"Just substitute Bitcoin with gold," Smith said from his Bethesda, Md., office. "If I bought gold for $10 and later gave it to someone in exchange for $100, I sold the gold for a profit. If I get paid in gold, it's considered income on the date I got it."
So a taxpayer who receives virtual currency as payment for goods or services includes that when computing gross income, according to the fair market value of the virtual currency on that day. The IRS has more answers about its tax notice at this link ( http://www.irs.gov/pub/irs-drop/n-14-21.pdf).
What about those who "mine," or create Bitcoin or virtual currencies?
"If a person mines 1,000 Bitcoins and the value of a Bitcoin on that day is $1, then that person would have to pay tax on $1,000 of income and each Bitcoin would have a tax basis of $1," says tax attorney Adam Grais, of Sugar Felsenthal Grais & Hammer L.L.P, in Chicago.
In the example above, the Bitcoin miner would recognize ordinary income - taxable at rates up to 43.4 percent - on the mining transaction, but would generally recognize capital gain or loss when spending the Bitcoins, Grais added. If you invest 1,000 Bitcoins and lost them all, you have a $1,000 tax loss.
How does one mine Bitcoins? Take a deep breath.
You essentially rent out your computer's power (or memory) to solve problems, almost like renting out your home as a factory to solve math problems.
You create a "wallet" and assign your computer as a "worker." Basically, just leave a program running on your computer. The better your system (or GPU), the more you make - in theory.
Last question: Can you pay your taxes in Bitcoin? Not yet.
Free tax help
Individuals with a household income of less than $58,000 may file their taxes online with the MyFreeTaxes tool. The local MyFreeTaxes link from United Way is: www.myfreetaxes.com/phillysjunited.
Individuals with a household income of less than $52,000 also may file online, or sign up for an appointment at any of the in-person Volunteer Income Tax Assistance (VITA) offices. The in-person VITA threshold is determined by the IRS. For a locator tool by zip code, go to the IRS website: http://irs.treasury.gov/freetaxprep.