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Virtual currency leads to tax law questions

At this point in the year California taxpayers are getting serious about submitting their income tax returns. This means carefully combing through one’s finances and making sure that all income and deductions are properly accounted for and that the details are all correct on the forms being submitted to the IRS. For California residents who are holders of the virtual currency bitcoin, there are some important decisions to make about how to report bitcoins on a tax return.

Many tax law experts believe that it is not a question of whether bitcoin is a form of income that must be reported, but rather what type of income it is and at what rate it should be taxed. This is an important question because choosing the wrong category for bitcoins could result in an accidental underpayment of taxes or a overpayment of taxes.

Unfortunately at this point the IRS has yet to issue guidance on this issue, so taxpayers and their advisors are left to make an educated guess as to the best way to proceed. In many cases tax experts are saying that it could be considered a foreign currency, a capital gains item, or a capital asset.

In choosing among these alternatives it is important to consider the definitions of each of these items as well as the accompanying tax rate. For example, the definition for a foreign currency is very narrow and the tax rate is relatively high, so choosing that category holds slightly more risk, since there are fines associated with misreporting income.

Source: Business Insider, “Here’s How to File Bitcoin Income on Your Tax Return,” Rob Wile, March 15, 2014. 

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