Bitcoiners know the frustration of tax season all too well. It’s never been easier to use Bitcoin as money. Yet, at the same time, the tax code puts an incredible burden on law-abiding citizens. Something as simple as buying a cup of coffee every day with Bitcoin can result in over 100 pages of tax filings.
The System is Broken
Capital gains taxes present many problems. Yet, the process is almost tailor-made to discourage the use of alternative currencies.
First, capital gains tax rates are structured to incentivize long-term holding. This policy distorts the market by incentivizing buying and selling solely to mitigate tax losses. However, it’s especially distortionary in the context of money, given that long-term holding policies discourage what is generally considered “currency use.”
Second, the complexity of administering the tax creates an additional burden on users of alternative currencies, including Bitcoin and other cryptocurrencies. Where a sales tax is usually a flat percentage added on to the bill, capital gains taxes require you to tell the Internal Revenue Service the date you got the Bitcoin, the date you paid for something with it, what you originally paid for the Bitcoin, and the gain or loss for each transaction. All of these details must be recorded on Form 8949 and compiled on Schedule D of Form 1040 to calculate the tax owed for each purchase of goods and services.
Third, with a process this complicated, there’s always the looming threat of an audit and penalty should you make a mistake (innocent or not). That threat alone can deter anyone interested in trying something new.
Spending Bitcoin is becoming easier every day. The payments company Square recently integrated no-fee Bitcoin payments in its merchant terminals. Similarly, self-hosted wallets like Bull Bitcoin, Zeus, and Trezor have made it easier than ever to use Bitcoin on the consumer side. Yet Form 8949 alone can run to around 70 pages if you spend Bitcoin every day.
Congress Can Fix This
If Congress is going to fix this mess, it should remove capital gains taxes to open the door to currency competition. There are a few options.
The simplest option is to end capital gains taxes completely. A slightly more complicated option, however, is to stop applying capital gains taxes to cryptocurrency and foreign currency use. Doing so would take the government’s thumb off the scale and let competition be the true decider of the best money.
Adding more complexity, another option is to remove capital gains from purchases of goods or services. While I used to be fond of this compromise, it risks creating its own compliance nightmare if people are required to prove the transactions. That’s better than being taxed, but the process would still be taxing.
One final option is to create what’s called a de minimis tax. In other words, as long as you don’t cross some threshold, capital gains won’t apply. For example, the Virtual Currency Tax Fairness Act would exempt personal transactions made in cryptocurrencies so long as the relevant gains are $200 or less. However, the threshold should be raised substantially. One way to better tether the bill to economic reality would be to use average household spending ($80,000) as the threshold. After all, $200 can be one trip to the grocery store.
Conclusion
The only thing worse than getting robbed would be having the robber demand endless forms about the money they are taking from you. Taxes are no different. Congress should simplify the tax code so the average American can do what’s required with ease. Doing so would go a long way toward easing Americans’ stress each tax season and creating a more competitive economy.