(USATODAY.com) - The federal government will tax digital money such as Bitcoin like property, not currency, the IRS said Tuesday in its first significant guidance on the virtual coin.
Although Bitcoin may operate like coin and paper currency and can be used to pay for goods and services, no country accepts it as "legal tender," the Internal Revenue Service said in its notice.
"Virtual currency is treated as property for U.S. federal tax purposes," the notice said. "General tax principles that apply to property transactions apply to transactions using virtual currency."
The guidance means that wages paid in Bitcoin are subject to federal income tax withholding and payroll taxes and must be reported on W-2 forms. Businesses that accept Bitcoin for goods and services will be taxed on the fair market value of the Bitcoin payment as part of their gross income, the IRS said. The fair market value would be calculated as the U.S. dollar value on the date payment was received.
Bitcoin traders are subject to capital gains taxes if they are holding the digital money as a capital asset, like stocks or bonds, the IRS said.
On Tuesday, Bitcoin on the Coinbase exchange was selling for $587.35, up from $571.93 on Monday.
The IRS has "given certainty to dealing in digital currency," says Steve Brecher, a senior adviser at the accounting firm WeiserMazars. "There are still a lot of unanswered questions, but this is a good start."
Bitcoin "miners," people who use special software to solve math problems and generate Bitcoin, must include the value of any Bitcoin they mine as part of their gross income, the IRS said. Miners must also pay self-employment taxes if they are operating as a Bitcoin-generating business, the IRS said.
Since Bitcoin is not a currency, exchanging Bitcoins for U.S. dollars would not be taxed as a foreign currency gain or loss, the IRS said.
The IRS guidance "provides clarity for taxpayers who want to ensure that they're doing the right thing and playing by the rules when utilizing Bitcoin and other digital currencies," Sen. Tom Carper, D-Del., chairman of the Homeland Security and Governmental Affairs Committee, said in a statement.
Carper has held hearings on Bitcoin and has called on the IRS and other government agencies to address how federal tax and money-laundering regulations apply to virtual currencies.
The new rules might discourage Bitcoin growth, says Mark Williams, a former Federal Reserve Bank examiner who teaches finance at Boston University's School of Management.
"The IRS tax ruling, combined with extreme daily price movements of up to 10%, makes Bitcoin even less economical and efficient as a transactional currency," Williams said.
Ajay Vinze, an information systems professor at the W.P. Carey School of Business at Arizona State University who researches Bitcoin, sees the IRS notice as a positive development for digital currency on a journey toward wide acceptance.
"What the IRS has done is legitimized Bitcoin as an investment or a property or a store of value," Vinze said. "It's one more step in the currency's life."
Bitcoin, launched in 2009, is decentralized digital currency that is traded from person-to-person, rather than through banks, and has no issuing or regulating country.
The IRS in its guidance defined Bitcoin as a "convertible currency" that can be used as a "medium of exchange, a unit of account, and/or a store of value."