Tag Archives: IRS

Bitcoin to be Taxed

Yesterday, the Internal Revenue Service issued a formal statement declaring Bitcoin property, as opposed to currency, for taxing purposes. An article in CNN Money explains that the IRS has decided payments worth at least $600 (in Bitcoins) will be taxed in the same way as any other property transaction taxed by the agency. This includes any payment with Bitcoin, gains acquired by investing in it. and income from producing Bitcoins on your computer (known as “mining”). Additionally, “If you pay your employees with bitcoins, that would have to go on your staff’s W-2 forms, and they would have to pay federal income tax on it. Paying an independent contractor? They have to put bitcoin payments on their 1099.” Notably, the IRS acknoledges that Bitcoin surely functions like real currency, but its lack of legal tender status means that there is no jurisdiction over it as such.

The IRS, the and United States in this sense, has joined many countries in the attempt to regulate Bitcoin as it becomes increasingly utilized/traded. The United Kingdom, Germany, and Singapore are among other countries that have put forth this effort as well. In the near future, we should expect to see many other countries joining in the attempt to regulate Bitcoin — assuming it continues to grow in relevance as it has been recently.

In fact, a Wall Street Journal article explains the growth in Bitcoin awareness and confidence. Pollster Harris Interactive outlined the thoughts of 2,039 people around the U.S. It found that 48% have heard of Bitcoin, but most of them don’t trust it enough to invest in it. In fact, only 13% said they would choose bitcoin as an investment over gold. Personally, I am surprised even 13% would choose to invest in it over gold; I figured it would be less. Additionally, results indicate a correlation between increased awareness and decreased trust. It seems that the more people learn what it is, the less they trust it enough to invest in it (hypothetically, of course). Interestingly, respondents in western states proved to be more likely to have heard about Bitcoin, but only 7% of those who knew about it said they would chose it over gold when investing.

Thus, the increase in Bitcoin’s popularity is eminent, though people’s trust in it is still very questionable. However, in pure numbers, it is gaining ground quickly. This decision by the IRS is not necessarily negative for Bitcoin-ers. In fact, I think it’s a positive step for those who want to see it grow in the future. A government attempt to regulate it means that it is being acknowledged as a significant “property” and that the US is taking notice of the increased popularity of Bitcoin. As of now, I find it almost impossible to convince me to invest in it, but all the power to those who do. Regulation may not be an investor’s idea of a positive step, especially when their investments are being taxed, but this move by the IRS is important as it creates a form of acceptance and acknowledgement (as property, though).

Increase in U.S. Capital Gains Tax on Wealthy: Incentive to Donate?

It’s that time of the year when American earners start to fret about their personal wealth. The IRS began accepting returns for 2013 income tax season on January 31st yet again in the U.S., and the WSJ has made sure that its readers are aware of many of the upcoming changes to the tax code that have come this year. Since many of the new provisions only affect high-income taxpayers, most of us in Econ 411 will likely be unaffected (unless you have your own lucrative hedge fund or startup on the side). However, since we have progressive income tax rates, the tax code has a significant effect on the distribution of wealth in our country, so these changes are useful to consider when analyzing inequality (at least in terms of taxable income). Furthermore, there are a few loopholes that allow some high earners to maintain their advantages.

One of the biggest changes for those in the top income bracket (singles making more than $400,000 a year, or married couples making more than $450,000 a year combined) is the increase in the top tax rate for long-term capital gains and qualified dividends (on assets held for more than a year) from 15% to 20%. In addition, there is also a new “net investment income” tax, in which those that earn more than $125,000 (if they’re single, $250,000 for couples) in investment income will pay an additional 3.8% on their investment income. This essentially acts as an additional tax on capital gains and dividends.  On paper, these new taxes may appear to some politicians to be a step towards evening out the inequality in this country, but there are also a few loopholes that may prevent this from being a successful strategy.

One important loophole was illustrated in different Wall Street Journal article. The article suggested to the average taxpayer to donate stock or other financial assets to charity rather than give a monetary gift. It’s widely known that charitable donations can be deducted from a filer’s tax return, but there is an added advantage to donating your financial assets. If you donate stock to a charity, not only do you receive a tax deduction at the fair value of the assets, but you won’t have to pay the capital gains tax on that asset. Individuals can deduct contributions of capital gains assets up to 20% of their adjusted gross income. This means a wealthy taxpayer that typically gives away a large portion of their salary to charity could simultaneously avoid paying taxes on their investment gains by simply donating a portion of their financial assets to a qualified charity.

For example, say a wealthy bachelorette in the top income bracket with a salary of $1MM per year gives away $50k in cash to her favorite charity annually and, after saving steadily, she has an investment portfolio of $500k that generates 10% dividend return annually (assume this is in a high-yield ETF, with reinvesting dividends), so she normally gets $50k worth of investment income annually. This year, she wants to take her annual capital gains and dividends out of the fund and spend it on a vacation with her partner. These gains would be taxed at 20%, given the 2013 capital gains tax increase. This would mean that she would only get to keep $40k of this year’s $50k capital gains ($500k * 10% interest * (100-20% capital gains tax) = $40k). Between her charitable contributions and her capital gains after tax, she would have spent $10k this year (simplified to only these two items for illustration). If she instead decides to donate $50k of her ETF portfolio to her favorite charity, she escapes the capital gains taxes on this stock and her gains from her portfolio ($50k) cancel out her charitable donation ($50k). So far, she’s left with $10,000 worth of extra cash flow this year. Furthermore, since charitable contributions are tax-deductible, she gets to write $50k off her annual income when she pays her income tax. This means she’ll get to keep an additional $50k*39.6% (for the top tax bracket) ~ $20k, instead of paying this in tax. The overall effect is that she pays 20k ($50k – $20k income tax savings -$10k capital gains tax savings) in order to donate $50k to charity; it’s a strong incentive to donate!       – Keep in mind this strategy only works for philanthropists that would have originally donated to charity anyways.

Overall, while this part of the tax code is likely to have some sort of an effect on income inequality in the U.S. directly, the higher tax may also incentivize wealthy people to donate to qualified charities. In the end this might have a positive redistribution effect, assuming the money donated to these charities is used appropriately and responsibly. This would make an interesting topic to research, to investigate whether there was an impact on the capital gains tax rates and charitable giving.