State Tax Snapshot: Bitcoin May Add to States’ Digital Property Tax Headaches

As the “cryptocurrency” bitcoin continues to grow—as of April, it was estimated that bitcoin was more valuable than the entire stocks of currency of 20 countries—concerns are also growing about the tax treatment of transactions paid for in bitcoins. The U.S. Government Accountability Office recently issued a report detailing the tax-reporting requirements for virtual currencies and the inherent challenges in trying to achieve compliance.

States attempting to tax transactions or purchases involving bitcoins may be dealing with issues similar to that in trying to tax cash transactions, albeit with new technological issues unique to virtual currency. Currently, there’s very little, if any, state guidance on the issue of taxation of bitcoin income or sales in which bitcoins are used as payment. Perhaps the GAO report on federal taxation will encourage more states to address the issue in the coming months.

A major problem for states trying to outline clear mechanisms for taxing bitcoin income and transactions could be  bitcoin’s anonymous nature and openness for purposeful evasion. For example, with regard to the effect bitcoins might have on sales taxes, Brian Fung, of the National Journal, suggests that if the Marketplace Fairness Act were implemented, bitcoins could grow further as a method of “escaping” sales taxes. Fung notes that this issue would be more likely to arise with consumers purchasing digital goods, such as music or software, rather than physical goods, because the latter would have to be sent to a physical address, making it much easier for taxing jurisdictions to trace the transactions.

While the GAO report was characterized as a guide for taxpayers who may be confused regarding whether bitcoin income is taxable, or how to calculate such income, others argue that the reason tax collection on bitcoin transactions is difficult is not because of taxpayer confusion over how a new, virtual currency will be taxed, but because the currency itself is specifically designed to make the transactions anonymous and difficult to trace. All that is required to complete a bitcoin transaction, according to the report, is a bitcoin “address”, a code of letters and numbers, which does not contain any personal identifying information.

Again, while the GAO report stressed the importance of self-reporting and third-party reporting, Evan Soltas, blogger for Bloomberg View, points out that if states required reporting of bitcoin income, it would be even harder to track than cash transactions, due not only to taxpayers failing to report bitcoin income, but also due to encryption and bitcoin’s peer-to-peer network structure.

Similarly, “many Bitcoin advocates believe, fervently, that one of the core attributes of the currency is that the government can’t collect taxes on Bitcoin-denominated income because it won’t be able to figure out who is earning what. Responsibility is not the issue. Tax evasion is the point,” writes Andrew Leonard, of Salon. Some taxpayers aren’t even trying to hide the fact that they intend to use bitcoins to avoid paying taxes.

In international bitcoin news, Canada has taken a seemingly more assertive approach, with the Canada Revenue Agency stating that bitcoins are not exempt from taxes, and emphasizing that they will apply “barter transaction rules” when bitcoins are used to purchase goods or services. A recent BBNA blog post also suggested that bartering rules could shed some light on bitcoin transactions, but cautioned that bitcoins add a further wrinkle, which is the fluctuating value of bitcoins means that they do not necessarily equal any specific dollar value at any given time.

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