Will sales tax break the bitcoin spell for merchants?

By Mark Faggiano , written on December 10, 2013

From The News Desk

In the past several weeks, the price of one bitcoin, valued at under $100 just six months ago, has flirted with that of an ounce of gold. Germany and the U.S., two of the world’s most influential governments, are taking steps to accommodate, rather than block, bitcoin growth. A pair of respected Wall Street analysts opined that bitcoin’s appreciation is just getting started; valuations, they claim, could grow a mind-boggling 10 to 100 times within ten years.

The bitcoin movement, if not the notion of digital currency itself, is quickly making its early ambitions seem almost quaint. As recently as last year, bitcoins were discredited, dismissed as a convenient facilitator of black market transactions. Today, more than 12,000 legitimate merchants, half of them located in North America, accept bitcoins as payment through BitPay, one of the best-known bitcoin payment service providers. Other startups, including Flexcoin and Toronto-based Coinkite, also support the fledgling bitcoin monetary system.

Amid all this activity, the online retail industry wonders how to react. Are bitcoins a flash in the financial pan? Could they actually change the face of global commerce? Should every merchant, from mom-and-pops to retail giants, begin accepting them? And if so, what are the business and financial issues that will inevitably pop up?

It’s easy to see why bitcoins are gaining traction, especially with those who sell goods and services online. As the first medium of exchange that is both practical and universal, bitcoins can potentially facilitate seamless commerce with any customer, anywhere in the world. Exchange rates and conversion fees are irrelevant; perhaps even more importantly, credit card transaction fees are eliminated. Many payment networks also claim that fraud, regulatory, and PCI (Payment Card Industry) compliance issues are significantly reduced.

Taxation, on the other hand, may not be so favorable. If you’re engaged in commerce with consumers within a state, you’re obligated to collect and pay sales tax on those transactions. Even if you’re conducting business online and the customer resides in another state from your own, taxes must be paid.

What state and local tax laws typically don’t bother to mention, is that the form of currency is irrelevant. Which means you can be held liable for not paying sales tax on bitcoin transactions just as you would be with U.S. dollars or any foreign currency.

If the U.S. government labels bitcoins as a legitimate “unit of account,” to use the official term, tax requirements resulting from bitcoin transactions will be the same as for any other retail sale. And this is where things get complicated for retailers.

At the moment, no service provider (or relevant software application, for that matter) supports the calculation and accounting of sales tax for bitcoin transactions. The need is just too new. Since you can’t pay the IRS in bitcoins—and probably won’t for some time to come, if ever—you’ll need to calculate the equivalent dollar price of your bitcoin transactions to charge the necessary sales tax.

The dramatic bitcoin price fluctuations make tax computations not only difficult but potentially punitive, since the conversion rate at the time of your quarterly tax payment may be dramatically different from what it was at the time of the sale. As recently as last October, bitcoin traded at less than $200. In early December the price topped $1,200. Who knows what the value will be next month, or six months from now.

Given that bitcoin exchange rates remain volatile, you can calculate sales tax in dollars at the time of each and every bitcoin transaction. Otherwise you may have exposure on the exchange rate at the time you make your tax payment.

Some merchants may be tempted to sidestep this by treating bitcoin sales as being “under the radar” and beyond the government’s ability to track. Many bitcoin proponents, in fact, claim that bitcoin transactions are fairly anonymous (a leftover of their use for illicit online commerce).

That might be an acceptable risk for black marketers, Saturday garage sales, or even Craig’s List users, but not for you. When established businesses buy and sell online, a digital trail is created. Shopping carts, carefully designed to manage inventory, track customer data and so on, also accumulate accounting data. That “digital exhaust,” as we call it, can be audited.

Bottom line is, if you’re tagged by the government for a sales tax audit -- a process more painful and expensive than an income tax audit -- you’ll likely have to produce reports of transactions from your online store that might include bitcoin sales. As a merchant, you have little choice and from a tax perspective, if you’re buying or selling online, you must follow the rules, including the one that requires you to ante up sales tax. If you ignore your obligation because you believe bitcoins are too small or too new, you’re opening yourself to penalties and interest.

Bitcoins (or, should the bitcoin experiment fail, some other future form of cybercurrency) are an inevitable outgrowth of the digital age. No less an authority than Ben Bernanke stated, in a recent letter to U.S. senators who were holding hearings on bitcoins, that the digital currency “may hold long-term promise.”

At the present time, however, merchants need to consider the issues and proceed carefully. If you choose to accept bitcoins, track your sales, compute the sales tax quickly, and make your payments. Unlike bitcoins themselves, there is nothing “virtual” about the tax man showing up at your door.

[Original image via Thinkstock]