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Are you considering accepting bitcoins as payment? If so, you should know the tax implications of accepting bitcoins in your business and the major pros and cons of doing so. I’m going to use an example to explain this.
Example. Carol is a freelance consultant. In exchange for her $1,500 invoice to a client, she receives 1.5 bitcoins. The bitcoin exchange rate at that time is $1,000 per bitcoin. Her payment processor charges 0.8 percent, up to a maximum of $8 per bitcoin transaction.
Two years later, Carol buys a $1,000 computer using 0.5 bitcoins. The exchange rate at the time is $2,000 per bitcoin.
Initial receipt. Carol receives property worth $1,500 in exchange for her services. The $1,500 value of the bitcoins is ordinary income to Carol (and subject to self-employment tax, since she received it in her trade or business).
Carol’s adjusted basis in the bitcoins received is the fair market value of $1,500 plus the $8 transaction fee, or $1,508. Because bitcoins are a capital asset (property), the transaction fee is added to its capital basis.
Computer purchase. Carol exchanged 0.5 bitcoins for the computer. Carol’s gain or loss on the transaction is the fair market value of the property received less her adjusted basis in the bitcoins.
Carol received a computer valued at $1,000 and gave up bitcoins with an adjusted basis of $503 (one-third of $1,508). Carol has a taxable gain of $497 and an adjusted basis of $1,005 in her remaining bitcoins.
The $497 gain is a tax-favored, long-term capital gain to Carol because she held the bitcoin property for more than a year.
Pros and Cons
Pro: Capital losses deductible. If you recognize a loss on a bitcoin transaction, then it is deductible from your other income, subject to the limitations applicable to capital losses. And if you are a noncorporate taxpayer, then you can carry forward any losses that you can’t use in the current year.
Pro: Taxable capital gains. Your bitcoins can appreciate in value, causing you to both gain extra income and pay taxes on that income. If you recognize a gain on a bitcoin transaction, then you have a short- or long-term capital gain on which you have to pay taxes. You may also have to pay the 3.8 percent net investment income tax on this gain. In cash transactions, you don’t have the possibility for profit or the complications of paying taxes.
Pro: Lower transaction fees. Stripe, a large third-party payment processor, processes bitcoin transactions for 0.8 percent of the gross amount, up to a maximum of $8 per transaction, compared with 2.9 percent plus $0.30 for credit card transactions (with no maximum).
If you receive a $2,000 payment for services rendered, your potential transaction costs are
- $8.00 for a bitcoin transaction, and
- $53.80 for a credit card payment.
Con: Basis tracking. Cash is cash and requires no special tracking. With bitcoin, you need to track the adjusted basis in your bitcoins and account for basis changes due to fractional sales.
Con: Liquidity. Once you get bitcoins, you may find it difficult to find others to transact with to use your bitcoins for goods and/or services.
You now have the big picture of how transacting business with bitcoins works.
Jesse Lothamer J.D., C.P.A., E.A.
Lothamer Tax Resolution
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