It is becoming more and more common for businesses to accept Bitcoin (“BTC”) as payment, with AT&T recently announcing that customers can now pay their bill using Bitcoin. While crypto enthusiasts may appreciate the flexibility provided by the increasingly large number of companies willing to accept BTC, it is important to understand the potential tax implications of using BTC to pay your bills. In short, spending your BTC may be a taxable event and cause you to owe tax on the sale, even though you may not receive any report or 1099 informing you of this. It is on you as the taxpayer to keep track of this, report it on your tax return, and pay the correct amount of tax.
A quick recap of the taxation of Bitcoin
Depending on the situation, BTC is generally taxed in one of a few ways:
- Bitcoin you mined – taxed as ordinary income at the fair market value (“FMV”) of the Bitcoin at the time it was mined. The value that you paid tax on becomes your basis in the BTC
- Bitcoin you received as a payment from a customer – taxed in the same way that revenue paid in any other form would be taxed. The FMV of the Bitcoin at the time you received it becomes your basis in the BTC
- Bitcoin you purchased – purchasing BTC is not a taxable transaction, but the price you pay becomes your basis in the Bitcoin you now own
- Bitcoin (or other cryptocurrency) you receive from an airdrop – Generally taxable as ordinary income at the FMV of the BTC when it was received
- Bitcoin you sell – taxed as a capital gain or loss based on your gain or loss on the sale. This is calculated as your proceeds (what you received from the sale) minus your basis
What constitutes the sale of Bitcoin?
There are several transactions that are considered a sale, some of which may not seem like a sale at first glance:
- Selling Bitcoin for US Dollars (“USD”) on an exchange
- Exchanging Bitcoin for another cryptocurrency on an exchange (this one can get very dangerous very quickly if you don’t stay on top of your tax situation, because it is possible to accumulate taxable gains without having offsetting capital losses in the same year all while losing value in your investments)
- Using Bitcoin to pay a bill or make a purchase
An example – spending BTC you mined:
- Alex mines BTC worth $100 and pays tax on the $100 of ordinary income and now has a basis of $100 in the BTC
- 13 months later, when the BTC is worth $150, Alex uses it to pay a $150 AT&T bill
- Alex has a sale of BTC with proceeds of $150 and basis of $100. Alex has a taxable gain of $50, which will be taxed at long-term capital gains rates because it was held for more than a year before it was sold
An example – spending BTC you purchased:
- Jamie buys BTC on an exchange for $100. There are no tax implications related to the purchase
- 13 months later, when the BTC is worth $150, Jamie uses it to pay a $150 AT&T bill
- Jamie has a sale of BTC with proceeds of $150 and basis of $100. Jamie has a taxable gain of $50, which will be taxed at long-term capital gains rates because it was held for more than a year before it was sold
The takeaway here is not “don’t spend Bitcoin” or “Bitcoin is dangerous”. The takeaway is that you should always understand what you’re doing and keep careful records of your transactions, because operating blindly or without a paper trail is asking for trouble. You should be able to look up, for every BTC transaction you have, the date of the transaction, the number of BTC involved, and the FMV of the BTC at that time. With this information your tax advisor can accurately report the necessary information on your tax return and effectively guide your tax planning.
This is complicated and developing area of the tax code. You should always consult your tax advisor to review your specific situation before taking any action.