Bitcoin is not a currency

By Yves Smith

Japan has just decided that Bitcoin is not a currency, which subjects it to sales and income taxes. This is consistent with the view of the Canadian Revenue Service, which has found Bitcoin to be property and not a legal currency, and the United Kingdom, which leaning towards treating Bitcoin as a voucher and subject to VAT.

Bitcoin is not a currency any more than gold bars or collectable baseball cards are. Or as tax maven Lee Sheppard puts it in a recent article in TaxNotes, Busting the Bitcoin Myths: “If Bitcoin is a currency, any tradable store of value would be a currency.”

That means the branding of Bitcoin as a “cyrpto currency” or “digital currency” is promoter hype which credulous journalist have repeated verbatim. As we’ll see, the fact that Bitcoin is not a currency in the eyes of many tax authorities, and the US will probably follow suit, has serious implications for this “innovation”.

The US Treasury will be determining what Bitcoin is for tax purposes. Sheppard is pretty confident that, like the Japanese, the US will deem Bitcoin not to be a currency. And Sheppard is not shooting from the hip. She’s a world-recognized tax authority and her article (sadly paywalled) is chock-full of references to the tax code, court cases, and regulatory practice.

Sheppard points out that a currency is defined as issued by a sovereign and accepted in legal transactions. Per Sheppard:

A privately issued medium of exchange is not a currency for tax and money laundering purposes. That does not mean that users of Bitcoin can’t get into tax or money laundering trouble, as the recent arrest of Charlie Shrem, vice chair of the Bitcoin Foundation, demonstrated.

Similarly, Financial Crimes Network enforcement regulators (FinCEN) have stated that Bitcoin exchanges need to register as money service businesses. New York’s financial services superintendent Benjamin Lawsky is also studying whether to regulate Bitcoin exchanges as money transmitters. Sheppard again:

FinCEN specifically stated that Bitcoin isn’t money, but when Bitcoin is exchanged for money, the exchanger has to comply with money laundering rules, which include reporting of large transactions.

And since FinCEN is part of the US Treasury as is the IRS, it’s highly unlikely that the IRS would go against the decision of another part of the Treasury (particularly since FinCEN is a big player in “terrorist financing” and hence has a lot of power, both domestically and internationally).

And don’t take any comfort from the SEC saying Bitcoin is a currency. The SEC does not have a vote on this matter. The only thing the SEC gets to decide is whether Bitcoin is a security. And it isn’t per SEC v. Shavers, a 2013 decision out of the Eastern District of Texas. Similarly, for real tax nerds, Section 988 isn’t germane either: “Section 988 is a property rule, but is applies only to property that started life as legal tender” which in the tax context, means foreign currencies and bank deposits.

The fact that some people might sell you stuff for Bitcoin, or baseball cards, or cigarettes, does not make it a currency. Moreover, merchants who accept Bitcoin quote their prices in government-issued currency.

So what is Bitcoin likely to be in the eyes of the IRS, and what are the implications?

Bitcoin is property. When property is exchanged for other property, that is a taxable event. Moreover:

Barter exchanges are reportable. Barter exchanges are required to report their members’ transactions to the IRS on Form 1099-B (section 6045 of the tax code). Section 6045(c)(3) defines a barter exchange as any organization of members who contract to trade or barter the property or services.

So not only is a venue that takes Bitcoin taxable on the revenues (which should be no surprise), the owner of the Bitcoin that traded them in is also taxable if he has a gain on the Bitcoin relative to when he acquired them. How that gain will be taxed depends on whether he is considered to be an investor, a dealer, or a trader.

Oh, and what about Bitcoin miners? Their income from mining is also taxable on the dollar value of the Bitcoins received.

And the fun part the IRS will not find it hard to enforce against Bitcoin users, since Bitcoin provides a complete audit trail of transactions. Sheppard agrees with our reading that the idea that Bitcoin is some sort of revolt against governments is delusional:

Libertarians, drug dealers, and tinfoil hatters like Bitcoin because it is not issued by a central government, but the irony is that it is more controllable and more traceable than the U.S. banknotes sloshing around former Communist countries…

Central bankers’s job of baby-sitting fiat currency would be easier if it existed only in digital form and not as counterfeit $100 banknotes. And a cashless system could have negative interest rates. So U.S. regulators seem to have decided to allow for Bitcoin to continue, while Russian and Chinese regulators are cracking down, and European central bankers worry about fraud on their customers.

And no, Bitcoin is not a way to solve the problem of the unbanked, particularly since Bitcoin will create all sorts of complicated tax reporting/compliance issues for users. As Sheppard tartly notes:

The problems of the unbanked are political….Provision of banking services to poor people at reasonable cost could be made a requirement of a banking license. Thinking that Bitcoin will solve banking problems is yet another example of digerati arrogance.

So while Bitcoin may play a role in commerce, it’s likely to fall well short of what its enthusiasts anticipate. And rather than striking an anti-government blow, its audit trail is a huge plus for official supervision and tracking. Indeed, if Bitcoin does attract something more than a fringe following, it will probably encourage to nudge it and bona fide digital currencies forward so as to eliminate much more difficult to track cold hard cash.