Taxing Bitcoin? IRS gets involved

Once again: is bitcoin a currency, and do currency rules apply? Or is it a capital asset and do those rules apply?

The Wall Street Journal is reporting that a large Bitcoin exchange Coinbase has been served with a so-called “John Doe” warrant in search of those people attempting to evade taxes.  A number of privacy advocates are upset at the breadth of the warrant, because it demands access for an entire broad class of people, and not specific people.

Bitcoin is used for all sorts of nefarious purposes, including online ransoming.  Tax evasion would be the least of its problems.  Were Coinbase a bank, they would be required to inform the federal government of transactions greater than $10,000 or of those individuals believed to be structuring transactions to avoid the $10,000 filing requirement.  These are anti-money laundering provisions that go hand in hand with tax enforcement.

And so my question: if it is wrong for the federal government to make such a demand of Coinbase, is it also wrong of them to make the same demand of banks?  If it is not, then why should Coinbase be treated differently?  And if Coinbase is not treated as a bank, is Bitcoin then not a currency?  If it’s not a currency, should it be treated as a capital asset for taxing purposes?  If that is the case, how would the IRS be able to enforce the reporting requirements associated with assets?

The alternative seems to be to trust people to not launder through Bitcoin.  If history, including recent history, is any measure, that’s a bad idea.  Either way, Bitcoin has already shown that privacy has its downsides.

Is Bitcoin Really Money Laundering?

For those who don’t know, BitCoin is an attempt at a new type of currency, one that isn’t linked to any nation.  In a way, bitcoin is a lot like gold or other commodities, only it differs in that you don’t actually have to ship anything around or even keep trading futures to stay in the game.  Still it accrues similar benefits as gold. In fact there is a bitcoin to gold price, based on milligrams of gold.  As you can see the number of milligrams one gets for a bitcoin has gone from about 300 in January to about 3,300 in October.  Bitcoins have clearly paid off for some people.

One of the other goals of bitcoin is that they be as anonymous as cash.  This is where the problems start.  Let’s say you want to sell a few bitcoins, and receive American dollars.  One question is simply this: do you have to list the sale on Schedule D?  I am no accountant, but I would think the answer would be “yes”.  Now let’s say that instead of selling them, you are just holding them, and let’s for the sake of argument say that you have $500,000 worth of bitcoins.  Do these represent foreign assets?  If so, you are required to file forms with both the Treasury (TD-F 90-22.1) and the relatively new IRS Form 8938.

Those who in any way behave like banks will find that the Treasury department expects them to do all the things banks do.  That includes reporting on suspicious transactions or any transaction over $10,000.

This hasn’t stopped people from attempting to hide transactions.  Here’s an article from CNN about a guy who attempted to do all sorts of nasty things with Bitcoins.  This led to a huge drop in their value, almost overnight.

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So, now the question: are bitcoins here to stay or are they a passing fad (read: pyramid scheme)?   The entire technical premise of bitcoins is in fact that they can be anonymously traded.  The bad news for people with bitcoins is that because there is no single management point that has guns (thus differentiating them from a classic currency), unless the likelihood is that those with the guns will want to limit or prohibit this sort of transaction; especially in large quantities.

A similar situation arose in 2001 when the U.S. government began to crack down on those using the old mechanism known as Hawala, even though the mechanism is legal.  And so one question is simply this: are bitcoins really anonymous?  A researcher named Sarah Meiklejohn will present a paper at SIGCOMM this month on just what law enforcement capabilities there are.  Watch that spot.