U.S. Tax Considerations for making Tax Payments In Bitcoin

Arizona passed a bill allow taxpayers to make payments using Bitcoin and other cryptocurrencies, potentially starting in 2020. For U.S. taxpayers, there is more than meets the eye.

General

According to Coin Telegraph, Arizona passed Senate Bill 1091 on February 8, 2018. The Bill still needs to be passed by the House of Representatives. The bill would allow the State's taxpayers to remit taxes to Arizona, penalties and interest using cryptocurrencies such as Bitcoin.

U.S. Tax Considerations

Bitcoin and other cryptocurrencies are treated as property for U.S. tax purposes (as long as they are meeting the convertible virtual currency definition of Notice 2014-21). This means the gain/loss on the sale of of appreciated cryptocurrency results in a taxable gain.

If a U.S. taxpayer uses appreciated currency to pay the tax authorities, this payment will result in a taxable event. The following are U.S. federal income tax considerations for paying taxes, interest and penalties to your State government using Bitcoin. Demonstrated through two examples:

Example 1 For example, Eric purchased 1.0 Bitcoin for investment for $1,000 in February 2017. In April of 2020, the 1 Bitcoin is worth $25,000. Eric owes the Arizona Department of Revenue $15,000 in 2019 State income taxes due in April of 2020, and he would like to make the payment using (a portion of) his Bitcoin. Eric sends 0.6 Bitcoin (worth $15,000) to the Arizona Department of Revenue in March of 2020. Transaction fees are ignored.

• Eric's Arizona tax liability that was due in 2020 is considered settled.
• For U.S. federal income tax purposes, Eric has a long-term capital gain of $14,400; a $15,000 selling price less a tax basis of $600 (0.6 BTC sold X initial purchase price of $1,000).
• Now Eric has an income tax estimate for his Federal income taxes due in April of 2020. He estimates he will have a capital gain tax on the sale of his Bitcoin to pay Arizona of approximately $2,880 (20% of the $14,400 gain). Eric will now have to pay $2,880 to the IRS by April of 2020 to avoid an underpayment of estimated tax penalty on his 2020 tax return due in April of 2021; by choosing to wait to pay in 2021, he will incur these penalties.

Example 2 For example, Eric purchased 1.0 Bitcoin for investment for $20,000 in December 2017 (the top). In April of 2020, the 1 Bitcoin is worth $15,000. Eric owes the Arizona Department of Revenue $15,000 in 2019 State income taxes due in April of 2020, and he would like to make the payment using his Bitcoin. Eric sends his entire 1.0 Bitcoin (worth $15,000) to the Arizona Department of Revenue in March of 2020. Transaction fees are ignored.

• Eric's Arizona tax liability that was due in 2020 is considered settled.
• Eric has a loss on the sale of his Bitcoin of ($5,000) - a selling price of $15,000 less his purchase price of $20,000.
• Eric will have the burden of proving to the IRS the Bitcoin was held for investment and not for a personal transaction (See https://steemit.com/bitcoin/@cryptotax/used-your-bitcoin-on-a-new-lambo-tv-bitcoin-personal-tax-loss-limitations) . To eliminate uncertainty, he may have been better off cashing out his Bitcoin for U.S. dollars to recognize a capital loss; and then pay the Arizona Department of Revenue with the U.S. dollars.

Takeaway

The announcement of the AZ Department of Revenue possibly accepting Bitcoin in the future is a step in the right direction from a regulatory perspective (this author's opinion). The reality is the convenience of paying tax obligations directly in cryptocurrency might help increase tax compliance overall. However, the individual should decide whether they are better off using U.S. dollars on hand (or cashing out the crypto first), by consulting with their tax advisor.

Source: https://cointelegraph.com/news/us-arizona-senate-passes-bill-to-allow-tax-payments-in-bitcoin

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https://pixabay.com/en/users/OpenClipart-Vectors-30363/

Disclaimer: This series contains general discussion of U.S. taxes in a developing and unclear area of tax law. As always, you should consult your own tax advisor in your jurisdiction to determine your specific situation as this is not personal advice; and consider any future guidance by the Congress/IRS after the date of this article. Under Circular 230 to the extent it applies, this article cannot be used or relied on to avoid any tax or penalties in the U.S., its States or any other jurisdictions. This post does not create a client relationship between the author and the reader.