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Tax Issues Relating to Bitcoins

Essay by   •  November 7, 2015  •  Term Paper  •  2,113 Words (9 Pages)  •  1,099 Views

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Tax issues relating to Bitcoins

1. Introduction

What are the flat currencies? The currencies created by a government. Then there is a central regulatory agency responsible for the issue. The accepted characteristics of present day use money are included a store of value, a unit of account, and a medium of exchange. However, the supplies of currencies are governed and authorized by the central bank on behalf of the government. However, after the mortgage crisis in 2008 the money supply increased sharply, therefore the confidence in the government issued currency declined among the people.

At this point, the paper by Satoshi Nakamoto was published online describing the “Bitcoin” for the first time. In the opinion of Nakamoto, the major problem with conventional currency today and discussed the easiness of bitcoins.1

In a nutshell, Bitcoin is an electronic cash system started in 2009. Therefore, it is new to the market. Still most of the countries have been studying the system and how it operates. But it is not fully accepted in a lot of countries as a legal tender. There are more than hundred thousand vendors in the market today who accepts bitcoins as a currency. There are more than sixty thousand in the USA.2 However, until March, 2014 IRS notice 2014-21 came into operation; the bitcoin was treated as currency in the USA for tax purposes. But thereafter, bitcoin is considered as a property, and gain and losses generate from bitcoins are considered as a capital gain or loss.3 However, existing tax laws provide a measure of guidance as to reporting and tax treatment for bitcoin transactions but still there are doubts among the users of bitcoin for proper treatment for tax purposes. Thus, the basic objective of this paper is to study a few selected tax issues relating to Bitcoins.

2. What is Bitcoins?

Bitcoin is cryptocurrency electricity converted into lines of code with monetary value.1 in the simplest of forms, cryptocurrency is digital currency. A form of payment that uses cryptography to control its creation and management, rather than relying on central authorities. According to Nakamoto, Bitcoin is a software-based online payment system and introduced as open-source software in 2009.

Bitcoin is considered as a peer-to-peer digital system of payment.2 therefore, no physically seen proof records as seen in the manual system. When the bitcoin founder Nakamoto created the mathematical algorithm, he fixed the total number of bitcoins that would ever exist to 21 million units. However, currently; over 14 million are in circulation. According to bitcoin market information, since 2009 the bitcoin mined has increased rapidly. As per the Nakamoto the final bitcoin will be mined in the year 2140, 1 at the current rate.

3. Why people use virtual currencies

The application of financial rules and regulations on bitcoins are least compared to money and banking system. Using the virtual currency can lower the transaction fee in order to credit card and other money transfers. Credit card fees run anywhere from 2-5% plus $.30 per swipe. Bitcoin transaction fees using the Coin of Sale POS are only 0.59% 7. Transactions are easily done Using bitcoins compared to check or credit card. Since the bitcoin uses the public key, therefore, personal information is not transferred from one person to another. This prevents the risk of identity theft. In brief, we examined how well the overall Bitcoin network has enabled bitcoin to fulfill the functions of a fiat money.

4. The related tax issues in bitcoins

In March 2014, IRS issued a special notice 2014-21 which describes how existing tax principles apply to transactions using Virtual Currency.3 Before this notice issued the taxpayers were free to declare their bitcoin income for tax purposes. But thereafter, taxpayers should review notice 2014-21 and use it in informed their decisions when reporting bitcoin transactions and income. And also be aware that the notice is neither to the sole nor final authority regarding the taxation of bitcoin.

Even there is an IRS notice in operation for bitcoins but tax issues relating to bitcoin are remaining. Prior to the notice 2014-21, the main question was the bitcoin income considered either currency or property but after the notice mainly bitcoin income treats as capital gain (property).

The selected tax issues of bitcoins are discussed here. Bitcoin transactions are taken place in between one computer to another. But IRS tax purposes bitcoin customers must be honest in disclosing their income and expenses. However, the biggest problem is how the IRS rely on the disclosed transactions are purely correct.

One another problem IRS notice 2014-21 does not include very clear information about Foreign Bank Account Reporting Obligations (FBAR). If US person's bitcoin is maintained on a computer in abroad and if the bitcoin exceeds $ 10,000 any given year, should the bitcoin owner report the existence of account to Financial Crime Enforcement Network (FinCEN)? The current FBAR regulations do not include bitcoins or virtual currency.5

However, under the Bank Secrecy Act says US person's foreign financial accounts reach FinCEN. Even the US person holds the significant amount in stores of bitcoin abroad then does it need to files under FBAR or not then how the IRS tax treatment on the income generates from these foreign bitcoin reserves.

The use of bitcoins for tax evasion is potentially very significant. Bitcoins like cash transfers cannot be tracked by third parties and the IRS cannot track them. In bitcoin customers, they use the public key but personal identity is not attached. Therefore, bitcoin users purposely mislead the correct amount of income. Further to that if anyone transfer money through bank the service fee and remit tax is easily traceable but when using the peer to peer network transfers the IRS will lose lot of money receivable to the government as a tax. These factors will result in illegal activities such as money laundering, avoiding financial requirements, terrorist financing and finally evading taxes due to the IRS.

Another important tax issue relating to bitcoins is the treatment of bitcoin as property in order to IRS notice 2014-21.3 The IRS notice recognizes the bitcoin as property rather than currency, but the main question here is whether the IRS will treat the bitcoin as capital or noncapital assets. This disposition is important to understand because dispositions of a capital asset lead by a taxpayer for a year or more are subject to lower rates of taxation than dispositions of noncapital assets. This is less favorable for taxpayers. However, capital assets are defined in the IRC

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