On March 25th, 2014 the IRS issued a unilateral edict which instantly put the entire U.S. Bitcoin community in a legal quandary. They’re calling it “Virtual Currency Guidance”.
The new rules designate all crypto-currencies as property, not currency, and state that any increase in value between the date of acquisition and the date of sale counts as capital gains and is taxable. All payments using Bitcoin are subject to the same reporting requirements as normal payments, and Bitcoin mining is also now considered taxable income. Oh, and by the way, these new rules and penalties apply retroactively.
If you run now to grovel at their feet they may be willing to reduce those penalties somewhat if you can convince them that you had a good reason for not reading their mind in the future:
A-16: Taxpayers may be subject to penalties for failure to comply with tax laws. For example, underpayments attributable to virtual currency transactions may be subject to penalties, such as accuracy-related penalties under section 6662. In addition, failure to timely or correctly report virtual currency transactions when required to do so may be subject to information reporting penalties under section 6721 and 6722. However, penalty relief may be available to taxpayers and persons required to file an information return who are able to establish that the underpayment or failure to properly file information returns is due to reasonable cause.
In one fell swoop the U.S. government has placed the entire U.S. Bitcoin community in a precarious legal position. Much of the allure of the currency lies in the fact that it has been widely viewed as a way to bypass government restrictions and to challenge the current monetary system. Up until this point this currency rebellion didn’t carry any risk (outside of the obvious price volatility). Now, however, those who have bought, sold or mined Bitcoin since 2009 have a choice: either attempt to go back and trace every single transaction and corresponding price in U.S. dollars, or go rogue and hope for the best.
Considering the libertarian leanings of the Bitcoin community, it’s unlikely that many will comply. The real question is whether this will push people to keep Bitcoin gains from touching their traditional bank accounts, or whether they will reduce their interaction with the currency.
The decision to apply these rules retroactively may have another unintended consequence. Given the massive undertaking that retroactive bookkeeping would entail, many Bitcoin users are very likely to make a conscious decision to not obey. For many, this could very well be the first time that they defy the taxman, and once their status is irregular it becomes much more likely that they will stay irregular.
For those of you who had chosen another form of currency resistance (precious metals), don’t be so quick to snicker and say “I told you so”. These rules set precedent that may very well be applied to gold and silver in the near future (and retroactively).