March 31, 2015
April Showers Bring…Taxes! Are You Paying with Cryptocurrency?
With the start of spring, can tax time be far away? When it comes time to pay, will you use “cryptocurrency”? This is one name for virtual currency or digital currency. The first and most famous cryptocurrency, Bitcoin, is not alone in this new frontier: it has been joined by the likes of Dogecoin, Peercoin, and Ripple.
Be sure to talk with your accountants about the proposed new IRS rule on Research Tax Credit for Internal Software.
We’ll leave the tax advice to the experts…you can read all about it here.
This new breed of currency is as easy to use online as PayPal and almost as anonymous as cash—ideal if you want to conceal your identity while making an online purchase. Scarcity is built into the system, so there is hope that values will go up rather than down. Unlike legal tender, there is no central bank to stabilize its value, so you may wake up and find your stash is worth less than the paper it’s not printed on. Or, as philosopher Yogi Berra once said, “A nickel ain’t worth a dime anymore.”
Proponents seem to like its decentralized nature. In place of a central authority, the Bitcoin economy is a peer-to-peer system of users who maintain the “block chain,” a public ledger of transactions that is crucial to the system. People “mine” Bitcoins by verifying the transactions in the chain using an SHA‑256 hash algorithm. The fact that anyone who can spare enough CPU cycles is welcome to work on the very heart of the system gives the whole endeavor a “wiki” feeling.
So is this new coinage really a currency? In one sense of the word, a currency is simply a medium of exchange: something you can trade for goods or services. It needs no value of its own as long as everyone accepts it and agrees on its value. A dollar is worth a dollar because we all agree on it (although a few of us old timers like to complain how much cheaper a cup of coffee was in the good ol’ days). As long as people accept it, anything can be used as a currency…potatoes, arcade tokens, in-game currency, you name it.
Of course, to be legal tender, the currency needs the backing of a recognized government. So far, Canada is the only country to show interest in minting digital currency: The Royal Canadian Mint launched their “MintChip” project, which was abandoned when they found it had nothing to do with ice cream. Oh, Canada.
The State of California passed AB-129 last year, making it legal to pay bills with virtual currencies. It eliminated a prohibition on alternative currencies, such as coupons and “bargain bucks” issued by some shopping centers and “community currencies” issued by cities to encourage local shopping (examples cited include “Berkeley Bread” and “Davis Dollars”). The text of the bill lists a variety of digital currencies, including one (COINYE West) that had already ceased to exist because it infringed on the image of a well-known rapper. Yes, the official legal analysis of this assembly bill features two paragraphs about Kanye West (possibly the only part of the bill readable by non-lawyers) including a gratuitous reference to two of his songs. All we can say is “Ludacris.” [AB‑129 Analysis]
Although a full legal analysis of the bill is beyond the scope of the FairCom eNewsletter, one must wonder if the State of California is now required to accept tax payments made in Bitcoins—or “Berkeley Bread.”
The IRS is staying ahead of the curve in its own way. Although the Taxman does not directly accept digital currency, the IRS has already issued policy guidelines for the taxation of said currency. (Essentially, they tax it as property…but, hey, you didn’t hear it from us: always consult a qualified tax attorney for tax advice.)
Modern tax question: If you incorrectly report the value of your cryptocurrency, which jurisdictions will allow you to post bail in Bitcoins?
You may have read about Mt. Gox, the Bitcoin exchange that was forced to close because hackers were able to exploit flaws in its software allowing the same money to be withdrawn multiple times. Mt. Gox suffered from a variety of attacks and the full analysis has yet to be completed. In fact, they found some of the missing Bitcoins in an old digital wallet, which had apparently slipped behind the cushions of a digital couch. Nonetheless, this reminds us of the importance of keeping financial transactions immediately consistent throughout the system. Know anyone with an ACID-compliant NoSQL database proven to handle mission-critical transactions on an international scale?