Tax News
Notice 2014-21: Treasury Lays the Law on Bitcoin
March 26, 2014
Administrative Actions
The investment fund industry's involvement in Bitcoin is in its nascent stages. Some early adopters, however, believe that this is the future. The Winklevoss brothers have been working on launching the first Bitcoin ETF and Second Market has already launched the first Bitcoin Investment Trust.  On the hedge fund front, Pantera Capital recently registered Pantera Bitcoin Advisers with reportedly a total value of $150m. Apparently Fortress is behind the fund. Separately, there are a myriad of pool vehicles that mine Bitcoins. These are basically online portals where individual or enterprises contribute their computing hash power and share in the mining profits. Some of the more popular ones are BTC Guild, Slush and GHash. Lastly, private equity and VCs have invested in a number of start-up Bitcoin ventures, from mining operations to servicing Bitcoin transactions.

Whether Bitcoin will continue to exist 5 years down the road is a question that I am not going to ponder. However, I’d say that one thing is relatively certain. Virtual currency, whether Bitcoin, Litecoin or whatever coin, is here to stay and it is a matter of time that there will be one unified dominant crypto currency that will rule them all. This also means that investment funds that operate in this space are also here to stay. As far as taxes go, until now there wasn’t much in terms of guidance.  That changed yesterday when the IRS issued Notice 2014-21, which could be found here.

The Notice is extremely scant by Treasury guidance standards. It is 6 pages. This means that a lot of questions regarding Bitcoins will remain unanswered for a while. However, the Notice does a good job of offering guidance on a few of the most important issues that cover the taxation and reporting of Bitcoin transactions.  Basically the Notice states that Treasury will treat Bitcoins as property and not currency.  This means that investment funds that purchase and sell Bitcoins will generally be under the same rules that apply to the purchase and sale of stock. The gains and losses will be long or short term capital gains or losses and subject to the same rates that apply to stock.

What about the mining pools? The IRS does not expressly address those but the following may be extrapolated from the Notice.  Clearly, the participants in the mining pool have to include the Bitcoins in gross income at FMV.  If the “mining” rises to the level of a trade or business, apparently the taxpayer would be subject to ordinary income rates and self-employment tax.  What is not entirely clear is what rates apply (ordinary or capital) if the activity does not rise to a trade or business. For example, a one-of individual who buys one Asic TerraMiner IV from Cointerra and enrolls it in BTC Guild. This to me clearly does not come to the level of a trade or business. Would this person be subject to ordinary income or capital gains on the Bitcoins he derives from BTC Guild? The answer is not that clear as of now. It would be rather unfortunate for taxpayers if the IRS takes the view that the pool itself is a partnership engaged in the trade or business and the individual is therefore taxed at ordinary rates.

What about a private equity or venture firm that invests in a Bitcoin mine? For, example Fund XYZ funds a joint venture for the purchase of 100 Monarch BPU 600s from ButterFly Labs. I’d venture to say that running 100 Monarchs in multiple designated servers at an industrial location would probably fall within the definition of a trade or business. Some ventures could be much larger than that.  In this instance apparently the income derived from the venture would be subject to ordinary income rates and be passed to the Fund on its K-1 which ought to pass it onto its investors. The question then is whether ultimately the profits are subject to self-employment or net investment income tax, or nothing at all.  At this stage, as to the Fund and investors, that’s not entirely clear. On the other hand, inferring from the Notice, the principal who runs the mining operation ought to be subject to self-employment tax unless he’s done some planning that deals with that particular issue.

So there you have it. I am sure there will be much more to come in the future, but for now, the IRS has given us the bare minimum, which is better than nothing I suppose.
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Tags: Bitcoin, Notice 2014-21