I am not a licensed tax professional or a lawyer; this is not tax or legal advice.
One year ago today, the Internal Revenue Service of the United States of America declared bitcoin to no longer be a currency. In one brief notice, the IRS all but killed bitcoin’s chances of going mainstream as a medium of exchange in the U.S., instead relegating it to more limited roles as a store of value and payment protocol like some strange hybrid of gold and SWIFT. Retroactively to the mining of the genesis block, all bitcoin users in the U.S. must update their taxes to reflect capital gains or losses on all conversions of bitcoin into other currency, goods, or services based on the USD exchange rate at the time bitcoins were received and the time they were spent (this applies to other cryptocurrencies as well). These burdensome reporting requirements could raise the frequency of tax audits in the bitcoin-using population due to the scrutiny that frequent bitcoin usage and detailed reporting may attract; after all, the more numbers there are on a tax return, the more numbers there are to dispute.
The market has been developing “solutions” in response to this new non-currency paradigm for bitcoin. Various accounting tools such as LibraTax and Tapeke have been developed which help bitcoin users keep track of their bitcoin finances, including tools for tracking capital gains and losses on bitcoin transactions in real time. There are also “hold dollars, spend bitcoin” services, such as the dollar-denominated wallets offered by Bitreserve and Coinbase, which give customers the ability to use bitcoin as a payment rail rather than a currency. By storing funds as USD and simply using bitcoin as a transfer mechanism, there are no gains or losses to report. The recipient receives all of the benefits of accepting bitcoin, such as fast settlement and no chargebacks, and the sender experiences most of the benefits as well, save for privacy if the wallet is hosted.
Even with these solutions available to bitcoin users, the fact remains that the IRS’s guidance has left the bitcoin token in a precarious legal state: while the IRS classifies bitcoin as property for tax purposes, FinCEN and state regulators are classifying bitcoin as a “virtual currency” and subjecting bitcoin businesses to the same – or more stringent – regulations as those applied to banks, money transmitters, and other money services businesses. This places bitcoin in the worst of both regulatory worlds, causing accounting burdens for users and regulatory compliance burdens for businesses. With ever increasing amounts of friction being added to the experience of using bitcoin in the U.S., it remains to be seen whether this country will remain a leader in bitcoin innovation or whether entrepreneurs and innovators will simply leave for more reasonable jurisdictions.