Category: Tax Filing Requirements

The Unresolved Tax Consequences Involving Cybercurrency Staking

Posted on by sommers

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?

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 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.

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.