Welcome back to Bitcoin Taxes, our special series over Bitcoin taxation with Mr. Daniel Winters. This week, we will be talking about what you should do when you work for Bitcoin rather than fiat currency. As a reminder, be sure to read last week’s article which covered the basics of Bitcoin taxation within the United States if you have not done so already. Each week we will build upon the previous article to cover a wide range of topics. You can comment with your specific questions in the comments field and Daniel and I will go through them and try to answer as many as we can on next week’s article. If you need very specific advice or help with your taxes, consider contacting Daniel through his firm, Global Tax, LLC. Daniel is giving a presentation on Bitcoin & Taxes on March 29 at the Texas Bitcoin Conference. He’s excited about the upcoming conference and looking forward to learning more about the world of Bitcoin.
Also Read: Bitcoin Taxes: Introductions, and the Basics
Let’s jump right into the content for this week!
Working for Bitcoin
Welcome back to our weekly series on Bitcoin and taxes. This week we will focus on tax issues related to working for Bitcoin.
Since tax law differs from state to state, the articles in this series will cover only federal tax issues. Other articles will cover mining, selling goods or services for Bitcoin, and why Bitcoiners may need to file a Foreign Bank Account Report (FBAR). Also, we want to hear from our readers – ask some questions in the comments and we’ll respond in the next article.
If you’re being paid in Bitcoin, it’s very possible that you will have a 2-stage calculation to accurately report your Bitcoin income.
Bitcoin is property, and for individual taxpayers Bitcoin is generally treated as a capital asset, the same as stock.
When you purchase Bitcoin, you need to record the USD value of the Bitcoin on the day of receipt. This is your cost basis. When you later sell or exchange the Bitcoin for goods or services, you need to calculate the gain or loss in USD. Just convert the amounts of Bitcoin sold into the USD value on that date, subtract your cost basis in USD and that’s the gain or loss.
Individuals who receive Bitcoin for performing services, whether as employees or independent contractors, have income equal to the USD value of the Bitcoin on the date of receipt. For employees, the income is wages and the employer should report this on Form W-2. Contractors should receive a Form 1099 and the income is subject to both income tax AND self-employment tax.
However, since Bitcoin is property, the individual also holds Bitcoin with a cost basis equal to the USD value on date of receipt. Unless the Bitcoin is immediately exchanged for USD that same day, you will need to record each transaction in which you later sell or otherwise exchange the Bitcoin, and calculate the gain or loss. This is the 2nd stage of the calculation.
For anyone being paid in Bitcoin on a steady basis, keeping track of the transactions can get complicated quickly.
Let’s say James Hendricks has a part-time job as an independent contractor studying crosstown traffic patterns. He started 2014 with zero bitcoins, but during 2014 he received 12 payments of Bitcoin, each worth 1,000 USD on date of payment.
Though the USD value of each payment is the same, James has a cost basis in 12 lots of Bitcoin. Each Bitcoin in a given lot has the same cost basis. Since the price of Bitcoin changes daily, each lot has a different cost basis.
James spends most of the Bitcoin during the year, and has dozens of transactions. On December 31, 2014 he owned 3 Bitcoin with a FMV of 750 USD.
James is now ready to file his taxes and needs to figure out his income for 2014.
The first stage of the calculation is straightforward. 1,000 USD x 12 = 12,000 USD
This is ordinary income and subject to self-employment tax. If James has any expenses, such as travel costs, he can reduce his self-employment income by those expenses.
However, James also needs to calculate the gain/loss during the year for the Bitcoins he exchanged. There are several different methods available, including FIFO (first in, first out), LIFO (last in, first out), and specific identification. Each method will result in different income amounts.
The IRS has not made any statements concerning which method should be used for virtual currency transactions. However, you should be consistent and use the same method for all virtual currency transactions.
Clearly, it would take some time to build a spreadsheet to track dozens of transactions.
Thankfully, LibraTax.com has built an online tool to run the calculations for you. I am not receiving any compensation for plugging LibraTax, but need to mention that I do have a business relationship with the company. I will say that I’ve investigated different tools for calculating Bitcoin income, and LibraTax is the best. Their site can import Bitcoin transactions from several major wallets, and can even import transactions directly from a public Bitcoin address. Once you’ve imported your data from Coinbase or Blockchain.info, you can calculate your gains using FIFO (first in, first out), LIFO (last in, first out), or specific identification (which they call LibraTax Optimized.) The site takes just minutes to run the numbers, then you can download a capital gains report and attach this to your Form 1040. You can also review your transactions to take into account mining income, gifts, transfers and charitable donations. If your favorite wallet isn’t supported, you can download a generic Excel sheet, fill in the sheet, then upload and run the numbers.
One of our readers asked a question about handling the gain/loss calcs for Bitcoins that are mixed within the same address, which I believe we’ve answered. He also asked “should I use a separate Bitcoin address for each purchase since I don’t know which of the three purchases the coins are coming from?”
Using a separate address for each purchase isn’t necessary. In fact, this just complicates matters. Since a Bitcoin wallet is a collection of addresses, I would calculate gains/losses at the wallet level, not for individual addresses. For services such as Coinbase, which generates a different address for each transaction, calculating the gains/losses at the wallet level is the only way to properly calculate your income.
Any tax-related opinions in any part of this document or website (including any links) are not tax advice. The above is a general explanation of tax law and should not be relied upon for your individual circumstances. Tax advice cannot be provided on a general basis, and must be specifically tailored for each individual by his or her particular representative. Any user of this website should seek the advice of a competent, independent tax professional regarding that user’s particular circumstances.
In addition, any tax advice given herein (and in any attachments) is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (i) avoiding tax penalties or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed therein.
Special thanks to Daniel for the incredible content and for sharing his extensive taxation knowledge regarding Bitcoin. If you need help with your Bitcoin taxes, please consider contacting Global Tax, LLC. Thanks for joining us this week as we continue to dig into the many issues regarding Bitcoin taxation. The Bitcoin Taxes series will continue as a weekly publication through April 15th, at which point it will switch to a bi-weekly publication. There are many taxation issues that need to be covered outside of the April 15th deadline.
In our comments section below, ask tax related questions and we will answer some of them each week as well as new ones in this ongoing Bitcoinist exclusive series.