On Tuesday, March 25 the United States Internal Revenue Service (“IRS”) issued a notice (Notice 2014-21) which classified “virtual currency” (such as Bitcoin) as “property” as opposed to “currency” or some other classification. This long anticipated guidance gives regulatory acknowledgment that virtual currency is now recognized for U.S. Federal income tax purposes, and firmly establishes Bitcoin as an economic reality subject to taxation. Classifying Bitcoin as “property” will allow Bitcoin users to plan their use of Bitcoin in a tax advantageous manner and in many cases lower taxes from what would otherwise have been the case had Bitcoin been classified as “currency”.

So, what will this mean for the average investor in Bitcoin? In order to have a better understanding, here is a look at several different scenarios:

1. Investor invests $100,000 into Bitcoin at $1,000 per Bitcoin. In 3 months, the price rises from $1,000 to $2,000. The investor liquidates his Bitcoin holdings for a total of $200,000 with a profit of $100,000. What are the tax consequences?

Assuming the investor is not treated as a “dealer” under the tax rules, the investor will generally realize capital gain or loss. Here, because the investor held the Bitcoins for less than one year, the $100,000 gain will be treated as a short-term capital gain and taxed at the same rate that applies to ordinary income. The maximum federal tax rate currently applied to ordinary income is 39.6%. In addition, a 3.8% “Medicare Tax” could apply. Thus, the maximum federal tax rate that could apply to the $100,000 short-term capital gain is 43.4%. Assuming the investor is in the top tax-bracket, this would result in tax due of $43,400 on $100,000 of profit.

Had the IRS ruled that Bitcoin was a foreign currency, any gains or losses would also be taxed as ordinary income.

2. Investor invests $100,000 into Bitcoin at $1,000 per Bitcoin. After more than 12 months have elapsed, the price rises from $1,000 to $5,000. The investor liquidates her Bitcoin holdings for a total of $500,000 and a profit of $400,000. What are the tax consequences?

Assuming the investor is not a dealer, the $400,000 gain will be treated as long-term capital gain and taxed at a preferential rate, which is currently a maximum of 20%. Taking into account the possible application of the Medicare Tax of 3.8%, the maximum federal tax rate that could apply to the $400,000 gain is 23.8%. Had the IRS instead held that Bitcoin was a foreign currency, the gain would be treated as ordinary income and taxed at ordinary income tax rates.

3. Investor invests $100,000 into Bitcoin at $1,000 per Bitcoin. After more than 12 months have elapsed, the price falls from $1,000 to $500. The investor liquidates his Bitcoin holdings for a total of $50,000 and a loss of $50,000. Investor had separate long-term capital gains (i.e., stock trades) for the year equal to $20,000. What are the tax consequences?

Assuming the investor is not a dealer, the $50,000 loss is a long-term capital loss which may be used to offset the $20,000 in capital gains. Up to $3,000 of the excess capital loss ($30,000) may be deducted from ordinary income (e.g., wages). The $27,000 in unused capital losses are carried over to succeeding tax years.

On the legal side, the IRS guidance does not affect the legality of Bitcoin use for the purchase of goods and services. The question of whether Bitcoins are “property” or “currency” has been before at least one court. A federal district court has held that Bitcoin “can be used as money” because it possesses attributes of a “currency or form of money.” It is important to note that irrespective of the IRS tax classification, Bitcoin may continue to be used in connection with financial transactions between private parties and be used to purchase goods and services. Nothing in the IRS guidance speaks to that. In a sense, Bitcoin may be seen as a bridge between barter transactions and payments made in traditional currency.

As Bitcoin continues to grow in popular acceptance, one of its greatest hurdles has been regulatory acceptance. Early regulations by FinCEN provided a first step toward universal regulatory acceptance. The IRS guidelines further that charge. While the IRS guidance is not binding on other regulatory agencies like the Securities and Exchange Commission, the Commodities Futures Trading Commission and State departments of commerce and financial services, those agencies cannot help but take notice of the IRS action and factor that into their consideration of possible Bitcoin regulation. Added regulatory guidance cannot help but to expand the Bitcoin user community.

The IRS guidance cannot be seen as other than providing the increased clarity, consistency and legitimacy needed to integrate the existing, relatively tight-knit Bitcoin user community into the financial community at large.

Please note that this letter is for information purposes only, and it may not be relied upon as legal or tax advice.

Written by:

Jim Jalil

Chair, Cybercurrency Group

Thompson Hine LLP

New York

james.jalil@thompsonhine.com

Brett Stapper

Co-founder and Director

Falcon Global Capital, LP

San Diego

Brett@FalconGlobalCapital.com