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The Unresolved Tax Consequences Involving Cybercurrency Staking

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Introduction:

There is a raging debate on social media about whether the activity of cybercurrency
staking is similar to a baker who creates a cake using raw ingredients and is not taxed until the
cake is sold, or whether staking involves personal services and the taxpayer is receiving assets
(new coins) as compensation, in which case, receipt of the coins is immediately taxable.

The Controversy:

The current controversy involves a Tennessee Federal District Court case, Jarrett v. US in which a taxpayer who paid taxes on “staking rewards” (new coins he received for his activities), sued for a refund claiming his actions were comparable to the baker making a cake. IRS agreed to pay the refund and has moved to have the case dismissed. Many commentators, without the slightest clue as to how IRS operates, have erroneously concluded that staking is akin to making a cake, because IRS decided to issue a refund in the Jarrett case and have the case dismissed

Potential Reasons for the Refund:

First, the amount in controversy involved a refund claim of $3,000 and is would cost the government probably ten times, if not twenty or thirty times the refund claim the litigate the matter. More importantly, IRS is working on the issue of how to tax staking activities and has not reached a conclusion. The issue involves potential hundreds of millions, if not billions in future tax revenue and, logically, IRS did not want a federal judge (who may or may not have substantial federal tax experience) making a potential adverse decision that would cause massive confusion, before it establishes a position on the matter. Thus, the issuance of a $3,000 refund should not be considered definitive win for those participating in staking.

Based on current law, staking income should be realized when there is payment for the services, in the form of an asset, whether a virtual asset or otherwise. In the Jarrett case, the taxpayers received Tezos tokens worth approximately $9,000, so they received property with an ascertainable value for work performed and taxpayers should be taxed upon receipt of the coins.

Taxpayers’ Argument:

Taxpayers’ claim that newly created property is not an accession to wealth that is clearly realized — the making a cake analogy– so they should not be taxed until the coins are sold. Taxing them when the coins are received is analogous to taxing a baker when the cake is finished and for sale, whether or not someone buys it. But were taxpayers actually making the Tezos coins? They reviewed and validated new blocks within an existing block chain, but did not actually create the Tezos coins in the sense that a baker creates a cake or an author writes a book.1 They were paid for their services with coins.

The” Central” Issue:

The core question is the value of the asset when received. In many cases, the asset’s value is zero, in which case the taxpayer does not have income when the asset is received (the taxpayer has a zero basis in the asset). When the asset has an ascertainable fair market value upon receipt, the asset should be immediately taxable; thus, if the asset’s value is $10 when received, taxpayer has $10 in compensation income and a $10 basis in the asset for determining future gains or losses. In Jarett’s case, the coins were worth $9,000 upon receipt, so they should be taxed on that amount as ordinary compensation income.

Conclusion:

It will be interesting to see whether IRS decides that staking is like making a cake or is just another form of payment for personal services.

1 Of course, they had a small role in the creation of the coins, but the same can be said of an auto assembly-line working making a car. If the worker received a car as payment, could the worker claim the car is not taxable under the “making a cake, writing a book” rationale?

Foreign Gift of an NFT, Part 1

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Introduction:

What are a U.S. taxpayer’s reporting duties when receiving a foreign gift of a non-fungible
token (NFT)? Let’s say your rich foreign uncle, who made a bundle buying NFTs, transfers one
of them to you as a gift. The good news is foreign gifts are not immediately taxed; however, there
could be current IRS filing obligations with potentially large penalties.

Example: Assume as a U.S. taxpayer you receive an NFT from your foreign uncle
worth $500,000.

Reporting Obligations:

Form 3520: I’ve discussed in a separate video the Form 3520 filing requirements when you
receive one or more foreign gifts in a calendar year exceeding $100,000 in total. Here, you need
to file Form 3520 to report your NFT.

Form 1040 Disclosure: On the first page of Form 1040, IRS asks about any transactions
involving virtual currency that must be answered Yes or No. An NFT is not a virtual currency, it
is an asset, a collectible, so you answer the question no, unless you had other transactions
involving virtual currencies.

FBAR: An FBAR is required when you have more than $10,000 in one or more foreign financial
accounts during the year that you own or have signature authority over the account). An NFT is
an asset, it is not a foreign financial account; therefore, an FBAR is not required, unless it is
stored on a foreign exchange or platform, or with a foreign financial institution, which is unlikely
but could happen.

Form 8938: Form 8938 is filed with your tax return if you hold foreign financial assets exceeding
certain thresholds. These thresholds depend on whether you are living outside the U.S. and
whether you file a joint return. An NFT is not a foreign financial asset for Form 8938 purposes.

Conclusion:

Because an NFL is an asset (it is property) that is not a financial asset, the reporting
requirements are much less onerous than receipt of money, securities or cybercurrency. In this
case, only Form 3520 is required. In Part II, I discuss the tax consequences when you sell an
NFT.

Form 3520: Foreign Gift of Cryptocurrency and Other Assets

Posted on by sommers
Global Crytocurrency image

Introduction:

Say you receive a gift or inheritance1 from a foreign individual of cryptocurrency, or other assets, including cash: First, the good news – the gift is not taxable to either the foreign donor (giver) or the done (recipient) – you receive the gift tax free. The bad news, check out these potential filing and disclosure requirements (including Form 3520)!

Example: Assume you are a single U.S. taxpayer (note, your citizenship or visa status is irrelevant– these rules apply to every U.S. taxpayer).2 In calendar year 2020 your foreign parent makes you three gifts on different dates, of: (i) $50,000 in cash; (ii) stock in a foreign company worth $75,000; and (iii) cryptocurrency worth $100,000, for a total of $225,000.3 Assume the cash was deposited into a foreign bank account owned jointly by you and your parent. What were your U.S. tax obligations?

Tax Reporting Obligations:

Form 3520: This form is required whenever you receive one or more gifts from one or more foreign individuals during the calendar year when the aggregate fair market value exceed $100,000. [See my Form 3520 video for more details] In our example, you received foreign gifts worth $225,000 reportable on or before the due date of your 2020 income tax return, either April 15, 2021 or October 15. 2021. Since you did not timely file Form 3520, you could be subject to huge penalties, 5% per each month the return is late, to a maximum of 25%. Form 3520 is a separate and independent filing obligation and must be paper-filed with the IRS in Odgen, Utah. The statute of limitations for IRS to assess this penalty is suspended until three years after the return is filed.

FBAR: Because there was more than $10,000 in your jointly-held foreign bank account in 2020, you were obligated to file an FBAR (Report of Foreign Bank and Financial Account) by the due date of your income tax return, with regard to extensions, similar to the deadline for filing Form 3520. The FBAR is filed on-line and is a separate and independent filing obligation. The FBAR also applies to stock held in a bank or brokerage account (or similar institution). There is a six-year statute of limitations for FBAR penalty assessments.4

Form 8938: Your foreign financial assets exceed the $50,000 threshold for single filers ($100,000 for joint filers residing in the U.S.); therefore, you needed to file Form 8938 with your income tax return. Your foreign bank account and stock holdings are foreign financial assets and your cryptocurrency might be a foreign asset if it is held by a foreign exchange or foreign $100,000, whichever is higher, if IRS concludes you willfully failed to file the FBAR. Penalties may be reduced or eliminated if you can show IRS that the failure was due to “reasonable cause” (a much-litigated concept) and there may be voluntary disclosure programs to mitigate the penalty. financial institution. The penalty for failing to file Form 8938 is $10,000 per year and there is no statute of limitations for assessment of the penalty until three years after the form is filed.5

Form 1040: On the first page of Form 1040, IRS asks, “At any time during 2020, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency? Yes or No.” You must answer this question “Yes” because you received a gift of cryptocurrency. Note receipt of cryptocurrency (other than by purchase), whether from a U.S. or foreign person and whether by exchange, gift or inheritance requires a “Yes” answer. Although there is not a specific penalty for failing to accurately answer this question, it is clearly a badge of fraud if you supply a false or misleading answer and remember, you file tax returns under federal laws of perjury. In short, there are criminal tax fraud implications if you deliberately falsify your answer to this question. Failing to answer the question in circumstances where you were required to answer “Yes” amounts to fraud, so don’t be clever and not answer the question.

Other issues: If your ownership interest in the foreign corporation is 10% or more, you could have a Form 5471 filing obligation. There is a similar, although not identical rule for foreign pass-through entities, such as partnerships or limited liability companies. If the foreign stock was held in a foreign mutual fund or other passive investment, you could have a PFIC (Passive Foreign Investment Corporation) Form 8621 tax issue. The PFIC rules can be extremely complex and only a handful of CPAs are qualified to handle them. Also, PFICs may have potentially punishing tax rates.

Conclusion:

What appeared to be a simple foreign gift/inheritance transaction with no immediate tax consequences may generate a multitude of reporting duties. A foreign gift/inheritance of —

a. Cryptocurrency could trigger Form 3520, Form 8938 and FBAR filing requirements, as well as a Form 1040 virtual currency disclosure.

b. Cash or assets could trigger Form 3520, Form 8938 and FBAR reporting obligations.

c. Foreign stock or securities could spark Form 3520, Form 8938, FBAR (if the stock is held in a foreign financial account). Form 5472 and PFIC filing duties.

  1. Note: The rules apply with equal force to foreign inheritances.
  2. Note: Those who are physically present in the U.S. illegally still must comply with U.S. tax law and these rules apply to illegal assets or substances as well. In general, the tax code makes no distinction between legal or illegal activities or assets.
  3. Note: non-cash gifts are priced at fair market value at the time of the gift.
  4. The penalties range from $10,000 for a non-willful failure to as much as 50% of the amount in the account or $100,000, whichever is higher, if IRS concludes you willfully failed to file the FBAR. Penalties may be reduced or eliminated if you can show IRS that the failure was due to “reasonable cause” (a much-litigated concept) and there may be voluntary disclosure programs to mitigate the penalty.
  5. As with other international form filing penalties, Form 8938 penalties may be reduced or eliminated if you can show IRS that the failure was due to “reasonable cause” (a much-litigated concept) and there may be voluntary disclosure programs to mitigate the penalty.

Taxation of Cybercurrency Exchanges

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Internal Revenue Code Section 1031 defers taxation involving exchanges of like-kind property held for investment or business. If a taxpayer traded one parcel of real estate for another, the transaction is, in general, tax-free. Congress changed Section 1031, commencing January 1, 2018, applying it solely to real estate. But what about exchanges of cryptocurrency prior to January 1, 2017; did they qualify for tax-free treatment? Tax experts reasoned that a swap of one cryptocurrency for another probably fell within Section 1031 and was not taxable.

IRS Memorandum

On June 8, 2021, IRS published a Memorandum (Number 2021124008, appended to this article) stating that exchanges involving swaps of Bitcoin, Litecoin, and Ether were not covered by Section 1031 because of differences in overall design, intended use and actual use. This Memo should apply to practically all pre-2018 cybercurrency swaps. Note: although the Memo is not law and the courts are not bound by it, it is followed by IRS so expect audits of pre-2018 cryptocurrency exchanges.

While the like-kind exchange rules are broadly interpreted for real estate, the same is not true for other assets. IRS has ruled that gold is not like-kind to silver and a bull is not like-kind to a cow. Cybercurrencies are intangible assets and the exchange rules for intangibles are much more restrictive than real estate; thus, successfully challenging the Memo could be problematic, if not futile.

Amending Your Return

So, should you amend your pre-2018 tax return to report cybercurrency exchanges? The answer may depend on whether the applicable statute of limitations for tax assessments has expired. The usual rule is three (3) years from the date the return was filed, so assessments for the 2017 tax year (assuming the return was filed on the due date, April 15, 2018), would have expired on April 1, 2021 (or will expire on October 15, 2021 if an extension was filed). There is a special six (6)-year statute of limitations when, in general, taxpayers fail to report more than 25% of their gross income1. Unless the exchanges were properly reported on Form 8824 or IRS was otherwise adequately notified of the transactions, expect the six (6)-year statute to apply.

As a practical matter, taxpayers claiming exchange treatment would have filed Form 8824 so the 3-year statute should apply for pre-2018 exchanges2. Note; If there was tax fraud with the return, there is no statute of limitations for assessment.

Conclusion

Taxpayers who timely and accurately reported their cryptocurrency exchanges for tax years prior to 2018, the statute of limitations for assessment will have expired (or will expire on October 15, 2021 if the return was on extension). If they failed to report their exchanges and the omitted gross income amount exceeding 25% of the income reported, the special six (6)-year assessment period applies, which means IRS could assess back taxes, penalties and interest for tax years 2015, 2016 and 2017.

1 Example: If a taxpayer files a return reporting $100,000 of gross income the omitted income must be at least $25,000 for the six(6)-year statute of limitations to apply.

2 The 6-year statute does not apply when IRS has been adequately apprised of the potential omitted gross income and filing Form 8824 puts IRS on notice of the exchange transactions.

Taxation of Student Athletes

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With the recent Supreme Court decision in NCAA v Alston (decided June 21, 2021), student athletes may now capitalize on their name, image and likeness (NIL), similar to professional athletes. Depending on the annual revenue, athletes may need to engage in complex and sophisticated business and tax planning, as this income, along with associated deductions, must be reported on federal and state tax returns.

The first major issue involves state income taxes. The default rule is that a student’s residence is where they lived before attending college; thus, a student living in California (a high-tax state) who plays football for the University of Miami (a no-tax state), will be taxed as a California resident, even though they are living in Florida. The athlete may change residence to Florida, but there are detailed steps to this process, including, in most cases, a waiting period and a showing of financial independence.

Student athletes earning NIL money are treated just like anyone else. This means reporting and paying taxes on the income and the potential for being sued; therefore, they should consider forming a limited liability company (LLC) or corporation for asset protection. Depending on the future earnings and whether the athlete wants to grow their brand, a traditional C corporation may be the best tax-planning option. Keep in mind that if you are coaching someone and they are injured, you could be liable for damages, that’s why you want to have a limited liability entity handling your business affairs. Another realm for potential legal liability is intellectual property (including trademark) infringements and contract disputes.

Even if an athlete successfully changes residence to Florida, many states will tax income derived from being physically present in that state. For instance, if the Florida resident comes to California for an autograph signing event, California could tax the revenue because the athlete was physically present in the state earning income.

Also, watch out for in-kind payments: the car dealer who gives the athlete a car – the value of the car is considered income so unless there are other sources of income to pay the taxes on this income, they could have a large tax liability without the funds to pay it. This applies to many types of non-cash property and benefits, such as non-business-related airline flights, hotels and meals, gift bags, clothing and assorted bling.

Although not a tax issue, to successfully capitalized on your NIL, consider the advice David Grohl (Foo Fighters) received to grow his fortune to more than $300 million. The story goes that he asked Paul McCarthy (Beatles) how to prosper in his musical career and was told never to sell anything he created1 and retain total control over every revenue source, especially his musical catalog. The lesson: never, ever, sell or transfer any ownership of your NIL, always license it.

Conclusion: Capitalizing on your NIL is fraught with potential pitfalls and traps. Obtain the best tax and legal advice before moving forward. Protect yourself with a limited liability entity (an LLC or corporation) and always retain full ownership and control of your NIL.

1 The Beatles music catalog was sold to Michael Jackson in 1985 for $47.5 million. It is now currently worth around one billion.

FBARS: Is Your On-Line Gambling Or Virtual Currency Account Reportable?

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With certain limited exceptions, U.S. taxpayers with one or more foreign bank and investment accounts containing at least $10,000 (in cash or assets) in the aggregate during the calendar year must file an FBAR (Report of foreign bank and financial accounts), FINCIN Form 1141. This obligation is separate from your obligation to file income tax return. See Appendix “A” for a detailed explanation regarding FBAR filings. 

What is a foreign financial account for FBAR purposes? 

If you have an on-line gambling account hosted in a foreign country in which you deposit funds to gamble, is it a foreign bank account? A federal district court said yes, but it was overruled by the Ninth Circuit Court of Appeals in U.S. v Hom (decided in 2016), in which the court held that merely having a foreign account that primarily facilitated online gambling, without additional characterizes of a financial account or bank – such as the transfer of funds from one financial institution to another, or providing interest-bearing accounts or lending services – was not a bank for FBAR purposes. Unfortunately, the Hom case was designated as “unpublished” and cannot be used for legal precedent; although, it appears that FinCEN has backed off challenging on-line gambling accounts for the time-being. 

What about a foreign virtual currency account? 

The same reasoning under Hom should apply to these accounts. But there is good news and bad news concerning virtual currency accounts: Currently, FinCEN’s position is they are not reportable on an FBAR; the bad news – FinCEN is drafting regulations to make them FBAR reportable. Expect the regulations to be finalized in 2021 or 2022. 

 Conclusion: 

If you currently have unreported on-line foreign gambling or virtual currency accounts that lack any traditional banking attributes, you probably do not have a FBAR filing requirement. For virtual currency accounts, this will change once Fin CIN publishes regulations requiring FBAR reporting in the near future. 

 1 FinCEN means Financial Crimes Enforcement Center and is part of the U.S. Treasury. 

Appendix “A” 

Taxpayers with an ownership interest or signature authority over foreign financial accounts (bank and brokerage accounts, corporate, trust and other entity accounts, certain retirement plans and life insurance with a cash value) are required to file an annual Foreign Bank and Financial Account Reports (FBARS) on-line with FinCEN. Starting with the 2016 FBAR, the due date is the due date of the 2016 income tax return, with regard to extensions. Both current and delinquent FBARs must be filed on-line: FBAR On-line. 

To determine the value of a foreign account during the year, the highest value of the account during the year is multiplied by the U.S. dollar exchange rate at the end of the year, using the U.S. Treasury Exchange Rates. If the rate is not available, then use any recognized exchange rate service. 

The maximum fine for a non-willful failure to timely file an FBAR is $10,000 and there is a six-year statute of limitations for assessment of the penalty (thus, there can be $60,000 in penalties, one for each delinquency). The penalty may be reduced or eliminated upon a showing of “reasonable cause,” which mean, basically, that taxpayers were not negligent in their failure to comply. There is an amnesty program if taxpayers reported their foreign financial account income and gains, but failed to file FBARS. 

For willful violations, the penalty can be as high as 50% of the highest amount in the accounts during the past six years or $129,210 (increased for inflation), whichever is greater, and IRS has a string of recent federal court victories upholding the imposition of willfulness penalties. Willfulness includes objectively reckless behavior in additional to intentional conduct. In a recent case, Horowitz, No. 19-1280 (4th Cir. 10/20/20), the court of appeals upheld a willfulness penalty where taxpayers failed to disclose to their accountants the existence of foreign accounts and checked the box “no” on Schedule B, Part III (that asks whether you have foreign accounts).

Understanding Form 3520, Reporting Foreign Gifts

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Little-known Form 3520 is required for reporting gifts or inheritances received from one or more foreign individuals totaling $100, 000 or more during the calendar year. Attorney Robert L. Sommers is based in San Francisco and is a Certified Tax Specialist, California Board of Legal Specialization, State Bar of California. He has represented hundreds of U.S. and foreign individuals and small companies on a variety of U.S. and foreign tax, business, and estate planning matters. A major portion of his practices involves foreign tax issues and obligations, including unreported foreign income, assets, gifts/inheritances and accounts. Bob explains the requirements and severe penalties if Form 3520 is not timely and accurately filed. This is the first in a series of Boomer Bob’s Tax Cafe and Coffee Bar videos, providing tax news you can use.

U.S. Tax Laws Involving Foreign Income, Assets and Financial Accounts

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1. U.S. Taxpayers (generally individuals physically present in the U.S. 121 days or more during a calendar year, long-term residents and citizens) must report their world-wide income, credits and deductions on U.S. tax returns (Form 1040) and, in general, are entitled to foreign tax credits for income taxed by a foreign country. Non-residents are subject to U.S.: (i) income tax on their U.S. source income; and (ii) estate tax on their U.S. property, including real estate and securities (stocks, bonds and debt instruments) of U.S. companies and individuals. See IRS Publication 54 (also available as a .pdf) for details. 

2. U.S. Taxpayers with an ownership interest or signature authority over foreign financial accounts (bank and brokerage accounts, corporate, trust and other entity accounts, certain retirement plans and life insurance with a cash value) are required to electronically file an annual Foreign Bank and Financial Account Reports (FBARS) on or before the due date of their income tax return for the following year. The maximum fine for non-willful failure to timely file an FBAR is $10,000 and there is a six-year statute of limitations for assessing the penalty. The penalty may be reduced or eliminated upon showing “reasonable cause.” 

3. In addition to the FBAR requirement, starting in 2011 U.S. taxpayers with foreign financial account and certain other financial assets (generally, stock or securities, including certain employee stock benefit plans) must report those assets on Form 8938, which is filed with the Form 1040. The threshold filing requirements start at $50,000 for single taxpayers ($100,000 1 for married couples filing joint returns) living in the U.S. 

4. U.S. Taxpayers who have a 10% or greater interest in a foreign corporation must file Form 5471 with the Form 1040. There are equivalent filing requirements for 10% or more ownership in a foreign partnership. 

5. U.S. Taxpayers who receive a foreign gift or inheritance from an individual of more than $100,000 during the calendar year must file Form 3520 to report the gift or inheritance. The due date of Form 3520 is the same as the Form 1040, and is extended if a valid extension is filed for the Form 1040. The threshold reporting requirement for a gift from an entity or trust is much lower. 

6. U.S. Taxpayers who earn wages or self-employment income while residing outside the U.S. may be entitled to a foreign earned income exclusion if they are considered residents of a foreign country or remain outside the U.S. for a period of 330 days during any 12-month period. The maximum income exclusion is $104,100 for 2018. The exclusion must be claimed on a timely filed U.S. tax return, it is not automatic. There is also a partial exclusion for housing costs, if they exceed a certain minimum. 

Let’s Audit Trump’s Tax Returns

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To understand some of the issues contained in Trump’s tax returns, let’s assume the role of an IRS auditor and examine Trump’s tax returns based on the information available in news reports, principally the New York Time’s (NYT) massive investigation published on September 28, 2020.

1. Disguised Gifts:

Fred Trump (Donald’s father) apparently made numerous disguised gifts to his children, designed to avoid gift taxes and that Donald has been following in his footsteps (“like father, like son”) with suspicious payments in 2017 to Ivanka of $747,600 for “consultant” fees, when she received a salary of $2.0 million working for the Trust Organization.  At first glance, if Ivanka pays income taxes on the consulting fee, what’s the big deal – the government collected the income tax, whether it was from Donald or Ivanka. We’d want proof that Ivanka actually paid taxes on the money and did not generate dubious deductions to offset the income, such as non-deductible personal expenses.

If the consulting fee was a disguised gift, Trump would owe gift taxes on the $750,000 at a rate of 40% ($300,000) in addition to the income taxes he’d owe on the non-deductible transaction, a combined federal tax approaching 80%, plus applicable state taxes.  Under the tax law, if we assert a gift tax, the burden of proof is on Trump to show there was not a gift, our determination is presumed to be correct.

By doing this numerous times, Trump would be transferring wealth to his children, grandchildren or other family members without paying gift taxes, just like his father, a generational family tax dodge.  Because the transaction was not reported as a gift, there is no statute of limitations, which means we could go back 20 years or more and audit each and every transfer from Trump to his children, grandchildren or other family members, searching for disguised gifts.  The penalty for failure to report gifts is 20% if the actions were negligent and 75% if they were fraudulent.  Depending on how consistent the pattern was, there could be sufficient evidence to assert a fraud penalty, which means if there were $1.0 million in gift taxes, the penalty would be an additional $750,000.

Conclusion:  Trump has huge exposure to gift taxes, penalties and interest.

2. Deducting Personal Expenses

The press is all a flutter about Trump deducting his hair cuts and personal care.  Flat out: these are non-deductible personal expenses.  The IRS and courts have ruled time and time again that expenses for personal appearance and clothing (except for uniforms worn by police and firefighters, for example) are not deductible.  There have been specific cases involving athletes (a tennis pro cannot deduct shoes or clothing because those items can be worn outside of playing tennis), similarly, a newscaster cannot deduct suits and ties worn on camera for the same reason. That means Kim Kardashian cannot deduct payments to her “booty” tailor; however, Lady Gaga can deduct her meat dress since it is not practical to wear it off stage (especially if she works as a dog walker….)  IRS has expressly ruled that expenses to enhance one’s personal appearance cannot be deducted, even if the goal is to generate income. 

The NYT article describes several other instances where Trump improperly deducts personal expenses.  One involves a vacation home in which he claims was a rental property, although his children have stated the property was used exclusively by his family.  Since deducting personal expenses appears to be a favorite tax dodge by the Trumps, we’d want to audit other family members to make sure they are not doing the same thing.  The penalty for this misconduct is usually negligence, but if it is blatant and repeated, fraud penalties could apply.

Conclusion:  This is a no-brainer, Trump cannot deduct his personal expenditures.

3. Deducting Real Estate Losses Against Non-Real Estate Income.

The NYT article stated that a special provision allows real estate developers to deduct their real estate losses against non-real estate income.  As a general statement, that is incorrect; a taxpayers must be considered a “real estate professional” under a set of stringent factual tests supported by sufficient evidence, before they are permitted to use real estate losses to offset other income and the test is reapplied for each tax year. 

When Trump became involved with the Apprentice in 2004 through 2016 and then president thereafter, he could no longer qualify as a real estate professional.  Indeed, Trump paid millions in taxes from on the earnings from the Apprentice during tax years 2005-2007, which indicates that he did could not use real estate losses to offset this income.  

After 2004, the NYT article establishes that Trump was in the entertainment and licensing business and was not a real estate professional.  Thus, his entertainment and licensing profits were taxable to him without reduction or offset by real estate losses.  As auditors, we’d look to see whether Trump deducted real estate losses against his non-real estate income. The NYT article indicates tax year 2009 and future years are remain open for audit. 

Conclusion:  If real estate losses generated after 2004 were used to offset entertainment or licensing fee income, those losses should be disallowed.

4. Trump’s Current Tax Audit

According to the NYT, IRS is auditing Trump for his claim of a refund for taxes paid on his earnings from the Apprentice and other licensing ventures. Trump paid taxes totaling $72 million in 2005, 2006 and 2007, then the great recission of 2008 hit the US and the Obama administration in 2009 changed the law to allow the carryback of losses for four years.  In 2009, Trump declared losses of $600 million and carried them back to tax years 2005-2007, claiming a full refund of $72 million in taxes.

From all indications, the dubious transaction (a purported “abandonment” loss) occurred after Congress was considering a change in the law and was devised solely for tax benefits.  A bedrock tenant of tax law is that a transaction must have economic substance apart from its tax benefits, so even if the abandonment transaction was within the literal provisions of the tax code, it must first pass muster under the economic substance doctrine.  This transaction may have been concocted after it was apparent that the loss carryback rules were being changed and devised solely with the purpose of claiming a tax benefit. At this point, there is not enough facts or evidence to analyze wither the economic substance doctrine applies.

Assuming the transaction is not stymied by the economic substance doctrine, the tax code does not allow a taxpayer to claim an abandonment loss that easily.  For an abandonment loss to offset ordinary income, the taxpayer may not have received any income or economic benefit from the transaction.  Relief of debt (failure to repay the debt in full) is considered income, which means that Trump had to own the investment free and clear of any debt, which goes against his established business practice of being leveraged (in debt) to the hilt.

If Trump received anything of value — note, the NYT reports Trump received a part of his abandonment transaction a 5% equity interest in new company — then the abandonment rules do not apply.  In addition, there is an obvious issue of whether Trump truly had $600 million in losses.  Remember, if he financed his interest in the transaction, in general he has offsetting income to the extent he was relieved of debt, meaning if he had $600 million of losses, but was relieved of debt by $550 million, losses are limited to $50 million and would be characterized capital losses ineligible to offset the ordinary income he earned in tax years 2005 through 2007.  In short, it is extremely doubtful Trump can successfully run the gauntlet of the economic substance and abandonment rules, which means he could owe IRS $100 million in taxes, penalties and interest if his refund is denied, plus additional taxes, penalties and interest from tax year 2009 forward.

5. Conclusion:

Although the press has been packed with articles about how the tax code is unfair and is gamed by the wealthy (which is certainly true), Trump’s tax planning seems to consist of potential fraud, phony deductions, disguised gifts, and overstatements of losses, rather than sophisticated gaming of the tax code.  IRS has him in their gunsights, whether they pull the trigger is a political issue rather than an application of the tax code.  In Trump’s case don’t blame the tax code, blame the taxpayer.

IRS is Gunning for Unreported Cryptocurrency Transactions

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Note: For more information on cryptocurrency taxation and tax planning strategies, purchase my Tax Brief for just $9.95: Cryptocurrency Income Tax Planning: A Tax Brief

Warning Letters:

It’s been all over the news that IRS mailed 10,000 letters to potential cryptocurrency participants, warning them that IRS suspects they have engaged in cryptocurrency transactions (IRS uses the term “virtual” currency) and reminding them to report gains and losses. IRS has received substantial information from Coinbase, which was obligated under court order to turn over transaction records. Coinbase subsequently supplied detailed information on more than 14,000 customers. Using its success against Coinbase, IRS is targeting other on-line exchanges with similar lawsuits and the court have thus far sided with the government.

If you receive an IRS warning letter, treat it very seriously. One letter asks you to sign under penalty of perjury that the response information is correct.1 It unwise to reply without first obtaining professional advice because signing under penalty of perjury could lead to criminal perjury charges if IRS already has or obtains information contradicting your written declaration.

WATCH THIS SHORT VIDEO

IRS Audits:

It is now IRS standard audit practice to inquire about cryptocurrency investments. Remember that IRS may already have this information and submitting a false response could lead to criminal charges or severe civil (non-criminal) penalties.

New Tax Return Question:

Starting tax year 2019, Form 1040 (Individual Income Tax Return), Schedule 1 poses the following question: At any time during 2019. did you receive sell send, exchange or otherwise acquire any financial interest in any virtual currency?

1]  The three letters are attached to this article.
2]  See the attached tax form.

You must answer that question “yes” or “no” under penalties of perjury. If you did not have transactions in 2019, there’s nothing to report and you can safely answer the question “no.”

If you answer the question “yes” and report your taxable cryptocurrency transactions, there is no reason to believe IRS will automatically audit you. If you answer the question “no” and IRS has information to the contrary, you could land in big trouble; if you intentionally failed to report your cryptocurrency transactions, in addition to taxes, penalties [3] and interest, you could be staring at federal criminal perjury or tax evasion charges. Note: failing to respond when you have significant cryptocurrency transactions is considered the same as marking the box “no.”

Conclusion:

IRS is aggressively pursuing on-line exchanges for information and forcing taxpayers to disclose cryptocurrency transactions with written responses made under penalties of perjury. If you have not reported your cryptocurrency transactions, it behooves you to get into compliance as soon as possible. Deceiving IRS by falsely claiming you do not have any transactions can lead to civil fraud penalties, perjury charges or possibly criminal tax evasion charges, depending on the severity of the situation.

[3] The typical negligence penalty is 20% of the tax due,; however, if there was fraud, the penalty can be 75% of the taxes due. Misleading IRS by falsely checking the box no is an indicator of fraud.