Bitcoin and Fred

I am going to dedicate this post to Fred.

Fred likes to talk about Bitcoin. He is a believer. He may as well be on the payroll.

I do not want to talk about blockchain or cryptocurrencies or any of that.

Let’s talk about the taxation of the thing, in case Fred has gotten to you.

As I write this Bitcoin is selling for around $15 grand.

On January 1, 2017 – less than a year ago – it sold for around $1 grand.

COMMENT: There is a reason why we are still working, folks.

There are even Bitcoin ATMs. I understand there around 70 or so locations around Miami alone. You can tap into one if you are going to the Orange Bowl at the end of this month.

Mind you, if you withdraw dollars-for-Bitcoins you probably have a tax consequence.

You see, the IRS has said (in 2014) that Bitcoin is not a currency. Given this thing’s propensity to swing hundreds if not thousands of dollars of day, it makes sense that it is not a currency. Currencies are supposed to have some stable value, at least until politicians run them into the ground.

No, Bitcoins are property, like stocks or a mutual fund. Like a stock or mutual fund, you have a tax consequence on the sale.

Let’s use the following numbers for the sake of discussion:

          Bought on 1/1/17                    $1,000

          Cashed-in on 12/31/17           $16,500

Let’s say you cash-in a Bitcoin while you are at the Orange Bowl. What have you got?

Way I see it, you have ...

    $16,500 (proceeds) - $1,000 (cost) = $15,500 gain

You are supposed to report $15,500 as income on your tax return.

What type of income is it?

I see a buy. I see a sell. I would argue this is capital gain. It would be short-term, as you did not own it for a year.

Let’s throw a curve ball.

Let’s say that you did some work for somebody in 2016. The paid you with that Bitcoin on January 1, 2017 – the one worth $1,000 at the time.

What are your tax consequences now?

You got paid with a Bitcoin worth $1,000. You have $1,000 of ordinary income. If you got paid for work, it is also subject to self-employment tax.

Then you sell it.

I see the following …

   $1,000 (ordinary) + $15,500 (capital gain) = $16,500   

This is what happens when Bitcoin is considered “property” rather than “currency.” It would be the same as you writing checks on your Fidelity or Vanguard mutual fund. Every time you do you are selling some of your mutual fund. And it all gets reported to the IRS at year-end.

Except that most of Bitcoin does not get reported to the IRS at year-end. Not yet, at least. In fact, in 2015 only 802 people reported Bitcoin on their tax return. You know that doesn’t make sense.

Which is why the IRS served a “John Doe” summons on Coinbase in November, 2016. Coinbase is an exchange for virtual currencies like Bitcoin and Ethereum. A “John Doe” summons substitutes a group or class or people for a specific person. It could be as easy as “anyone who sold more than $600 of Bitcoin between 2013 and 2015.”

Coinbase fought back, of course, but in the end the two wound up compromising. Coinbase will not provide 100% of its account data, but the IRS is getting information on over 14,000 account holders and almost 9 million transactions.

Bitcoin and other virtual currencies have become the new overseas bank accounts. It is time to come clean on this stuff, folks.

And yes, I believe there will be IRS reporting – akin to what the stock brokerages do – in the near-enough future. The government is flipping the sofa cushions for every nickel it can find. Until they get us to a 100% tax rate, they are going to keep looking for new sofas.

Someone – probably Fred - was telling me about a Bitcoin credit card.

That is a tax nightmare

Why?

Say that you bust to Starbucks in the morning. You put your coffee on the card. You stop for fuel – on the card. You go to lunch – on the card. You stop at the dry cleaners and Krogers on the way home – both on the card.

You have 5 “sales” that day. Each one has a cost, and who knows how we are going to come up with that number. Say that you do something comparable almost every work day. I will probably “fee discourage” you from using me as your tax advisor.

BTW, a similar thing can occur if you accept Bitcoin as payment for your services. Say that you are an independent contractor and two or three of your clients pay you in Bitcoin. You are going to have to price the Bitcoin every time you get paid with one, as your “proceeds” are its value on the day you receive it.

That is an accounting hassle.

Can you think of a nightmare scenario?

I  can.

What if you get paid with Bitcoin next year when it is worth $20,000. You hold onto it. Let’s say Bitcoin drops to $9,000 by December 31, 2018. You bring me the info for your taxes. How much do you have to report as income from that Bitcoin?

You have to report $20,000.

But it is only worth $9,000 now!

Yep. That is how it works since Bitcoin is not considered a currency.

What can I do to get my taxes down? Should I sell it?

Now you have a different problem. If that thing is a capital asset – and we said earlier that it was – you will have a capital loss upon sale. You will report a $11,000 capital loss on your return.

And unless you have capital gains to absorb those losses, you continue to have tax problems. Capital losses are allowed to offset only $3,000 of your “other” (read: Bitcoin) income on your tax return. You get no bang on the remaining $8,000 ($11,000 - $3,000), at least until the following year when you can use another $3,000. 

Don’t forget that you are also paying self-employment taxes on that $20,000 and not on $9,000.

This is ridiculous. If I were you, I would fire me as your tax advisor.

I do not accept Bitcoin for my fees, but I am waiting for someone to bring it up. I might do it for an isolated transaction or two. 

But no way am I using a Bitcoin credit card.