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Digital Currency: A New Worry for Tax Administrators?

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By David D. Stewart and Stephanie Soong Johnston
Monday, October 29, 2012

Controversies surrounding presidential candidates are old hat in any
given election year, but 2012 could very well be the first time that
hackers, presidential tax returns, and a mysterious digital currency
called bitcoin all had starring roles in one of the oddest politically
motivated tax capers in recent memory.

In early September it was reported that a group of hackers
claimed to have broken into PricewaterhouseCoopers’s Franklin,
Tennessee, office in late August and copied Republican presidential
candidate Mitt Romney’s sought-after tax returns to thumb drives.

The hackers then said they had sent the thumb drives to
local Democratic and Republican offices, along with ransom notes
demanding that $1 million — all in bitcoins — be paid by September 28
to one of two accounts to destroy or release the cyberkey required to
access the files contained on the thumb drives. (For prior coverage of
the hacker incident, see Tax Notes, Sept. 10, 2012, p. 1253, Doc 2012-18670, or 2012 TNT 174-2.)

That deadline has since come and gone, and the incident was
declared a hoax by many. But the news certainly accomplished one thing:
shining the spotlight on bitcoin, a decentralized, peer-to-peer Internet
currency that has been growing in popularity and prominence in the
digital age — and in doing so has raised a series of legal questions,
especially in the area of taxation.

A ‘Bit’ of History

The currency was created in 2009 by Satoshi Nakamoto — likely a
pseudonym for the programmer or programmers responsible for developing
the system. It is distinct from virtual currencies used in online gaming
communities. Virtual currencies, such as World of Warcraft gold,
function within the universe of the game but may be bought and sold
using real-world currency. The function of virtual currencies is limited
by their utility to other game players. (For discussions of the tax
implications of virtual economies, see Tax Notes Int’l, Jan. 15, 2007, p. 149, Doc 2007-997, or 2007 WTD 10-8; and Tax Notes Int’l, Nov. 21, 2011, p. 579, Doc 2011-22984, or 2011 WTD 224-18.)

Bitcoins function as a unique currency with its own
free-floating exchange. It has no government and no central bank and is
intended to be used worldwide. Think of it as the Esperanto of currency.

Coffees from San Antonio-based BitBrew can be purchased
only by using the bitcoin system.

Users can also send and receive bitcoins using unique
Internet addresses and store their bitcoins — each of which is broken
down into 100 million units known as satoshis — in a virtual wallet.
The stored bitcoins, which offer some degree of anonymity to users, can
then be used to buy everything from coffee and T-shirts to LSD tablets
and drug-fueled energy drinks.

Tax Analysts sought out members of the bitcoin community as
well as tax experts to identify what the implications are for tax
administrators. Some believe that the system could be used to facilitate
tax evasion, while others contend that the open nature of the
transactions would deter such evasion. All believe, however, that
bitcoins raise significant questions. For tax administrators, the
challenge is how to approach a system that is outside the traditional
streams of commerce and finance. For users, the challenge is how to
navigate an ambiguous regulatory climate in which guidance is difficult
to come by.



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