code.

Section 988 is still in play here though (for individuals who use bitcoin as their currency of choice), because Section 988(e)(2) lets me off the hook for transactions where I would realize a “gain” of less than $200.00.  I’m going to ignore the fact that the gain is actually measured in dollars and might not be a gain at all. The point is that if I purchase an e-book for $5.00, I don’t experience a taxable event as long as bitcoin is considered to be a “nonfunctional currency. Now. if I purchase a fancy TV or computer with my bitcoins, I might have to pay taxes on the “gain.”

But what if the gain is over $200?  Then the transaction is treated similarly to a barter transaction. 

Say, for example, that I bought a guitar at a garage sale for $50, but then I realized that the guitar was worth $900.  If I give the guitar to my landlord instead of paying $900 in rent, I am supposed to report that gain of $850 on my tax return (Schedule D) as a “gain from the sale or other disposition of property.”


With appreciated nonfunctional currency, the situation is analogous once the gain exceeds $200.


Here’s an example:

For simplicity sake, assume I only got paid one paycheck in bitcoins, and the value of BTC at the time was $30.00.  My gross pay was 40 BTC.  For income tax purposes, I  received employment income in the amount of $1200 (USD), I will report this employment income as ordinary income on my tax return.  Now, BTC has risen to $90.00 and I got to buy a computer for 30 BTC.  My “basis” in each BTC (if I choose to allocate it this way) is $30.00.  The computer I am buying is worth $2700.00, and my total basis is $900.  The result?  I have realized a capital gain of $1800.  I’ll need to report this on Schedule D and 8949 as a capital gain. 

The cool part is that if  the situation were reversed, and I was spending BTC that had decreased in value, any loss that I experienced from dabbling in bitcoins would be nondeductible under section 165(c).

Ok – but what if the IRS doesn’t treat BTC as a currency?  Well, then it gets really fun.  If BTC is not a currency, then the $200 exemption under 988(e)(2) on recognizing gains from personal use of the BTC does not apply!  If you think that BTC isn’t currency, then you should be reporting EVERY transaction you make with appreciated bitcoins to the IRS.  Fun, right?

Nothing in this fantastic blog post is intended or written to be used, and it cannot be used by the reader or any taxpayer/bitcoin fan/nontaxpayer/people who play satoshi dice/redditters (i) for the purpose of avoiding taxes or penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction.

  1. And the same could be true if you were using say the New Zealand Kiwi (a currency not intentionally devalued).

  2. The article says "capital gain of $1800."? What about 988(a)(1)(A) "Except as otherwise provided in this section, any foreign currency gain or loss attributable to a section 988 transaction shall be computed separately and treated as ORDINARY income or loss."

    • The purchase of a computer would not be a 988 transaction. See 988(e)(1), discussed in the article.

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