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Want to Receive Bitcoin “Tips”? Here is what you need to know to stay IRS compliant.

If you already understand that compliant accounting for bitcoin transactions is a great challenge (http://www.forbes.com/sites/irswatch/2014/12/04/irs-approach-to-taxation-of-bitcoin/), understand this too: proper accounting for bitcoin ‘tips’ is a nightmare.  Simply put, most ‘bitcoin tips’ are not ‘tips’.  So in light of the exploding trend of Bitcoin ‘tipping’ and the recent $3.5M funding of ChangeTip by Pantera (cleverly announced last week on #GivingTuesday) I’d like to chime in with some important insight. Though it’s common to refer to sending BTC to one another on internet forums as ‘tipping’, a ‘tip’ is not the correct taxclassification for these transactions.  Rather, these transactions fall into the tax classification of ‘gifts’.  But so what?

Receiving a ‘gift of property’ is, from a compliant accounting and tax perspective, significantly different than receiving a ‘tip’ (i.e. waiters receiving tips).  For what the tax framework considers a tip, it doesn’t matter who the gifter is, and if it is in the form of property, it doesn’t matter how much the gifter originally paid for it (cost basis) or how long they’ve had it (holding period).

When receiving a tip:

  • There must be a clear transfer of goods or service performed
  • The amount must be reported to an employer
  • The amount counts towards income

Remember, now, that Bitcoin and digital currencies are officially considered ‘property’ (so think stock equity).  Transactions involving property require the extra record keeping detail of ‘holding period’ and ‘cost basis’.

When receiving a gift (of property):

  • There is no expectation of service, reciprocation or sale
  • The value of the gift does NOT count towards income when received
  • The holding period and cost basis of the property transfer from the gifter to the giftee

So let’s make this simple:

  1. I buy a coin for $10
  2. The value of the coin increases to $20
  3. I give the coin to someone random on the internet because I like what they said
  4. That person sells the coin later when the value increases to $30

Result:

  • The person I gave the coin to realizes $20 of capital gains at the time that coin is sold (but owes nothing before the coin is disposed)
  • I owe no taxes for this transaction because one does not realize capital gains if property is ‘gifted’ (there is an exception, ‘gift tax’, for gifts that exceed $14,000).

Make of this what you will.  I believe the issue can be addressed with software, and without sacrificing the privacy of users.  LibraTax already supports gift transactions and automates a large piece of the recording and reporting burden. To address this in further detail we will be publishing a new white paper.  This post is merely highlighting a present issue that deserves more attention.

Are you a financial professional new to digital currency? Read our last white paper here.  Also, check out the Digital Currency Council, a great resource for learning about and getting certified in the professional practice of serving bitcoin and other digital currency users.