Who will tax Bitcoin and how?

Will 2014 be the year we trade in our credit cards and abandon our wallets in favor of virtual currencies? If you follow the recent hype surrounding bitcoin, the trendiest of the new crop of digital currencies, you could be swayed into thinking that good, old-fashioned cash was going the way of the dinosaur.

According to The Wall Street Journal, over the course of 2013, the price of bitcoin rose from $13.50 to roughly $650, down from a high of $1,200 in November. By contrast, the U.S. dollar gained about 0.5% over the year, according to the ICE Dollar Index. Clearly, there is a growing interest in bitcoin. But it’s not just currency speculators, digital miners and early adopters driving the surge in interest. Regulators, banking institutions and tax authorities have also started paying attention to bitcoin and asking one big question: Who will regulate it?

bitcoinThis week, Wells Fargo called a “Bitcoin summit”, convening a group of finance executives, virtual currency experts and U.S. government officials to discuss the “rules of engagement” with bitcoin amid concerns that the currency could lead to money laundering and tax evasion. Wells Fargo chief executive John Stumpf was quoted:

“We want to make sure we understand what it is, what it does and what it does not… The world is changing and will continue to change. Whether bitcoin will be a big part of that, who knows?”

Exactly, who does know?

In December the Congressional Research Service issued a report Bitcoin: Questions, Answers, and Analysis of Legal Issues, which came to the following conclusion:

“Bitcoin raises a number of legal and regulatory concerns including its potential for facilitating money laundering, its treatment under federal securities law, and its status in the regulation of foreign exchange trading.”

And, more recently, when the Journal asked the IRS for its stance on bitcoin, the agency issued the following statement:

“The IRS continues to study virtual currencies and intends to provide some guidance on the tax consequences of transactions involving them. The agency is also aware of the potential tax compliance risks posed by virtual currencies.”

One of the central questions surrounding taxes on bitcoin transactions is whether bitcoin will be treated as a capital asset, like a stock or commodity that is subject to capital gains taxes (up to 24%) or as a fiat currency, such as dollars, euros and yen, for which gains are taxed like income (up to 43%). EY’s Roger Willis shed some light on the matter in The Guardian:

“Fiat currency is essentially currency the government decrees to be legal tender. Bitcoin wasn’t really developed to be a replacement for fiat currency… But it was really developed to be used in ecommerce and for micro transactions. It wasn’t really to replace our sterling, our U.S. dollars, and our euros.”

Right now, there are more questions than answers about the future of bitcoin and other virtual currencies, but the huge amount of interest and investment in the currency is impossible to ignore.  Reports recently surfaced that bitcoin was technically used to buy a Tesla from a dealership in California and the currency was even mentioned in an episode of the new Fox sci-fi drama Almost Human. And, with a few early adopters like Overstock.com, Zynga and Richard Branson’s space travel start-up Virgin Galactic announcing they will accept payment in bitcoins, some serious decisions about how to regulate virtual currency will need to be made soon.

This post originally ran on Forbes.com.

Joe Harpaz is the head of the Corporate Market for the Tax & Accounting business of Thomson Reuters that builds the corporate tax software used by many of the world’s largest multinationals, as well as the Big 4 accounting firms. He works closely with global business leaders to set up their tax technology. In this blog, he analyzes the connections between economics and business opportunities, highlighting examples of where tax helps or hinders growth.

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