Friday, February 21, 2014
Omri Marian (Florida) presents How Bitcoin Challenges the Federal Income Tax System at Ohio State today as part of its sympsoium on In Bitcoin We Trust? A Forward Look at the Regulation, Use, and Growth of the Digital Currency hosted by The Ohio State Entrepreneurial Business Law Journal:
I explore the challenges that Bitcoin transactions present to the U.S. federal income tax system. I divide these challenges to substantive challenges (i.e., how Bitcoin transactions should be taxed), and collection challenges (i.e., how income on Bitcoin transactions should be reported and how the tax can be collected). I suggest that in the substantive category the challenges are sometimes overstated. Much effort is spent trying to decide what is Bitcoin for tax purposes. This exercise is not always necessary. In most circumstances the tax-classification of personal property is based on the use of the asset in the hands of the taxpayer, and not on the nature of the asset. Bitcoin is no exception. Looking at the process by which Bitcoins are generated and circulated (i.e., how they are used) I conclude that Bitcoin mining income is always ordinary income that must be recognized upon receipt of the Bitcoins, regardless of Bitcoin’s “classification”. Moreover, once Bitcoin enters circulation, the only major threshold issue is whether Bitcoin is a nonfunctional currency. I suggest that under current regulatory framework Bitcoin should not be classified as a nonfunctional currency. Once this issue is resolved, most substantive questions relating to Bitcoin transactions find answers under current guidance. That said, there might be good policy reasons to change certain guidance when it comes to Bitcoins.
The collection issue, on the other hand, is much more challenging. Our tax reporting and collection system is built, among others, on the assumptions that (i) parties to a taxable transaction know each other (or can reasonably obtain information about one another and send information to each other), and (ii) that there are some uniquely situated taxpayers (such as banks) that regularly collect financial information about other taxpayers in a centralized manner. The operation of Bitcoin defeats both assumptions. Parties to Bitcoin transactions do not necessarily know each other, and the operation of Bitcoin is decentralized. Thus, important assumptions that stand in the basis of our traditional collection mechanisms collapse. Effort should be expensed in favor of exploring new reporting and collection mechanism to address the challenges that Bitcoin presents to tax collection.