Complying with the federal tax code is akin to mission impossible for users of alternative currencies such as bitcoin, and that is giving rise to mass non-reporting. Strangely, the Internal Revenue Service (IRS) appears to have all but thrown in the towel, and is leaving users and tax professionals in the dark.

In March 2014, the IRS released Notice 2014-21, a Q&A and attempt to describe “how existing tax principles apply to transactions using virtual currency.” Their notice, however, opened a can of worms. In particular, they declined to classify alternative currencies as currencies — because they are not legal tender from a central bank — and instead classified them as property.

Perhaps the most troubling aspect of this classification is that users are required to calculate the realized gains and losses of every transaction. In other words, if I buy one bitcoin at $500, and then spend it after it has risen in value to $750, I should report income of $250, and that goes for transactions as small as the purchase of a cup of coffee. (The price of bitcoin today is $588.) Needless to say, except in rare instances such as with large companies like Overstock.com, no one is undertaking this Herculean task.

The Coin Map demonstrates the locations of 8,036 businesses that accept bitcoin, with the highest utilization rates in North America and Western Europe.

The Coin Map demonstrates the locations of 8,036 businesses that accept bitcoin, with the highest utilization rates in North America and Western Europe. (Photo: CoinMap.org)

The confusion and standoff over reporting of alternative or “virtual” currencies came to a head in June, with a letter from the American Institute of Certified Public Accountants. Although they thanked the IRS for at least making a statement in 2014, they pointed out “major issues” not addressed and requested “additional, much needed, guidance.” The letter listed 10 areas of concern, and within those they sought clarification on how to value alternative currencies, how to compute the gains and losses, and how to classify them among many types of property.

Given the clout of the Institute of CPAs, as the world’s largest accounting association, one might expect a swift response from the IRS. However, a call to the authors of the IRS notice on alternative currencies came up empty. Both the principal author, Keith Aqui, and the information-reporting specialist, Adrienne Griffin, confirmed that they have no plans to respond, nor are there any ongoing or planned projects to update the 2014 notice.

To verify the depth the problem, even the authors themselves struggled to explain the meaning of their 2014 notice. Simple questions, such as how one would go about computing gains and reporting them for every transaction, had them deflecting to other coauthors and finally to media relations — even though they listed themselves as the contacts on the notice.

Still, there is about $9 billion worth of bitcoin in circulation, with approximately $80 million traded each day. Of the US taxpayers this includes, many are still trying earnestly to be as compliant as possible, and there is a growing group of alternative-currency legal and accounting specialists. One such man is Bob Derber, an attorney with the Summit Legal Group, which has offices in Utah and California, and a contributor to the Coin Center think tank. He agreed to explain how those working in the field grapple with the confusion as best they can.

He emphasized that the underlying challenge is that bitcoin is new and evolving at a pace faster than the IRS can keep up with. Not only is its price incredibly volatile, making it a vehicle for speculators, its uses are changing and going well beyond a straight medium of exchange: “[IRS officials] don’t necessarily have a circumstance or a history to follow.” Its classification as property, he says, was the conservative approach, “which raises, obviously, a significant number of concerns for taxpayers.… As property, it’ll raise capital or ordinary gains and losses on its use, [and] reporting requirements.”

While there are not reliable numbers available, Derber suspects “widespread non-reporting” in response to an unreasonable burden. He does not necessarily characterize this as civil disobedience, since it is not done overtly in a protest manner, but these users “consider the amount or the volume not significant enough to warrant” IRS attention.

Even if the IRS is focused on the problem, he adds, they appear to be flatfooted and have been unwilling to prosecute anyone in this area: “I have not seen an audit yet that specifically deals with bitcoin.… Things take time for the IRS to have returns and the information that would [put them in a position] to respond.”

Bitcoin and other alternative currencies are, to some degree, acting as canaries in the coal mine. They are showing how the information age, with non-geographical transactions, is throwing a spanner into the works of the archaic tax code and IRS approaches to enforcement.

The excruciating difficulty of compliance, leaving both IRS attorneys and accounting professionals with confusion, is telling that the complexity cannot remain. Just as private alternative currencies are delivering creative destruction upon conventional legal-tender currencies, so too are they making tax avoidance and noncompliance easier. A new coat of paint will not be sufficient, and the IRS will have to either adapt or be left even further behind. They could, for example, get over the fact that alternative currencies do not come from a central bank, and accept their use as a medium of exchange.

For now, Derber requests that at the very least the IRS could “offer some kind of safe harbor. For those who are out there and want to be compliant with the law, and simply don’t know how to be compliant with the law, it would be wonderful to see [an IRS] pronouncement that would say, ‘this is how we would expect you to treat it.… You will not be subject to penalties if indeed you disclose it in this fashion.’ At least the [IRS] is then giving taxpayers a heads up on how to comply.”

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