Photo: Jason Benjamin

Finally, the IRS has spoken.

A new notice from the Internal Revenue Service explains how it intends to tax Bitcoin transactions.

Here's 4 things you should know:

1. Bitcoin will be subject to capital gains taxes
Because Bitcoin is defined as property, gains from buying and selling the digital currency will be treated like any other capital gains. Long-time holders will be pleased to find that Bitcoin gains can be taxed at favorable rates as low as 20%, significantly lower than the highest income tax bracket.

2. Bitcoin income is taxed as income
Get paid in Bitcoin? That's income, and the IRS wants its fair share. The notice explains that Bitcoin payments should be treated as income, and the Bitcoin should be valued at the market price in U.S. Dollars at the time a payment is received.

3. Miners pay more
Whereas gains from Bitcoin's price appreciation are treated as capital gains, mining Bitcoins won't be. Mined Bitcoins are to be treated as income, and priced at the fair market value when received.

4. Spenders pay, too
The IRS notice complicates taxes for Bitcoin users, who spend the virtual currency to buy anything from free-range meats to subscriptions to online dating sites. Spending Bitcoin is a taxable event, requiring the payor to determine his or her capital gain on Bitcoin used to purchase a good or service.

Thus, if you purchased $20 of Bitcoin, watched it rise in value to $50, and spent it all at the $50 price, you would need to declare $30 in capital gains. Losses are treated similarly.

A blow to the currency?
The IRS may complicate the use of Bitcoin for individual users. Bitcoin is volatile, and its price is ever-changing. Thus, virtually every transaction will create some kind of capital gain or loss, which individuals are required to declare to the IRS.

Depending on the holding period, capital gains will generate vastly different tax treatment. Bitcoin held for more than one year qualify for long-term capital gains. Bitcoin held for less than one-year are treated as ordinary income.

How this impacts Bitcoin is anyone's best guess. But for the law abiding citizen, the tax treatment of Bitcoin just became more clear. Staying in compliance of the law, however, appears that much more complicated. 

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