In March 2014, the IRS finally released important guidance on taxation of virtual currency, such as Bitcoin. The key point made in the guidance (Notice 2014-21) is that such currency should be treated as property rather than a foreign currency. That is helpful. I blogged on that earlier (4/1/14).  If you are a tax practitioner and don’t think you need to deal with it, I’d be surprised if none of your clients uses bitcoin. In fact, a new standard question to ask of people you prepare returns for needs to be: Do you own or use a virtual currency, such as Bitcoin? There are also a lot of dollars going into Bitcoin and other virtual currency start-ups – one could be your client.

There are still some significant issues for the IRS to address. I note several in the article. A key one is how to track the use of the virtual currency so you can calculate the gain or loss and whether short-term or long-term, every time it is used. The IRS regulations on basis (section 1012) suggest use of FIFO, but that rule only addresses securities. Thus, the default is specific identification. Does this mean you’d have to truly identify the bitcoin you used (if feasible – and that may depend on how you hold the bitcoin) or can you just identify on your own which bitcoin you think you used (and that would really need to be done at the time used, rather than when later filing your return).

There are also some state tax issues (I’ll have more on that later). In June 2014, the California Board of Equalization issued a notice to help retailers who use a virtual currency. There are state income tax questions about sourcing.

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Original Post By: Annette Nellen