2014-06-19 Hour 1 Reed Jessen from Ernest Hancock on Vimeo.

The Internal Revenue Service's plan to tax virtual currencies could crimp their use as an alternative to cash or credit for retail transactions.

The IRS, in a ruling last week, said under existing law bitcoin and its brethren areproperty, not currency. That means anyone who spends bitcoin, even on a $2 cup of coffee, may have to pay taxes based on any "gain" over that bitcoin's original value.

The rules are similar to reporting a "capital gain" on selling a stock: The spenders would have to figure out a "cost basis" for a transaction and report a gain or loss, calculated by comparing how much they paid for the bitcoin originally and its value when they traded it for a cup of joe.

The requirement is stoking fear among some bitcoin advocates, who worry it will diminish the digital payment system's attractiveness as an alternate currency.

"Treating all bitcoin transactions like transactions in property is just an untenable position because it requires onerous record keeping and reporting requirements for everyday bitcoin users," said Marco Santori, chairman of the regulatory affairs committee of the Bitcoin Foundation, which advocates for the technology.

The IRS, in a question-and-answer document published March 25, said it was aware that virtual money could act like a currency in practice. But the agency said it isproperty "under currently applicable law," pointing out that "it does not have legal tender status in any jurisdiction."

That same day, an IRS attorney who worked on the document, Keith Aqui, told The Wall Street Journal in an interview that consumers using bitcoin for small transactions may not "have to worry" about the new agency guidance. Contacted again several days later, however, Mr. Aqui said he "probably misspoke" and that the policy would apply to all transactions.

"It would be cumbersome, but that's the way the law is written, and that's the way we have to administer it," he said. An IRS spokesman declined to comment on Mr. Aqui's remarks.

While the IRS is accepting comments on its ruling, its citation of current law suggests Congress may have to act to change the agency's approach. No lawmakers have yet urged altering the tax code to accommodate virtual currency, but some are studying the issue.

"We must see that tax regulatory changes do not preclude the use of this currency," Rep. Nydia Velazquez (D., N.Y.), the top Democrat on the House Small Business Committee, said at a hearing on bitcoin Wednesday.

Despite its drawbacks, the IRS ruling was a milestone for virtual money because the agency recognized the technology as a legitimate store of value. Bitcoin, which consists of a computer code created and controlled by its users, has boomed in popularity and value during the past year, thanks to an innovative system for limiting the availability of new "coins" and publicly verifying each transaction between twobitcoin owners.

Proponents say bitcoin could revolutionize banking by providing a payment system more efficient than checks, credit cards or wire transfers. In an effort to expand the use of bitcoin—and profit from it—startups are offering services that facilitate the use ofbitcoin to purchase consumer products. One firm pitching a sort of bitcoin-banking service, Circle Internet Financial Inc., said last month it has raised a total of $26 million from investors.

Bitcoin advocates say technology will overcome tax burdens with time. Coinbase, an online "wallet" provider that helps people transact in bitcoin, is researching a way to make it easier for customers to track their "cost basis" and tax liability, said spokesman Alex Kirschner.