Tracking Point of Austin, Texas, is the latest in a growing number of gun manufacturers to accept bitcoins, the controversial digital currency, as a form of payment. The precision-guided “smart” rifle maker decided that the gun lovers and tech enthusiasts of Austin would appreciate the opportunity to use the cryptocurrency.
Since bitcoin’s unveiling in 2009, the monetized computer code has been both the darling of venture capitalists, anti-government activists, anarchists and futurists, and the scorn of law enforcement and national taxation agencies — who criticize the currency’s use in money laundering activities and illegal purchases as well as its seemingly tax-exempt status.
The adoption of bitcoins by Tracking Point and by Central Texas Gun Works, which also accepts bitcoins as payment for firearms and firearm training, reflects a turning point in the acceptability of the cryptocurrency. In recent months, the bitcoin saw the collapse of two of its major exchange hubs, the closing of most of the Darknet’s bitcoin-accepting illicit online storefronts and a loss of nearly half the bitcoin’s valuation. At the same time, banks have moved to start trading in the bitcoin, an increased number of stores and businesses have accepted the bitcoin for purchases and services and the security flaws that have plagued the software have finally been resolved.
A recent move by the Internal Revenue Service, however, threatens to bring the bitcoin to its knees. On March 25, the IRS ruled that bitcoins and all other forms of virtual currency are not currencies at all, but property. The IRS’s recognition of bitcoins as a form of security will not only make the bitcoin itself taxable, but it will make all shifts in the valuation of held bitcoins taxable capital gains or losses.
“For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt,” read the IRS ruling. “If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.”
This ruling also extends to bitcoin “mining,” or the computational creation of the hashcode used to verify the authenticity of an individual bitcoin. The creation of a bitcoin would represent the earning of business income for the miner.
Capital gains tax is useful in taxing the amassed value of a long-sitting commodity, such as stocks or precious metals. As the value of the commodity can appreciate from the time the commodity is purchased to the time it is sold, measuring and taxing (or crediting, in the case of a loss) the change in value is a sound way to take into consideration growth in the market. For bitcoins, however, the IRS’s strategy of recognizing the cryptocurrency as a commodity may present a burden that the bitcoin may not be able to overcome.
While there are investors who hold on to bitcoins, the flux in the bitcoin market — which can shift by $10 or more in valuation per bitcoin in a day — makes the bitcoin unattractive as an investment vehicle. Typically, bitcoin users use the digital currency in place of fiat currency for everyday transactions. The bitcoin offers the user a range of features that make it preferable to nationalized money.
First, the bitcoin is designed to be anonymous. While individual bitcoins can be traced to a particular “wallet” or holding account, the “wallet” itself is detached from any real world connections.
Second, the bitcoin is decentralized. While there are agreed-upon conventions for bitcoin use and while the bitcoin itself is defined by a mathematical equation that is growing increasingly difficult to solve, the bitcoin — in its purest form — is a reflection of the transaction more than the currency itself. Without a set value determined by a central bank, bitcoin purchases, more often than not, resemble compromises between what the seller is willing to accept and what the buyer is willing to offer.
As the bitcoin is stripped of the expectations and symbology of an “official” currency, many of its users appreciate the freedom and lack of structure using bitcoins afford. Retailers can use bitcoins to avoid the high cost of credit card processing. Entrepreneurs can literally create money with their computer rigs. Anti-government advocates and anarchists can use money that is in no way attached to a government. For many, bitcoins and other cryptocurrencies represent freedom.
What the IRS rule effectively did is permanently attach the dollar to the bitcoin, making them inseparable and making the bitcoin a de facto regulated currency. In November 2013, bitcoin daily transactions peaked at 93,000. This does not represent just trades and sells, but everyday purchases ranging from haircuts to houses. The IRS rule says that for each and every one of those transactions, the value of the item purchased must be recorded in U.S. dollars at the time of the purchase in order to determine the gain or loss from the time the bitcoins were obtained.
For example, say a person obtained 20 bitcoins in 2009 at a price of $5 per bitcoin — a total of $100 at the time. Today, those 20 bitcoins have a net worth of more than $10,000. What if the person bought a computer from Overstock.com for two bitcoins? According to the IRS’s new ruling, the buyer will owe the IRS taxes based on the value of the bitcoins today, minus the initial $5 per bitcoin, and the seller will now owe taxes on the accrued value of the bitcoins, starting from the computer purchase. Worse, as the law is retroactive, the purchaser may owe back capital gains taxes for every single bitcoin purchase he ever made.
“It will get complex if you are spending at multiple merchants… over the course of a year,” said Marc Nickel, a Silicon Valley attorney who closely studies bitcoin, to CNN.
A new line of attack
While this move can be seen as a way to shut down a perceived tax shelter, actually implementing this rule for the average bitcoin user would be difficult, if not impossible. As bitcoin use is anonymous by nature, any effort to investigate bitcoin transactions to determine capital gains would exceed the IRS’s current manpower and capabilities. However, establishing this ruling would empower law enforcement to imply tax evasion consequences to the illicit use of bitcoins.
“This ruling is a warning shot across the bow, mostly to business and large traders, that you’ll have to deal with the income tax evasion consequences,” said Alex Daley, a technology investment analyst with Casey Research. “I don’t think it’s a signal to consumers that we’ll take away the anonymous nature of Bitcoin.”
By creating a tax obligation for the bitcoin and other virtual currencies, the IRS and other law enforcement agencies may be attempting to create a line of attack against retailers such as the Silk Road, which was once a major hub to secure drugs, weapons and other contraband materials. While it may be difficult to pursue a sale that happened outside of American borders, the ruling offers the possibility of pursuing the failure to report the sale as a criminal offense.
While this may mean little for legitimate gun dealers, such as Tracking Point, the ruling may help to stop the use of bitcoins and other virtual currencies for criminal activities. Increasingly, bitcoins are being used for online gun purchases in an attempt to avoid background checks. In March, Facebook officially banned the buying and selling of guns without background checks on its website and started blocking minors under the age of 18 from viewing gun listings.
It is believed that between 30,000 and 40,000 attempted illegal gun purchases happen each year among American firearms retailers.
However, the undisclosed nature of the possible sanctions for non-compliance, the yet-to-be defined scope of the IRS’s enforcement of the law and the fact that previous bitcoin purchases are subject to the ruling are all factors that are expected to have a chilling effect on the future use of virtual currencies.
Since the IRS announced the ruling, the bitcoin’s valuation has dropped 17 percent. With most cryptocurrencies being traded or used in the United States, this shift in policy may see the U.S. rake in a significant amount of the bitcoin market cap in capital gains taxes while everyday consumers debate whether it is worth it to maintain a diary of purchase costs and trading values every time they want to use bitcoins.
“It’s challenging if you have to think about capital gains before you buy a cup of coffee,” said Pamir Gelenbe, a venture partner at Hummingbird Ventures, to Bloomberg.