As cryptocurrency continues to inspire global awareness and dialogue, the news in the US has mostly focused on its regulation as a commodity; however, very recently, states like Arizona and Georgia are on the brink of recognizing Bitcoin, and its kin, as currency–allowing people to pay their tax bill with it. While neither state has finalized the proposed laws, Arizona’s Senate Bill 1091 was passed on February 8, 2018, and now awaits the consideration of Arizona’s House of Representatives. As it stands in Arizona, the cryptocurrency used to pay the tax bill would be converted to dollars at the prevailing rate.
While the validation of cryptocurrency as a legitimate source of payment of income taxes would profoundly affect its bid for acceptance in the mainstream, paying taxes with cryptocurrency should be carefully considered in light of the tax consequences.
Significantly, in Notice 2014-21, 2014-16 I.R.B. 938, the Internal Revenue Service (IRS) has taken the position that cryptocurrency is property. So, what happens if you pay your taxes with cryptocurrency? You’ve paid your tax bill, and you’ve sold your property. As with any sale of property, it could mean even more taxes.
Consider the following example: State approves cryptocurrency as means to pay tax bill. You acquired cryptocurrency about a year ago for $1,000. You owe $10,000 in taxes. Your cryptocurrency is now worth $10,000. You use this to pay your tax bill. You must now report a gain of $9,000, for which you will have to pay taxes. Let’s hope it’s a long-term capital gain for lower treatment.
Certainly, the potential acceptance by states of cryptocurrency as a legitimate source of payment of income taxes is an encouraging move for validation, but it’s important to remember that gain or loss is possible with each transfer of cryptocurrency. As such, tax basis and holding periods must be tracked–record keeping is essential.