While the Bitcoin cryptocurrency is still a relatively new phenomenon, it is one that is generating real money for people. Enough money, in fact, that Bitcoin has now attracted the official interest of the U.S. Internal Revenue Service.
The taxman always wants to get his due, and Bitcoin is no exception.
In a notice posted on the IRS Website on March 25, the IRS provided official guidance on how virtual currency like Bitcoin should be treated for taxation purposes.
The U.S. government and the IRS do not officially consider Bitcoin to be legal tender and is not taxable as such. That said, the IRS recognizes that Bitcoin does have value and considers it to be property—and, as such, it is taxed as property. Tax revenue from Bitcoin could come from any number of sources. If wages are paid in Bitcoin or if payments are made in Bitcoin, the IRS wants to know about it.
"A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property," the IRS stated.
Going a step further, the IRS has issued a frequently asked questions (FAQ) notice listing 16 items about how Bitcoin virtual currency is treated for tax purposes.
One of the questions explains how capital gains and losses apply to Bitcoin.
"A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer," the IRS states.
Another key point that the IRS makes is that the action of creating Bitcoins, which is known as "mining," is also a taxable activity. The IRS notes that the fair market value of mined currency should be included in a taxpayer's gross income for income tax purposes.
"If a taxpayer's 'mining' of virtual currency constitutes a trade or business, and the 'mining' activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment (generally, gross income derived from carrying on a trade or business less allowable deductions) resulting from those activities constitute self-employment income and are subject to the self-employment tax," the IRS states.
What all this means is that the IRS can and will look to generate tax revenue from Bitcoin. Bitcoin is being used by American businesses to receive and make payments, and it is also being mined. All of those activities are taxable, and the IRS will generate tax revenues as a result.
Given the recent collapse of the Mt.Gox Bitcoin exchange in February of this year, the IRS notice on Bitcoin is coming at an interesting time. Hundreds of millions of dollars were lost in that debacle, and it likely also served to diminish some of the confidence in the Bitcoin space.
No doubt some of the Bitcoins lost in the Mt.Gox collapse were held by American taxpayers. By treating Bitcoin as property, those taxpayers can likely now take their Mt.Gox investments as a capital loss at tax time.
The IRS notice on Bitcoin also serves in some respects as validation for the whole virtual currency space. Even though the U.S. government doesn't recognize Bitcoin as legal tender, it does recognize it as an economic activity and deserving of attention.
Sean Michael Kerner is a senior editor at eWEEK and InternetNews.com. Follow him on Twitter @TechJournalist.