Bitcoin is the world’s first completely decentralized digital currency and has dramatically changed the landscape of the world market place. As the digital currency has grown in popularity, so too has the Internal Revenue Service’s interest in taxing it.
Bitcoin does not comply with existing definitions of currency or fit the mold of other financial instruments or institutions. According to the Mercatus Center, “Bitcoin has the properties of an electronic payments system, a currency, and a commodity, among other things.” Furthermore, the Financial Crimes Enforcement Network (FinCEN) defines Bitcoins as “virtual currency…a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency.” The problem with taxing Bitcoins is in its ambiguity, and the fundamental concern is whether to define the technology as a currency or a commodity.
Before the release of the guidelines, users, miners, and traders of Bitcoin have been left in the dark as to what their tax implications of the online tender are. Now, “virtual currency is treated as property for U.S. federal tax purposes...general tax principles that apply to property transactions apply to transactions using virtual currency,” according to the IRS.
This means that even though “in some environments, it [Bitcoin] operates like ‘real’ currency…it does not have legal tender status in any jurisdiction.” Essentially, Bitcoin functions and operates like a real currency, but unlike the U.S Dollar, the value of a Bitcoin is only backed by its ability to hold its value.
Because Bitcoin is defined as property, not currency, the IRS will tax Bitcoin transactions the same way it taxes stocks and “a payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property,” as laid out in the guidelines.
Senator Tom Carper (D-Del.) who serves as a member of the Finance Committee said that the guidelines “provide clarity for taxpayers who want to ensure that they’re doing the right thing and playing by the rules when utilizing Bitcoin and other digital currencies.” The guidelines issued by the IRS have validated Bitcoin as a legitimate investment by defining the digital currency as value holding property.