Tag: crypto trading tax tips

Why Is An Old Law Still Relevant For Like-Kind Exchange (LKE)?

Find out why an old law is still relevant for using like-kind exchange (LKE) for crypto returns before the 2018 tax year.

Like-kind exchange (LKE) can still be used for cryptocurrencies for returns before the 2018 tax year (Footnote 1). Returns can be amended to add Form 8824 to report like-kind exchange (LKE) exchange transactions that had never been reported. The purpose of doing this is to avoid the risk of an audit of unreported income and associated penalties and interest. The penalties include a 20-40% accuracy penalty.

Returns that had reported crypto-to-crypto trades on Form 8949 can be amended to reduce tax liabilities or claim refunds for 2017.  I have gotten refunds of over $396,000 by doing this for clients.

How did Congress change the like-kind exchange (LKE) law?

like-kind exchange (LKE)

In December 2017, Congress passed the TCJA bill, which among many other things, limited the use of like-kind exchange (LKE) to real property like land or buildings.

Why did Congress change section 1031 for like-kind exchange (LKE)?

like-kind exchange (LKE)

The like-kind exchange (LKE) section has been in the tax code since 1921, with only minor changes (footnote 2). The purpose of the law was to promote investment by not taxing exchanges unless there was a distribution of gain. For this reason, the courts have taken a liberal view to interpret the laws to the benefit of taxpayers (footnote 3).

In the original version of the 1921 law, property had to be held for at least two years before benefiting tax-deferred exchange. The purpose of the holding period was to differentiate between speculative and investment property (footnote 4). In 1924, the law was changed to require the property to be of like-kind exchange (LKE)  to receive deferred tax treatment (footnote 5).

As a result of losses in court, the IRS has issued many administrative rulings to reign in abuse. The Volker Report identified aggressive use of Section 1031 as distorting the financial system leading up to the 2008-2009 financial crisis (footnote 6).

By 2014, several concerns were being raised. The sharp increase in deferred gain reported on Form 8824 meant that too much tax was being avoided by like-kind exchange (LKE). Another ongoing concern is that like-kind exchange (LKE) allowed the investments to grow without tax until the investor died.  After that, they could also be transferred tax-free to an inheritor. This last concern became compounded by the rise of cryptocurrencies, which allowed the investor the possibility to never return to fiat and be taxed.

What is the statute of limitations of a crypto tax return?

The statute of limitations is a legal time limit on how long the IRS has to find errors in a tax return. It is a form of taxpayer protection. The primary limit is three years after a return’s filing due date (footnote 7).  The second limit is two years after all tax liabilities are paid. This second limit doesn’t affect people who pay off their taxes on the due date.

However, if a return is fraudulent or was a willful attempt not to pay taxes, then there is no statute of limitations. Crypto traders who intentionally didn’t report their crypto gains in 2017 or other years are at risk.   The amount of income hidden would have to be significant for the IRS to press this claim.

Another exception is if the unreported income is related to foreign financial assets and is greater than $5000. When this happens, the statute of limitations on auditing is six years (footnote 8). What is a foreign financial asset?  An asset is considered foreign when the issuer or counterparty is other than a U.S. person (footnote 9). When you trade on a non-SEC registered crypto exchange, your trades are matched up with an anonymous person whom you can not prove is a U.S. person; therefore, you have to assume that he is not a U.S. person (footnote 10).

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Footnotes

  1. Eli Cole, “Cryptocurrency and the Section 1031 Like Kind Exchange” Hastings Science and Technology Law Journal Winter 2019 10:1, p 102.
  2. Marjorie E. Kornhauser, “Section 1031: We don’t need another hero”, 1987 Southern Cal Law Review 60:397.
  3. Kornhauser, P397
  4. Kornhauser, p418
  5. Bradley T. Bordon and others, “To Repeal or Retain Section 1031: A Tempest in a $6 Billion Teapot”. ABA Taxation News Quarterly 34:1 13 May 2015 < https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2603878> accessed 22 Jun  2020, p1.
  6. Bordon p18.
  7. IRC 6501(a)
  8. IRC 6662(j)
  9. IRC 6038D(b)(2)(B)
  10. As of 8/16/2020, I have not heard of the IRS pressing this exception to the Statute of Limitations on crypto tax returns.

IRC Section 1031: Like-Kind Exchange Treatment Of Cryptocurrencies Explained

Crypto tax expert explores the controversial position of IRC section 1031 and the use of Like-Kind Exchange for crypto taxes.

Applying the like-kind exchange treatment is a controversial position in crypto taxation, where exchanging one cryptocurrency for another qualifies for tax-deferred treatment under IRC section 1031.

In my previous article, I explained how Donnelly Tax law is on the bleeding edge of like-kind exchange (LKE) with two open audits being reviewed by the IRS.  

I explained how like-kind exchange (LKE) could save crypto traders a lot of money on their crypto tax bill.  

Today, I will lay out the legal case for like-kind exchange (LKE) by exploring the controversial position that exchanging one cryptocurrency for another qualifies for tax-deferred treatment under IRC section 1031.

IRC Section 1031: Cryptocurrencies Are A Specific Class Of Property

IRC Section 1031

26 CFR 1.1031(a)-2 states the “nonrecognition rules of section 1031 do not apply to an exchange of one kind or class of property for property of a different kind or class.” The asset classification rules of 1.1031(a)-2(b) do not apply to cryptocurrencies because they are not tangible property. There are no classes for intangible property. (Footnote 1)  

Interestingly, IRS Notice 2014-21 classified all cryptocurrencies as “convertible virtual currencies,” a sub-class of virtual currencies which satisfies the requirement that exchanged property be of the same kind or class.

IRC Section 1031: Cryptocurrencies Differ Only In Grade Or Quality, Not Nature Or Character

In determining when a property is of like kind, “The words like kind have reference to the nature and character of the property and not to its grade or quality,” according to 26 CFR 1.1031(a)-1(b).

With regard to intangible property, the regulations state:

“Whether intangible personal property is of a like kind to other intangible personal property generally depends on the nature or character of the rights involved (e.g., a patent or a copyright) and also on the nature or character of the underlying property to which the intangible personal property relates.” (Footnote 2)

The nature and character of a cryptocurrency are that it is a digital store of value using bytecode recorded on a blockchain using a cryptographic method. Variations in bytecode instruction set or blockchain protocols are just matters of grade or quality. 

When the IRS determined that the exchange of an FCC license for a radio frequency  was a like-kind exchange for a television frequency, they stated:

 “Even the narrowest interpretation of the like kind standard does not require that one property be identical to another or that they be completely interchangeable. Thus, we find that the differences in the assigned frequencies are not differences in nature or character, but are merely differences in grade or quality.” (Footnote 3)

Five years later, A similar conclusion was given by the IRS regarding matters of grade or quality:

“We note that the bandwidth of a particular frequency dictates the amount of information that the frequency can carry. In comparing the nature or character of the assigned frequency of the electromagnetic spectrum referred to in each FCC license, it is clear that the spectrum rights transferred by the Taxpayer have different bandwidths from the spectrum rights received by the Taxpayer. However, even the narrowest interpretation of the like kind standard does not require that one property be identical to another or that they be completely interchangeable. As stated earlier, the spectrum rights being transferred by the Taxpayer to AA and the spectrum rights being received by the Taxpayer from AA are all suitable for use in the Taxpayer’s business of providing Services. Thus, we find that the bandwidth differences in the spectrum rights being transferred and being received in this exchange, which underlie these FCC licenses, are not differences in nature or character, but are merely differences in grade or quality, and thus constitute like-kind property.” (Footnote 4)

IRC Section 1031: Pre-TJCA Wording Of Section 1031

IRC Section 1031

The TCJA amended the wording of section 1031 primarily by limiting section 1031 to only apply to real property effective January 1, 2018. In Appendix 1, I have reconstructed the pre-TCJA wording of section 1031.

Cryptocurrencies Are Held For Investment Purposes

Cryptocurrencies reported were held for investment purposes, according to IRC 1031(a)(1). This is the primary motivation for owning cryptocurrencies.

Exception For Property Held For Sale Doesn’t Apply To Cryptocurrencies

IRC 1031(a)(2) does not prohibit like-kind exchange between cryptocurrencies because cryptocurrencies are not one of the listed exceptions. Clearly, cryptocurrencies are not forms of stock-in-trade, property held primarily for sale, stocks, bonds, notes, interests in partnerships, certificates of trust or beneficial interests, or choses in action.

Cryptocurrencies do not qualify as “other securities”. This IRS code section doesn’t provide or refer to  a definition of “other security”. The IRS has not issued any direct guidance regarding the issue of whether cryptocurrency is a security. 

The Security and Exchange Commission (SEC) issued a 2017 report on cryptocurrencies. The SEC uses a four-prong test, known as the Howey test, to determine if a property is a security: “A [security] is [1] an investment of money [2] in a common enterprise [3] with a reasonable expectation of profits [4] to be derived from the entrepreneurial or managerial efforts of others.” (Footnote 5) The advancement of cryptocurrencies are not related to the ongoing entrepreneurial or managerial efforts of other persons, but rather to consensus algorithms.

IRC Section 1031: Procedural Requirements For Completing Section 1031 Exchanges

IRC Section 1031
  1. IRC 1031(a)(3) requires that property to be exchange be identified and the exchange happen within certain time limits.  Exchanges on cryptocurrency exchanges are instantaneous. The property given up and the property received are clearly identified at the time of the exchange.

  2. IRC 1031(b) and (c) don’t apply on cryptocurrency exchanges because only cryptocurrencies are exchanged and no other property.

  3. IRC 1031(f)  regarding related persons is not applicable because on cryptocurrency exchanges, the parties are anonymous to each other because they are matched up by an exchange. After the transaction, both parties remain anonymous. The possibility that a transfer would occur between related parties would be coincidental, unintentional, and unknown to the parties.

Receipt Of Other Property

The nature of online exchange of cryptocurrency is that they match buyers and sellers for exchanging assets without any other property as described in 1.1031(b)-1.

IRC Section 1031: Summary

The exchange of cryptocurrencies for other cryptocurrencies are like kind exchanges under IRC 1031 as supported by IRS Technical Advice Memorandums.

There are additional court cases that can be added to the evidence in favor, but this short article lays out the key issues.

Stay tuned for the next article where I will discuss why the old law is still relevant.

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Footnotes

  1. 26 CFR 1.1031(a)-2(c)(1)
  2. 26 CFR 1.1031(a)-2(c)(1)
  3. IRS Letter Ruling 200035005, May 11, 2000.
  4. IRS Letter Ruling 200532008, May 9, 2005.
  5. See SEC v Edwards, 540 U.S.389, 393 (2004); SEC v W J Howey Co., 328 US 293, 301 (1946); United Housing Found, Inc v Forman 421 US 837, 852-53(1975)

Appendix 1: Pre-TCJA Wording of 26 USC 1031

26 U.S. Code § 1031.Exchange of property held for productive use or investment

(a)Nonrecognition of gain or loss from exchanges solely in kind

(1)In general

No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.

(2)Exception for property held for sale

This subsection shall not apply to any exchange of—

 (A) stock in trade or other property held primarily for sale,

 (B) stocks, bonds, or notes,

 (C) other securities or evidences of indebtedness or interest,

 (D) interests in a partnership,

 (E) certificates of trust or beneficial interests, or

 (F) choses in action.

For purposes of this section, an interest in a partnership which has in effect a valid election under section 761(a) to be excluded from the application of all of subchapter K shall be treated as an interest in each of the assets of such partnership and not as an interest in a partnership.

 

(3)Requirement that property be identified and that exchange be completed not more than 180 days after transfer of exchanged property

For purposes of this subsection, any property received by the Taxpayer shall be treated as property which is not like-kind property if—

(A)

such property is not identified as property to be received in the exchange on or before the day which is 45 days after the date on which the Taxpayer transfers the property relinquished in the exchange, or

(B)such property is received after the earlier of—

(i)

the day which is 180 days after the date on which the Taxpayer transfers the property relinquished in the exchange, or

(ii)

the due date (determined with regard to extension) for the transferor’s return of the tax imposed by this chapter for the taxable year in which the transfer of the relinquished property occurs.

(b)Gain from exchanges not solely in kind

If an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or of section 1037(a), if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.

(c)Loss from exchanges not solely in kind

If an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or of section 1037(a), if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain or loss, but also of other property or money, then no loss from the exchange shall be recognized.

(d)Basis

If property was acquired on an exchange described in this section, section 1035(a), section 1036(a), or section 1037(a), then the basis shall be the same as that of the property exchanged, decreased in the amount of any money received by the Taxpayer and increased in the amount of gain or decreased in the amount of loss to the Taxpayer that was recognized on such exchange. If the property so acquired consisted in part of the type of property permitted by this section, section 1035(a), section 1036(a), or section 1037(a), to be received without the recognition of gain or loss, and in part of other property, the basis provided in this subsection shall be allocated between the properties (other than money) received, and for the purpose of the allocation there shall be assigned to such other property an amount equivalent to its fair market value at the date of the exchange. For purposes of this section, section 1035(a), and section 1036(a), where as part of the consideration to the Taxpayer another party to the exchange assumed (as determined under section 357(d)) a liability of the Taxpayer, such assumption shall be considered as money received by the Taxpayer on the exchange.

(e)Application to certain partnerships

For purposes of this section, livestock of different sexes are not property of a like kind. 

(f)Special rules for exchanges between related persons

(1)In general

If—

(A)

a taxpayer exchanges property with a related person,

(B)

there is nonrecognition of gain or loss to the Taxpayer under this section with respect to the exchange of such property (determined without regard to this subsection), and

(C)before the date 2 years after the date of the last transfer which was part of such exchange—

(i)

the related person disposes of such property, or

(ii)

the Taxpayer disposes of the property received in the exchange from the related person which was of like kind to the property transferred by the Taxpayer,

there shall be no nonrecognition of gain or loss under this section to the Taxpayer with respect to such exchange; except that any gain or loss recognized by the Taxpayer by reason of this subsection shall be taken into account as of the date on which the disposition referred to in subparagraph (C) occurs.

(2)Certain dispositions not taken into accountFor purposes of paragraph (1)(C), there shall not be taken into account any disposition—

(A)

after the earlier of the death of the Taxpayer or the death of the related person,

(B)

in a compulsory or involuntary conversion (within the meaning of section 1033) if the exchange occurred before the threat or imminence of such conversion, or

(C)

with respect to which it is established to the satisfaction of the Secretary that neither the exchange nor such disposition had as one of its principal purposes the avoidance of Federal income tax.

(3)Related person

For purposes of this subsection, the term “related person” means any person bearing a relationship to the Taxpayer described in section 267(b) or 707(b)(1).

(4)Treatment of certain transactions

This section shall not apply to any exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection.

(g)Special rule where substantial diminution of risk

(1)In general

If paragraph (2) applies to any property for any period, the running of the period set forth in subsection (f)(1)(C) with respect to such property shall be suspended during such period.

(2)Property to which subsection applies

This paragraph shall apply to any property for any period during which the holder’s risk of loss with respect to the property is substantially diminished by—

(A)

the holding of a put with respect to such property,

(B)

the holding by another person of a right to acquire such property, or

(C)

a short sale or any other transaction.

(h)Special rules for foreign real and personal property

Real property located in the United States and real property located outside the United States are not property of a like kind.

(i)

For purposes of subsection (a)(2)(B), the term ‘stocks’ shall not include shares in a mutual ditch, reservoir, or irrigation company if at the time of the exchange—

 

  1. the mutual ditch, reservoir, or irrigation company is an organization described in 
  2. section 501(c)(12)(A) (determined without regard to the percentage of its income that is collected from its members for the purpose of meeting losses and expenses), and

 

(2) the shares in such company have been recognized by the highest court of the State in which such company was organized or by applicable State statute as constituting or representing real property or an interest in real property.”

Crypto Tax Expert: Like-kind Exchange (LKE) Is Highly Effective And Equally Controversial

Find out how Donnelly Tax Law is on the bleeding edge of like-kind exchange (LKE) and how it saves crypto traders big money.

Like-kind exchange is a topic fueled with such controversy that many tax professionals  disagree on it.

In an article published on Cointracker, on November 15, 2019, Christopher Wrobel (Special Counsel to the Associate Chief Counsel, IRS) walked back Suzanne Sinno’s (General Attorney, IRS’s Office of Chief Counsel) comments from two days earlier at the AICPA National tax conference in Washington, DC.

Wrobel stated, “that while like-kind exchanges are disallowed for cryptocurrency starting in 2018, for pre-2018 transactions, they are still a grey area that will be decided on a case-by-case basis.”

This controversial topic has IRS lawyers in such a twist that they’re publicly editing one another.

IRS special counsel, Wrobel, says like-kind exchange is held on a case-by-case basis, and I currently have two crypto tax audit cases heading into review with the IRS special counsel. 

We have written the legal briefs in the IRS’s hands right now with a reasonably compelling argument for like-kind exchange.  

That puts Donnelly Tax Law on this controversial topic’s bleeding edge with two open audit cases containing significant arguments for like-kind exchange. 

Like-kind exchange is no small tax savings strategy for crypto traders.  

My firm, Donnelly Tax Law, has helped taxpayers owning cryptocurrencies to avoid taxes on over $40 million in gains by using Like-Kind Exchange calculations.

This article will explain how like-kind exchange works and how it saves big money on your crypto taxes.

What is like-kind exchange (LKE)?

like-kind exchange (LKE)

Like-kind exchange (LKE) is the way most crypto traders agree cryptos should be taxed. You only are taxed when you convert back to cash. The U.S. tax law permitted this type of trading under section 1031, frequently called “like-kind exchange” (LKE).

An easy way to think of this is that the second property inherits the original property’s purchase price (basis) and purchase date during an exchange.

How does like-kind exchange (LKE) defer the gain until profits are taken?

Section 1031 allows the deferring of gain when exchange property.

For example, say you buy $2000 of BTC. When the value reaches $3000, you exchange the BTC for XRP. The gain of $1000 is considered deferred.  The cost basis of XRP is the same as BTC or $2000. If XRP is later sold for $5000 in fiat USD, the gain would be $3000 because the cost basis is $2000, not $3000.

Like-kind exchange (LKE) treatment does not make the gain tax-free.  The gain is deferred. It is eventually taxed as sold for fiat.

Deferring gain is important, especially when prices drop. Consider our example above. The price of our XRP holdings had collapsed to $2500. The gain when going to fiat would be only $500. The taxpayer is saved from having to pay tax on earlier gains, which later evaporated.

How do like-kind exchange (LKE) trades qualify quicker for long-term rates?

like-kind exchange (LKE)

Since the second property inherits the first property’s purchase date, it qualifies for long term capital gain tax rates sooner when converting to fiat. Once a property is held for over a year, it qualifies for long term capital gains taxes, usually 15%. (Footnote 1)

How does like-kind exchange (LKE) reduce penalties and interest?

Here is where like-kind exchange (LKE) gets exciting for crypto traders.

Tax returns for 2014 to 2017 can be amended to report the like-kind exchanges without incurring an additional tax liability. This technique removes the audit risk of unreported crypto trades. There are no penalties or interest risk for reporting like-kind exchange (LKE) trades because there are no additional taxes owed.

The IRS charges an accuracy penalty and interest when it discovers unreported gains. Many customers come to me with unreported gains, especially for the 2017 tax year.

Would like-kind exchange (LKE) help me?

like-kind exchange (LKE)

Like-kind exchange (LKE) is recommend for traders who need to report crypto-to-crypto trades before 2018. (Footnote 2)

Traders who would not benefit from like-kind exchange like-kind exchange (LKE):

One trader claimed he did crypto-to-crypto trades but turned out he always went back to cash before buying the next crypto. 

One trader had huge crypto-to-crypto trade gains, but on December 28, 2017, he panicked and sold everything for cash. A day later, he reinvested all the cash back into cryptos.  By cashing out, he had to recognize all the capital gains.

Why like-kind exchange (LKE) is the best way to report 2017 gains?

Consider this scenario: An investor buys 10 BTC on 1/1/2017 for $9600. On 12/21/2017, he exchanges the 10 BTC for 535 LTC at a fair market value of about $162,000. LTC price declines until he relents and sells all the LTC on 12/30/2018 for $17,000. Assume that the investor was in the 33% tax bracket in 2017 and the 32% tax bracket in 2018. Long term capital gains rate is 15%.

If the investor were to report each trade as capital gain, what is the tax impact?

Capital Gain Scenario: The investor pays $50,160 in taxes in 2017. But the gain of $152,000 is illusionary. In 2018, the market collapsed, resulting in a $145,000 loss.  BUT, there is a $3000 limit on claiming a capital loss, so the capital loss carryover to 2019 is $142,000. The net tax burden over the two years for this transaction is $49,160.

like-kind exchange (LKE)

Like-Kind Exchange Scenario: Under like-kind exchange, the investor pays no tax on the trade in 2017. The LTC inherits the original purchase price and purchase date of the BTC when treated as a like-kind exchange. This is shown in red down below. Although prices dropped in 2018, the selling price is still higher than the original price of the BTC, so there is a small gain. Since the holding period is extended because of like-kind exchange (LKE), the sale is taxed at lower long term gain rates. The net tax burden over the two years for this transaction is $1,110 or a savings of $48,050.

like-kind exchange (LKE)

Amending Returns to add LKE: If this investor hadn’t reported his gains in 2017, amending his 2017 and 2018 returns results in a smaller tax using like-kind exchange (LKE). Also avoided are the substantial late payment penalty and interest on taxes.

Will using like-kind exchange (LKE) attract an audit?

Original filing of a like-kind exchange (LKE) return has never generated an audit for my clients.

Can a return be amended to use like-kind exchange (LKE)?

like-kind exchange (LKE)

I have filed dozens of like-kind exchange (LKE) returns without audit. The only time I have difficulty is when a large refund is claimed on an amended return. This gets an extra review, but you should still get it if you are entitled to a refund.

One client was selected for audit, but this was related to unreported K-1 income.

Is using like-kind exchange (LKE) legal?

In December 2017, Congress passed the TCJA tax law, which modified Section 1031, limiting like-kind exchange (LKE) to only real estate.  Over the prior decade, section 1031 was used for more purpose to defer gain. There was a debate; it was time to limit the application of 1031.  It was not because of cryptocurrencies alone that it was changed.

The law only applies to tax years 2018 and forward.  The law doesn’t apply to prior years. The law change has no implications for the legality of non-real estate like-kind exchange (LKE) trades in prior years.

If you are looking for some formal IRS document that says like-kind exchange (LKE) is permitted for cryptocurrency trades, it doesn’t exist. It will never exist.  The IRS tries to educate taxpayers on what the tax law and regulations specifically say.  They leave the application up to you.

Stay Tuned

Stay tuned, or subscribe to my newsletter, for my next post where I lay out the legal case for like-kind exchange (LKE) by exploring the controversial position that exchanging one cryptocurrency for another qualifies for tax-deferred treatment under IRC section 1031.

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Footnotes

Footnote 1: 20% if you are in the top tax bracket.

Footnote 2: At the end of 2017, Congress changed Section 1031 to only apply to real estate

International Crypto Tax Competition – Stephan Livera Podcast: Part Four

Learn from tax experts about international crypto tax competition and determine if making a move is worthwhile.

Dennis Wohlfarth of Accointing and Clinton Donnelly of Donnelly Tax Law join Stephan Livera to talk about Bitcoin tax recordkeeping, and strategies to minimize tax. In the full podcast, we chat about:

  • Current Bitcoin tax treatment
  • Capital gains Bitcoin tax treatment
  • Bitcoin tax recordkeeping
  • Bitcoin tax strategies locally
  • Bitcoin tax strategies for those willing to go overseas
  • International crypto tax competition

In part one, we talked about Bitcoin tax treatment and Austrian economics on Stephan Livera Podcast, episode 183, and our guests were from the company Accointing and Donnelly Tax Law. 

In part two, we talked about Bitcoin tax recordkeeping.

In part three, we talked about how various crypto tax situations should be treated locally and internationally from a crypto tax law perspective.  

Today, our podcast show notes are about international crypto tax competition and determining if moving is worthwhile.

International Crypto Tax Competition

international crypto tax

What are the ways that people could explore if moving is worthwhile?

Clinton Donnelly: Let’s take the situation with someone who’s not an American.  

I’d propose that the best place for your money is to invest in the United States. 

It is the largest tax Haven in the world because the financial industry is an essential part of the US economy, and they’ve created powerful incentives to attract foreign money. 

Notably, there are zero capital gains on your crypto assets in the US if you’re a foreigner.

If you go to Bank of America, Citibank, or Wells Fargo, or any of these major banks as a foreigner, you can easily open up a bank account. But you’ll have to go there physically and open one up. 

It’s not going to be a question as to why somebody from Australia or Switzerland is coming to the US to open up a bank account because the US wants to be the world’s marketplace.

Opening a bank is not going to be a problem, and you’ll want to do it with these major banks because they’re accustomed to international wire transfers. 

Suppose you have an account at a US bank. In that case, nobody will question it from an anti-money laundering perspective if you are trying to transfer money back to Australia. As you know, it’s widely respected as opposed to a BVI (British Virgin Islands) bank or credit card. 

The US does information sharing between countries regarding how much money citizens have in foreign bank accounts.  

The US has FATCA Law. 

All the world’s banks have to tell the US (the IRS) twice a year about American bank accounts in foreign countries. In response to that, the OACD countries created common reporting standards, CRS. 

I think about a hundred countries have signed up to where once a year, they will report back the total amount of each citizen’s bank account to their home country.

And the US didn’t sign that. The US did not sign the common reporting standards. 

What that means if you have a bank account in the US, the US doesn’t tell any other country about it. So, it’s kind of ironic. 

I guess maybe that’s like being the bully. 

The U.S. demands that everybody gives information to them, but they won’t share it with anyone else. This is because the US is the most prominent financial player out there. 

So they can have this, and whereas it is considered a bit of a tax haven or a low tax jurisdiction, but for everybody who’s not a United States citizen.  Thus making it a great place to put your money because it’s a rich investment area. 

You can move your money out of cryptos when you want to put it into some of the world’s safest banks and invest in some of the best real estate in the country and Wall Street. 

There’s a lot of affluent financial areas with powerful incentives. 

You’ve just got to use a US credit card, like a Bank of America credit card that you can use buying things all over the world for the rest of your life, and your local jurisdiction would have no visibility to it unless you disclosed it to them. So that’s a very attractive thing to do without having to change residents.

Stephan Livera: That could be one idea if you don’t even want to become a US citizen. All of that by just opening an account in the US.

Then there are the other options for moving or getting residents in BVI (British Virgin Islands) or multiple places. I presume that’s also an option that some of your clients might explore.  For some of them it might be worthwhile to consider that.

Clinton Donnelly: I do a lot of consulting in this area. For virtually every country, the principle of taxation is that you’re subject to taxation if you’re in the country for more than six months. 

Typically, you’re subject to taxation on your worldwide income in that jurisdiction where you’ve lived for six months. 

Now, the US has a different tax law. They tax their citizens on their worldwide income, regardless of where they live in the world. So it’s a little different wrinkle for Americans, but a common underlying theme in international taxation is that it is based on residency. 

Residency is typically defined six-months or approximately 183 or 185 days. It varies how you define it, but roughly the six-month thing. 

This creates a massive international tax loophole, which I would call a three-country shuffle, where if you’re never more than six months in one country in a given period, you can keep moving around. It’s kind of like the digital nomad strategy. 

You keep moving around, and you’re not going to have to report taxes to anyone. So, again that’s not for a US citizen. It is assuming you’re not a US citizen. 

Now US citizens have a different problem. US citizens are taxed under income worldwide. However, two massive tax breaks are given to US citizens:

One is, for every dollar they pay in taxes to a foreign country. They get about a dollar to dollar credit back on their tax bill, which is nice. 

The US taxes are lower than most other developed countries. I have clients living in Germany, and their German tax bill is higher than their US tax bill. We still do a US return. They take the German credit, and then they don’t owe anything back to the US. 

That’s if you’re an American citizen living in a low jurisdiction where you are still going to have to report back to the US, and you’ll probably end up paying taxes back to the US.

Now for American citizens, there is a fantastic loophole called Puerto Rico. Puerto Rico is a little country South of Florida next to Cuba, and this area is a possession of the United States. It’s not a state, although there’s always talk about statehood. It’s a possession now in the US tax law. 

Puerto Rico is treated as a possession, kind of like as though you’re living in a foreign country of all of US possessions, and they’ve negotiated the right to tax their citizens. 

If you’re a Puerto Rican citizen, all your income comes from being in Puerto Rico. You do not file a US tax return. Puerto Rico pays its share to the US government on your behalf. So this creates an interesting loophole. Puerto Rico is a Caribbean country, not a lot of indigenous resources. Earthquakes, tsunamis, hurricanes have crushed them.

I mean, the country is bankrupt. However, they created an incentive called act 60 formerly, act 22, where it’s a 0% tax on your capital gains. 

So if you’re an American whale and want to do this, you can move to Puerto Rico, which does mean actually moving there. 

It’s not like, visit for a day and then go back to California. No, you are moving to Puerto Rico for at least six months of the year, in which case, 0% tax on your capital gains on the Bitcoin that you sell when you’re in Puerto Rico. This is a fantastic thing. 

Now, there are some costs.  You have to make a $10,000 donation to Puerto Rican charities. There’s a $5,000 annual fee you pay. And you’ve got to buy a house or apartment in Puerto Rico, and you can’t rent it out. There are some serious out-of-pocket costs, but it’s probably worth it for that extra 15% savings. If you were a whale Bitcoin holder in the US, that’d be the movement for you.

Stephan Livera: Fantastic. So that’s a very nice breakdown there. 

So if you’re a non-US person, it might make sense for you to do this whole three different countries, different residencies, etc. But if you’re in the US potentially, one idea is moving to Puerto Rico. 

One other idea I was interested in discussing related to what we were just saying is what it takes to break your nexus with your home country. 

So, as I understand, it’s like you have to break that six months or 180 days aspect.  

Are there any other things there that people have to think about when breaking that connection so that they can access the lower tax rate?

Clinton Donnelly: Usually, getting a divorce helps. 

I’m just being silly. 

Usually, it is the “Let me go back to visit mother” and that sort of thing, you know.  There is a bit of travel to it. If you take that strategy, you’re at least saying I’m going to be outside. 

Depending on which country you’re from, staying outside that home country for, you know, 9 to 11 months of the year, at least to break the connection.

A couple of things to think about are think of the cost of living. 

You can think about creating awareness of other cultures for your family and speaking other languages. 

There are several websites where you plug in two cities, and they’ll tell you the comparative cost of living. 

And I will tell you, it’s the cost of living that changes a lot between different countries. I just think it’s a great thing to do is once you start traveling, you get the bug. 

What I find is I’ve worked with digital nomads as they travel a bit, and then they decided to have a home base, and they stay there, you know, five months a year, and then they move around or that sort of thing.

If you are not a US citizen, if you're willing to do a three-country shuffle, put your investments in US crypto exchanges, have crypto or at least in wallets, and then use US banks. You can move towards a pretty close to zero tax situation and see the world simultaneously.

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Stephan Livera: That’s very impressive.

Exploring The Dynamic Between Different Countries Of The World And International Crypto Tax

Stephan Livera: I think another area that you were touching on as well, Clinton was just around the dynamic between the different countries of the world.

So as you said, it’s almost like there are specific pressures where some countries try to push reporting taxation levels onto others. 

But then there’s also this dynamic where you said that it’s almost like the richer countries allow individual nations to keep lower taxes and have relatively fewer rules around that. 

Could you explain that dynamic a little for us?

Do richer countries allow individual nations to keep lower taxes?

Clinton Donnelly: There was a real concern right before globalization in the eighties.  

Starting in the eighties, we had issues with international drug trafficking. We had, people like Ferdinand Marcos in the Philippines, who pretty much alluded his own country and took the proceeds and took them to Swiss and Lichtenstein banks and trusts. 

The creation of anti-money laundering laws through FATF

The international community got together and said, we have to stop this. So they created anti-money laundering laws coordinated through the financial action task force (FATF).  

The International Monetary Fund (IMF) and the (OECD) are the Organization of Economic Co-operation and Development of about 34 countries that did not like tax havens. 

For example, tax havens, like Seychelles and the British Virgin Islands (BVI), believed these little countries were siphoning off a lot of money and bringing no value to their area. So they clamped down on those using the same anti-money laundering laws, and what that ended up doing was it forced people back to the OECD countries that made it a club of the halves.

The OECD countries treat themselves as plus countries. So, that crushed the small island tax haven network. 

But at the same time, in Europe, we have rich countries like Germany and France, and we also have tiny countries, Luxembourg, Netherlands, who have tiny revenue streams. They need to allow them to have more latitude to have incentives or lower tax options to bring business there. 

The EU is excellent about that, but other countries of the world have to fend for themselves. 

This is a massive issue, by which countries compete with each other. There’s massive competition. 

The US used to have some of the highest corporate tax rates.

It was at 35%; I think France was higher. But then, the UK and Ireland slashed their corporate tax rates significantly. The UK slashed down to 20% on a phase method. Ireland brought it down for foreign countries working in Ireland down to 12.5% corporate tax. This is a big incentive and part of why Google, Facebook, and Apple all move their call centers to Ireland. 

So what the US did to change its international competitiveness is they slashed their corporate tax rates down to 21% and made it exceptionally aggressive. So it is designed to bring big companies who might have been in other countries back home to the US. There is a real war going on for multinational corporations’ tax revenues by countries that are lowering their tax rates to bring them in.

So this will only get more competitive, as people in countries start to do that, they’re going to have to fund it by putting more of the tax burden back on the individual. 

In the US, I looked at a pie chart, and individuals pay roughly 80% of all the US taxes to the IRS. The rest of it is corporate taxes. 

The argument would be, if they put a tax on companies that make sure you buy a shirt in Australia, then your shirt will be more expensive because you’re paying the company’s tax, right? 

Company taxes are indirectly taxed back on the individual. As individuals, we can vote with our feet and move just as I talked about with the three-country shuffle and keep our assets in the US. 

We see the same struggle in the US. 

We have some high tax states like California, New York, and because of remote offices and this sort of thing, people are starting to flee from big states like New York and California.

They’re not willing to pay high property taxes, high sales taxes, high-income taxes anymore.

We're in a period of transition where we as individuals have a lot of power to change our life's tax dimension and make sure we're getting as much value as we can out of the money we have to pay.

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Stephan Livera: That was an incredible breakdown. Great information there, Clinton. One of the exciting things there is that dynamic that you were teasing out: there’s this kind of competition between different countries, and for some smaller ones, like say the BVI or Vanuatu, part of the way they compete is they have low tax, etc. 

And for some of them, the offshore investment or the citizenship by investment programs that they offer a part of a good part of their taxation is part of their revenue, that’s part of how they kind of make money.

Clinton Donnelly: An interesting country in South America is a country called Panama. It’s still country, but everybody knows that if anything gets unstable, the US will invade it in a heartbeat because of the Panama Canal. 

Now, what happened is Panama has a tax regime where if a company or an individual drives their income from outside of Panama, then it’s not taxed in Panama. Okay. So it’s a true territorial system. 

What’s happened is that multinationals who want to do business all over Latin America set up their headquarters in Panama. They take all their money in Latin America back to Panama, Panama doesn’t tax it because it’s a drive from outside of Panama.

This is just a unique arrangement that has enabled Panama to attract incredible amounts of business because almost all the Latin American countries are unstable Argentina, Brazil, Colombia, and Venezuela. 

I mean, it’s a volatile mess there, but Panama has the most reliable banking system in all of Latin America. The problem is it was a bit of a shady tax haven and was blacklisted once. It’s got many issues, but it’s moving to progress and improve things, so I would keep an eye on it. 

If you were an individual living in Panama, you’re not American citizens.

So any other country, they’re not going to tax your income. 

If you’re a remote worker, because you’re getting your income from outside of Panama. It’s a lovely tropical country where they speak Spanish and a bit of English, and it’s got a great airport.

Stephan Livera: Right. And, so I guess the other thing there is, the question of getting residency, citizenship and so on. You might not necessarily need citizenship, but you might need the right to live and work there. 

Clinton Donnelly: It is easy. Go to Panama. You put down money, and you open up a bank account. 

You put $20,000 in the bank account and, you get a lawyer about $3,000. 

They can get you, what’s called a friendly nations visa, and this would be 45 countries that Panama likes. Australia is one of them, you know, all of Europe, pretty much, you get a friendly nation visa. You are now a permanent resident of Panama. 

You need to visit for two weeks every two years. But otherwise, you can set up bank accounts, and you have residency there, and you can travel all the world, still say your Panama citizen, keep your business operating out of Panama. You know, so you’re not going to be taxed cause it comes from outside of Panama. 

Stephan Livera: Yeah. It’s interesting because I’m thinking back through Bitcoin people or people who’ve famously attacked Bitcoin people like Peter Schiff, he’s in Puerto Rico, as I understand.

I think even Eric Vorhees has talked about it and went to. I think, but I’m not sure. Correct me if I’m wrong, but I think he might’ve gone to Panama. But the other point I wanted to raise is everyone’s got their different view on the justice of taxation and AML laws. 

You might be against them, but I think one factor that is potentially playing in favor of the individual.  A typical book a lot of people read is called The Sovereign Individual. 

And part of that is this idea of going to better countries or going to better jurisdictions for better tax laws or other laws. 

I think most people grow up and have this inertia– I grew up here, so I’m going to live here, and I’m going to die here. But perhaps we’re moving more into a world where people can work remotely. 

They can then start accessing some of these overseas tax planning and overseas tax structuring to improve the level of competition between the different countries. And ideally, keep it a bit lower for the individual. What do you guys think?

Dennis Wohlfarth: Yeah. I think that’s one big part. Clinton also said you have to think about where you want to spend like the next years, right? 

I moved to Zug, Switzerland, to the Crypto Valley or at least what they call it because we started our company there. 

It’s a tax Haven for people from Europe because you can easily move there. It’s just; you have to think about all the consequences, right? 

For example, you’re not allowed to keep a key to your parents’ home when they live in Germany, because you’re just not allowed to have a residence in another country. 

If so, the other country would tax you on your group to income, and there are also the 185 days you have to be there in this other country. 

So you need to be aware of the cultural differences. You need to be aware if you speak a different language. You need to think about the costs of living, especially in Switzerland.

And Switzerland, for example, is entirely different from area to area. So it’s not just, I moved to the border of Switzerland. If you come from France or Italy or Germany, you have different areas, and they are small, like Zug, and have excellent taxation law on crypto because you don’t pay any crypto taxes. 

You just pay a wealth tax at the end of the year. It would be easy for a European citizen to move there. You just have to keep in mind that you kind of give up your home or where you grew up. 

You can move back in the future pretty quickly. It depends on your situation. If you have a family, it’s maybe even harder to move there.

“As Clinton said before, the future of all these taxation laws, especially for crypto, will be another five or ten years until they figure out the correct regulations there.”

- Dennis Wohfarth, Accointing Tweet

My team and I are encouraging everyone to accept these regulations because it also brings grip to the next stage, right? 

It’s not just a bad thing. If new regulations are coming in, you have better guidelines. 

You would know exactly how to behave. And with those guidelines, you can find loopholes to go around these taxes. 

If you don’t have any guidelines, it’s tough to decide what to do, because it’s just not defined yet. Right? That’s a big part to consider for the future.

Stephan Livera: Yeah. Clinton, anything to add?

Clinton Donnelly: I talked to a client, from Serbia, and said he had lived through the time when it was broken up, it became very lawless, and there was no real central government. 

And, the criminal element kind of dominated law and order. So there was a real breakdown. 

And when I was talking to him, he said, “I want to pay taxes! I’ve lived in a country where we didn’t pay taxes, and it was chaos. I want to pay taxes, and I want a stable government.” 

And I thought, wow. It was refreshing because so many people think that even paying a dime to a government or some crime is a value that governments give to you. 

And as you were saying Stephan, we should become shoppers to a certain extent. We can make choices about the tax impacts on our lives. The governments generally like you to stay put in one spot and never move, like everybody who has a hand on you can tax you there. They don’t like you moving around because it’s tougher for them, basically changing your residency.

Tax burdens are outrageous, worldwide and it has to do with the number of services we expect governments to give us.

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We want the governments to give us social insurance, that if we get old, they’re taking care of us. 

We want the roads to have no potholes. 

We think that the government ought to do stuff to make things better and regulate and define what it means to be organic, all these sorts of things. Let’s have the government do it.

Every time you say the government ought to, you have to rephrase it and say, I want to pay more taxes so that the government ought to do this.

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Governments never shrink themselves, so the only way you can sometimes vote is with your feet and move somewhere else, and the grass isn’t always greener on the other side. 

Suppose you have substantial family ties that you love going visit, you know, the big family on Sunday, and having a pasta dinner. In that case, you know, you’re going to miss that if you take off and go live somewhere else.   

But you might replace it with something more exciting and adventurous in your life. So you have to look at the whole picture. It’s not just the tax issue.

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Bitcoin Tax Strategies Locally and Overseas – Stephan Livera Podcast: Part Three

Learn about Bitcoin tax strategies locally and overseas with tax experts Clinton Donnelly and Dennis Wohlfarth on Stephan Livera’s podcast, episode 183.

Dennis Wohlfarth of Accointing and Clinton Donnelly of Donnelly Tax Law join Stephan Livera to talk about Bitcoin tax recordkeeping, and strategies to minimize tax. In the full podcast, we chat about:

  • Current Bitcoin tax treatment
  • Capital gains Bitcoin tax treatment
  • Bitcoin tax recordkeeping
  • Bitcoin tax strategies locally
  • Bitcoin tax strategies for those willing to go overseas
  • International crypto competition

In part one, we talked about Bitcoin tax treatment and Austrian economics on Stephan Livera Podcast, episode 183, and our guests were from the company Accointing and Donnelly Tax Law. 

In part two, we talked about Bitcoin tax recordkeeping.

Today, our podcast show notes are about how those various crypto tax situations from part two are treated from a crypto tax law perspective locally and internationally.

Bitcoin Tax Strategies Locally

Bitcoin tax strategies

What are some different ways various Bitcoin Tax Recordkeeping situations are treated from a crypto tax law perspective?

Clinton Donnelly:
If I sell Bitcoin and buy a car, I have capital gains when I dispose of that Bitcoin. 

I bought it at a lower price, and I’m selling it at a higher price. That’s equivalent to what I’m paying for the car, that’s the capital gains. 

And we see countries like Portugal are saying, if you pay for Bitcoin, we’re not going to have a VAT tax involved, which is kind of a duplicate tax: a VAT on top of capital gains. 

In the US, it’s just the sales tax, which is the taxes on what is sold, not how you paid for it. So it’s a bit of a different structure.

Cryptocurrencies are turning the tax regimes upside down with blockchain technology, DeFi, and smart contracts.

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These exciting innovations are transforming the financial industry and turning our whole notion of currency and property upside down, especially from a tax and accounting perspective.

How do we do accounting when we are no longer trading in Fiat currency, and we’re trading in a Bitcoin? 

It’s an asset that’s continually changing value relative to the Fiat’s in which we have to report our business results to the tax authority. So, everything’s getting very complicated. 

The tax authorities find that defining cryptocurrencies merely as assets or merely as a property is not adequate, because it’s changing so fast. It’s becoming far more than mere property. 

Nor is it adequate to call it currency because it’s not only embraced by one government and everything that is involved with that.

We're seeing that tax authorities are holding back in moving forward with new taxation regimes targeted at cryptocurrencies because they don't know where it's going. They don't want to hamper progress by having tax rules making no sense as technology progresses.

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I think we’re going to see taxation rules that are much like property continue, at least for the next five years until there’s a real settling down of this massive finance evolution. That’s frustrating to some people, but I think there will be something newer and better coming out of it.

Stephan Livera:
So for most people who are just holding it’s going to be treated as property, and it’ll just be the capital gains tax (CGT). 

I suppose most people are looking for ways to minimize taxes on that legally. I guess one of them is tax-loss harvesting, and another might be moving to a better jurisdiction or things like that might be typical strategies that people are employing. Or the collateralized loan idea is putting out some Bitcoin and getting USD so that you’re not incurring a capital gains event. 

Are these the typical strategies that you see in your experience? Are there any other ones that people are employing?

Clinton Donnelly:
Yes. Lots of those people are putting in trust and then getting payments from the trust. These are all variations. 

There’s a bit of a shell game here. You’re moving the tax to the different places the tax eventually gets paid.  

The thing you mentioned with the collateralized loans: that’s a great strategy. Suppose you want to use a short-term asset’s value until it’s been collateralized long enough to characterize it as a long-term asset and then sell it at the long term capital gains rates. That makes sense. But these are just small micro strategies.

Bitcoin Tax Strategies For Those Willing To Go Overseas

Bitcoin tax strategies

Let’s say you’re a Bitcoin whale, and you have massive positions in Bitcoin. If you see yourself liquidating a lot of this, then the one strategy would be to relocate if you want to improve on the long-term capital gains rate.

Let’s put a framework in place to how you can make that decision.

So you want to ask yourself some questions if you were to relocate. 

But first off, you would be selling where you currently live and moving somewhere else, so you would be incurring new expenses. 

What’s the cost of living there? 

What’s the quality of living? 

Will you find yourself so bored living on an island in the South Pacific that you fly back to Sydney every month to go to an opera show? 

There are some quality of life things. 

You also have issues relative to banking access. 

When liquidating some Bitcoin, you want to put that into a bank and get access to it. 

Ask yourself if you can open up a bank in that foreign jurisdiction?

People may ask why you are coming to Bali to open up a bank account, for example.

They may wonder why you are coming to the British Virgin Islands to open up a bank account if you live in Europe or live in Australia.

These are valid, “know your client” type of due diligence questions that may be difficult for you to open up a bank. If you don’t have a bank, will moving elsewhere be a foolish thing to do? 

Let’s think about the cost of that. 

If your upside is that you have a $100,000 worth of Bitcoin, long-term capital gains rates, let’s use the US rate at 15%. That means your tax is $15,000. 

What can you do? 

That’s going to reduce $15,000 if you move somewhere that you might end up spending. It might be zero tax right there, but you might be spending more than the $15,000 to have moved there.

If you had $100,000 Bitcoin, then we’re talking about a lot of money. 

You might be slowly liquidating your positions over multiple years in this scenario and might be thinking about how much you will liquidate yearly? 

Will it be $100,000? Well, you’d typically be generating a $15,000 tax. Will you do better living somewhere else? 

It’s possible on an ongoing basis if you’re doing that. 

Portugal has an attractive tax regime with zero tax, and it’s also a beautiful cultural area in Europe. That’s an excellent thing.   

The British Virgin Islands, any of the Caribbean countries, and Seychelles, all have an interesting tax regime. The problem with these banks is that if you’re doing something with a Seychelles bank, BVI (British Virgin Islands) bank, or any other bank in the world, it will raise a red flag.

It isn't easy to work with any country in the gray area when it comes to anti-money laundering laws. An option in the US would be in Puerto Rico. It’s an exciting option for Europeans and non-Europeans (Americans).

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I’d be happy to dig into those some more if you’d like.

Stephan Livera:
Sure. Let’s talk a little about some good places around the world, as you mentioned. 

I know Portugal, Singapore, and Switzerland all have no capital gains tax and Germany, as Dennis mentioned. 

I think if you hold for more than one year, there’s no capital gains tax. Depending on where you look around the world, some places might be a little better and others, not so much. 

You can find out more about International crypto competition and the ways people should explore options to determine if it were worthwhile for them to consider moving in part four of the Bitcoin Tax Strategies Podcast notes.

READ MORE: Puerto Rico For Crypto Traders

Final Part Of The Bitcoin Tax Strategies Podcast

Stay tuned for the final part of the Bitcoin Tax Strategies Podcast with our host Stephan Livera. 

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CRYPTO TAX ALERT: IRS Starts Sending New Virtual Currency Education Letters

Crypto Tax Expert writes about crypto client experience and perspective on the new round of Virtual Currency Education Letters from the IRS.

The IRS has officially resumed mailing out virtual currency education letters to taxpayers suspected of inaccurately reporting all their crypto income.  

The IRS first mailed the Virtual Currency Education Letters in July and August of 2019 to about 10,000 taxpayers. 

Dozens of crypto owners contacted me having received the first round of virtual currency education letters, and all of them had crypto holdings in 2017 above $900,000.

The first round of virtual currency education letters showed that the IRS knew who the crypto whale traders were.

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IRS Sends a New Round of Virtual Currency Education Letters

This week (August 24, 2020), a crypto owner contacted me, having just received a virtual currency education letter.

virtual currency education letters

However, his 2017 maximum crypto holdings were less than $150,000.

“The recent virtual currency education letter suggests that the IRS now uses much looser criteria for determining whom to send letters.”

- Clinton Donnelly Tweet

What is the significance of this development with the new round of virtual currency education letters?

crypto tax lessons

The federal income tax is a voluntary system in that taxpayers voluntarily report their income to the IRS. The IRS uses audits to find and punish tax evaders. The IRS cultivates a healthy fear in the public to encourage broad voluntary compliance. It is easier for the IRS to send out these education letters to motivate taxpayers to fix their mistakes, then to commit valuable IRS time and resources doing actual audits.

Restarting the education letter campaign again shows the IRS is increasing their focus on non-reporters of crypto income.

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“Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest, and penalties,” said IRS Commissioner Chuck Rettig. “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”

What are these virtual currency education letters?

IRS letter

There are three different virtual currency educational letters: 6173, 6174, and 6174-A.

Directly receiving any of these virtual currency education letters identifies you as a person of interest to the IRS.

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Letter 6173 is sent to those whom the IRS suspects of having possibly engaged in tax misreporting of a criminal level. 

I strongly encourage you to amend your tax returns quickly to avoid legal complications if you have received Letter 6173. Also, engage a criminal tax lawyer.

Letter 6174 and 6174-A are similar and sent to taxpayers suspected of misreporting their crypto income at a non-criminal level. 

Letter 6174-A is a little more verbose than in 6174. I’ve not identified any difference between the situations of those receiving either letter. These are the most common letters.

What do the virtual currency education letters say?

crypto traders

The letters state, “We have information that you have or have had one or more accounts containing virtual currency but may not have properly reported your transactions involving virtual currency, which include cryptocurrency and non-crypto virtual currencies.” 

The taxpayer is encouraged to amend or file tax returns accurately, reporting crypto income. 

The warning is added, “If you do not accurately report your virtual currency transactions, you may be subject to future civil and criminal enforcement activity.”

Trust me, that’s not a good thing for anyone.

Specific instructions are given to mark a crypto return and provide a particular mailing address for sending the returns. 

These instructions are important because it allows the IRS to track that you acted on the letter.

Recipients who don’t act when receiving a virtual currency education letter will be more likely to get audited.

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If you prepared your return, I recommend engaging a professional to assist in the review and amendment of returns, to be safe.

Should you call the IRS telephone hotline information?

enrolled agent crypto

The letters offer a telephone hotline number. The IRS will only provide general advice. 

Be aware, the IRS records all phone calls and keeps a log of the phone numbers of who calls the IRS. 

These call logs and recordings can be used by an auditor or revenue officer if you disclose any clues about your situation.

What can be done about the virtual currency education letters?

crypto tax advice

For most people, the odds of getting audited are low. But if you have received a letter, your odds are high of an audit. 

Getting a professional recalculation of your crypto income and amending 1-3 years of returns is not inexpensive, but getting audited will be several times more expensive. 

Undergoing an IRS audit can also significantly impact a person’s emotional, marital, and financial strain.

At Donnelly Tax Law, we recommend:

– Amending your crypto tax returns using our bulletproof crypto return methodology

– Consulting with an experienced crypto tax return preparation professional about your risks.

How can Donnelly Tax Law help?

US crypto tax services

We believe every crypto taxpayer can have a “Bulletproof Crypto Tax Return.”  

Our website offers powerful do-it-yourself resources and full-service crypto tax preparation services. 

We’ve helped taxpayers owning cryptocurrencies:

  • Avoid over $40 million in gains by using Like-Kind Exchange calculations.

  • We have prepared over 850 anti-money laundering reports required for many crypto traders. 

  • We have prepared over 1025 tax amnesty returns needed by crypto traders correcting back filings. Our acceptance rate is 100% success.

  • Moreover, we’re one of the few firms with experience defending crypto returns at an IRS audit. 

We are experts at filing returns for expats and foreign corporations.

  • We have clients in 48 countries.

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