What is a bitcoin tip?
Likely you know what a tip at a restaurant is. Your waiter does a good job serving you food and then you give him a tip for it. But you also can get tips on the internet! If you say something that people like, they might just tip you for it! As an accounting student however, this begs a question: what exactly is a bitcoin tip for tax purposes? An internet tip has two possible ways of being taxed:
- A non taxable gift. This is like receiving a present from a friend or relative. As long as its under 10,000, it’s exempt from a gift tax too.
- It is compensation and should be taxed as ordinary income.
I feel there are valid arguments for both sides. Although some examples are more clear cut than others. For example, someone who you know gives you a bitcoin tip as a gift, it could very well be a gift. However, if the intent of the giver is to make a profit somehow on the tip, it would seem more like compensation. An example of this is if someone offers bitcoin in exchange for work.
In a Revenue Ruling titled “Notice 2014-21”, the IRS made some statements to clarify how bitcoin transactions should be taxed. Just for background information, there are many different sources of rules in regards to taxation.
The ultimate source is the constitution. Following that is something called the codification. Because Congress is needed to change the codification, the IRS will issue its own statements – in effect creating its own tax practices. A Revenue Ruling is such a document. The following explains the stance held by the IRS:
Q-3: Must a taxpayer who receives virtual currency as payment for goods or services include in computing gross income the fair market value of the virtual currency?
A-3: Yes. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, 3 measured in U.S. dollars, as of the date that the virtual currency was received. See Publication 525, Taxable and Nontaxable Income, for more information on miscellaneous income from exchanges involving property or services.
Let’s say, for the sake of illustration, you receive a bitcoin tip that is in fact taxable. What now? Well, the amount of tax due on the taxable income is the amount of the tip received converted into US dollars using the current exchange rate (i.e., that day). This is clarified below:
Q-4: What is the basis of virtual currency received as payment for goods or services in Q&A-3? A-4: The basis of virtual currency that a taxpayer receives as payment for goods or services in Q&A-3 is the fair market value of the virtual currency in U.S. dollars as of the date of receipt. See Publication 551, Basis of Assets, for more information
Sadly, the IRS has not commented on bitcoin tips in particular. The nature of the tip likely will determine what kind of of treatment the transaction should receive.