But you also do not owe any taxes if you whole income is in bitcoins and there is no way to tie bitcoin value to usd.. :)
First, you'll have to pay taxes based on the USD value of the goods/services/whatever for which you got that bitcoin income.
Second, you'll have to justify how you got to that value.
Third, if IRS doesn't like your justification and think that you're underestimating the income, they'll charge you a fine for the difference if they think it's a mistake; or prosecute you with tax evasion if they think that it was intentional.
After all that you'll pray for Feds to issue official guidelines on how to tie bitcoin value to USD, since it will make all of this simpler and safer for you.
My point was - if US government will make hard or impossible converting bitcoin into usd, they can't claim you owe them any taxes if sole income you get is in bitcoins. Or they have to accept it in bitcoins.
As an analogy - let's say you made business where whole income is produced via bartering and in goods, not currencies. Let's imagine that us government made some law which prevents you from exchanging these goods to USD which is the only tax payment option. How you can pay taxes and from what amount?
The previous posts said there would be no possible way to transfer the item into dollars. By definition, that makes the value equal to zero dollars. There is no transaction that can possibly made to demonstrate the fair market value being any greater. Of course the IRS will find some loophole to fabricate some value above zero, but that doesn't change the real market value.
Suppose, for example, you have a scheme where people use goats as currency. The goats are all kept on a big farm somewhere, and when one person wants to transfer money to someone else who is a member of the scheme the farm operator updates the notional total of goats owned by each party. If there are enough members in the pool to provide a variety of goods and services to each other, it could be a tax avoidance scheme. You could proscribe that trade, while estimating liability by looking at the number of goats owned by the individual members and/or the $ value of goods and services exchanged, even if it were impractical to realize that money by selling the goats (because they all had a disease or because the nominal value had become wildly inflated compared to the going rate in agricultural markets).
"Possible" and "legal" are two different words, and two different concepts.
That's your problem, under current law. Just like it's your problem if you don't declare illegally obtained income and pay taxes on that: that means you can be tried for tax evasion on that income.
No one ever claimed tax law is fair or sane (though in fact levying taxes on all income no matter what form is in fact somewhat sane as a starting point if you're going to tax income at all).
And, to be very clear, the government is not, in any way, saying thst you can't trade your BTC for dollars. What they ARE saying is that you might have to disclose your identity in return to make that exchange ...
To pick a nit, sales and property taxes aren't, strictly speaking, U.S. taxes, and the actual taxing authorities - usually municipal governments - could theoretically accept payment via some alternate means.
Really, do smuglers pay the tax of their profit on frugs, as thry are required to?
However, if their defense proves that the stuff they sold was legal (as some new party drugs might be temporarily), then they can still be prosecuted for tax evasion. And, of course, there is the historical case of Al Capone.
[edit] See also http://en.wikipedia.org/wiki/Taxation_of_illegal_income_in_t... as noted by another commenter.
This is as brilliant an idea as the bank robber who thought covering himself in lemon juice made him invisible to security cameras.