Bitcoin seems to be gaining acceptance as a viable exchange medium more and more each day. It seems inevitable that any business, regardless of size, will eventually deal with the question of whether to accept Bitcoin as a mode of payment in the regular course of business. Based on current trends, I dare say it’s probably not a question of whether, but of when. Many factors, including the market, competition, not wanting to be left out, etc., seem to be drawing people in. Where it will all end up is hard to say, but if you decide to accept bitcoin from your customers, there are certain financial and tax aspects you’ll want to consider. But first, some background.
What is Bitcoin? Bitcoin is often described as a virtual currency, or more precisely, a cryptocurrency, capable of being exchanged between two users directly, peer‐to‐peer, with no intermediary. (Bitcoin is one example of a cryptocurrency, there are many others.) It has, at any given time, an established value that is quoted on organized exchanges, and it can be readily traded or exchanged for U.S. dollars or other so‐called fiat currencies. The underlying technology that gives Bitcoin its viability and security is known as blockchain technology. Bitcoin, as an application of blockchain, is believed to enjoy a high degree of integrity and safety, notwithstanding the fact that the underlying network is highly decentralized, and has no central bank or government agency backing it up. That’s not to say that transactions conducted using bitcoin are unregulated, because they are subject to regulation. (Think IRS, FinCEN, etc.) For further reading, or to learn how to get started, try a website such as bitcoin.org or coinbase.com.
Bitcoins, as a medium of exchange, have their pros and cons. On the pro side, there’s the chance to attract new customers, increase sales, and enhance your public profile. Given the absence of the ubiquitous middleman, merchants may see lower processing and transaction fees, compared to say, credit cards. Lastly, owing to the perceived integrity of the underlying technology, when compared to traditional banking and credit channels, businesses may feel better protected against fraud and system failures using Bitcoin. You may know of additional pros.
In terms of cons, there are two aspects that tend to jump out, both having to do with uncertainty. One is regulatory uncertainty, in that, will regulations grow or become so burdensome with respect to Bitcoin (virtual currency) transactions that the costs of compliance will outweigh any benefits of working with Bitcoin? I doubt it, but it’s worth asking. Secondly, and probably more pressing, is the price volatility that Bitcoin has shown since its inception in 2009. These price fluctuations have been dramatic, such that if a business were to hold on to Bitcoin receipts for any length of time, some degree of risk is introduced into the business. (See, for example, coindesk.com for historical price information).
Fortunately, this risk can be mitigated by working with a third party payment processor such as Coinbase or Coingate, to quickly convert your Bitcoin receipts into U.S. dollars. That said, if you do wish to invest or speculate in Bitcoin holdings, this can be done outside of the business, on your personal ledger.
Understanding the specific income tax reporting responsibilities for Bitcoin transactions should probably start with IRS Notice IR‐2014‐36, published in 2014. In it, the Service sets forth the premise on which bitcoin transactions are to be taxed, and illustrates the application of this premise to multiple transactions in both business and personal settings. Suffice it to say that Bitcoin‐based transactions are fully subject to the provisions of the Internal Revenue Code, and hence can result in taxable income or gain.
The tax reporting nuances of Bitcoin follow largely from the IRS’s classification of virtual currencies as not a currency at all, but rather as an item of property held by the taxpayer. Without getting too far in the tax trenches, the take‐away from this seems twofold—one being property, in which the holder will have to track the cost basis of any bitcoin holdings on hand; and two, every time Bitcoin is used, spent, exchanged, etc., in any sort of transaction, the basis of this Bitcoin will need to be compared to the value received, and any resulting gain or loss will have to be recognized and reported. At even small levels of activity, you can see that the accounting for this can quickly become intensive. Hence, using Bitcoin in your business will require a commitment to tracking and recording this activity in a systematic way. Beyond some of these particulars, please note that general tax principles do otherwise apply, meaning that wages, payments to independent contractors, sales of Bitcoin, etc., all trigger the usual array of tax compliance and reporting schedules, such as W‐2s, 1099s, and capital gains, to name a few.
Again, this is all relatively new and still evolving in many ways. Fortunately, there is an abundance of resources out there on which to draw s that you can gain an understanding and making a decision. With a fair amount of due diligence and proactive thinking, your business can successfully integrate this new technology and form of currency into its operations, much like many businesses already have.
Arthur Caccamo is a manager based out of our Albany, NY office.