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IRS: Mined Bitcoins are Taxable

March 25th, 2014 2 comments

Let’s applaud the Internal Revenue Service for issuing fresh guidance on the agency’s application of the tax law to virtual currencies.

I was nodding along until reaching the discussion of “mining” virtual currency:

When a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.

You’ll be taxed upon the creation of bitcoin, says the IRS. Mining bitcoins is a reward in exchange for providing services required to operate the bitcoin payment network.

Taxing fiat currency when received in exchange for providing services is a fundamental principle of U.S. taxation. But here, the IRS has explicitly said that bitcoin is property, and not foreign currency, under the tax code.

If I receive property, such as a car, in exchange for providing legal services, I have to pay tax on the fair market value of the car upon receipt.

But what if I build a car for people to drive? When would I have to pay tax on that? Not until I sell or exchange it.

The sale or exchange moment is formally known as a “realization” event under the tax code. There is no taxable income without a realization event.

There is no realization event when I merely produce a car for resale. And I’d argue that there may be no realization event when I produce bitcoins from mining.

That’s why I think the IRS may have gotten it wrong: Mined bitcoins shouldn’t be taxable until they are traded on an exchange or exchanged for other property or services.

According to blockchain.info, approximately 1,371,425 bitcoins have been mined within the last year. Assume a conservative average exchange rate of $250 per bitcoin over the past year. If all mined bitcoins are subject to U.S. income tax (they’re not), that’s $342 million of potentially taxable income.

A big win for the U.S. Treasury this round.

(Thanks to William Lewis for bringing this to my attention.)

Categories: IRS, Virtual Currency Tags: ,

GAO: Bitcoin Presents Tax Compliance Risks

June 27th, 2013 4 comments

Last month, the U.S. Government Accountability Office (GAO) issued a report to the U.S. Senate Committee on Finance titled Virtual Economies and Currencies: Additional IRS Guidance Could Reduce Tax Compliance Risks.

I first learned of the report in a piece from Accounting Today. Before going into the GAO report, though, I must comment on how the title to the Accounting Today piece, “IRS Could Begin Taxing Bitcoin and Other Virtual Currencies,” is misleading.

The Internal Revenue Service does not make tax laws. Instead, it enforces them, and promulgates regulations and issues guidance based on interpretations of the Internal Revenue Code. In fact, even the GAO report notes that “IRS must implement the laws Congress enacts through detailed guidance.”

So we shouldn’t say the IRS may decide whether or not to tax Bitcoin. Either transactions involving Bitcoin are taxable under the Internal Revenue Code or they are not.

Of course, the IRS can issue guidance on how it will treat various types of Bitcoin transactions under the IRC. Perhaps the title of the Accounting Today piece meant to convey that the IRS may look to issue such guidance. Even if we see IRS guidance, it doesn’t mean the IRS view is absolute, of course, as it can be challenged in court.

Back to the GAO report. It emphasizes two points in particular several times:

  1. Transactions involving virtual currencies may be taxable.
  2. The likelihood of taxpayer noncompliance regarding such transactions is high because of the lack of guidance on these issues.

The report defines virtual currency as a digital unit of exchange that is not backed by a government-issued legal tender. In virtual worlds, there are “closed-flow” transactions, “open-flow” transactions, and hybrid transactions.

Transactions in closed-flow virtual currency systems don’t generate taxable income because the virtual currency has no value outside of the system. Simple as that.

In the middle of the road hybrid virtual currency system, some of the flow between the virtual currency and items outside the system is closed, but there is a (third-party) exchange allowing users to exchange virtual goods for real money.

Example: In the multiplayer online-role playing game World of Warcraft, users create avatars that acquire skills and traits, and these avatars may be sold to other users for real dollars.

In an open-flow virtual currency system, virtual currencies can be used to purchase both real and virtual goods and services, and can be exchanged for government-issued currency.

Example: Bitcoin.

Back to point #1, whether transactions involving virtual currencies may be taxable. The report discusses one example in a hybrid system:

  • Ann plays an online game and amasses virtual tools that are valuable to her avatar. The online game does not allow users to directly exchange their virtual tools for U.S. dollars, but rather they can do so using a third-party, making this a hybrid system. Ann uses a third-party exchange not affiliated with the online game to coordinate the transfer of her virtual tools to another player in exchange for U.S. dollars. The transfer is conducted by the third-party exchange and payment is mediated by a third-party payment network. Ann may have earned taxable income from the sale of these virtual tools.

And two examples involving Bitcoins:

  • Bill is a bitcoin miner. He successfully mines 25 bitcoins. Bill may have earned taxable income from his mining activities.
  • Carol makes t-shirts and sells them over the Internet. She sells a t-shirt to Bill, who pays her with bitcoins. Carol may have earned taxable income from the sale of the t-shirt.

In other words, a transaction happens so it may be taxable. Gee, thanks. I believe the report doesn’t take a more firm position by analyzing the possible tax treatment of the transactions because it doesn’t have the answers.

Sure enough, on the page following the Bitcoin examples, the report notes

characterization depends on whether the virtual economy activity or virtual currency unit is to be treated as property, barter, foreign currency, or a financial instrument. . . . [S]ome virtual currency transactions could be considered barter transactions.

It also notes basis issues, but that’s pretty much it. By not delving into the arguments in favor of or against each of the characterization types, the report punts on trying to figure out proper tax treatment of transactions involving Bitcoin and other virtual currencies.

So yeah, taxpayers may not be compliant on transactions involving Bitcoin because they don’t have the answers either.

I can only take the GAO’s punt as a challenge to the IRS—and practitioners like me—to figure it all out.

We’re on it, GAO. Stay tuned.

Feds Seek Forfeiture in Billion Dollar Gambling Ring Case

July 2nd, 2012 No comments

According to a story from NBC 5 Dallas-Fort Worth, federal authorities have uncovered an illegal sports gambling ring located in North Texas that took in over $1 billion in revenue from September 2009 to September 2010.

No indictments have been unsealed. Expect that to change, however. In forfeiture papers filed in court, approximately 22 individuals were involved in the operation, which used offshore sites and a toll-free phone line. The line apparently received 20,000 calls per month.

The IRS seized cash, automobiles, jewelry, and sports memorabilia, among other things. Claims have been filed by those seeking return of the items.

Stories such as these add substance to those seeking an expansion of legalized sports betting in the United States. Earlier today, for example, New Jersey released its draft of sports betting regulations.

A showdown in court over the federal ban on sports betting seems imminent.

Offshore Tax Investigations: First Switzerland, Is Israel Next?

June 19th, 2012 No comments

Maybe.

The strongest indication emerged last week when a superseding indictment was unsealed, charging three American tax preparers for assisting their clients with concealing assets and income in unidentified Israeli banks.

U.S. residents must report all income earned to the IRS. U.S. residents must report whether they have a financial interest in a foreign financial account worth more than $10,000 in a particular year.

According to the Department of Justice press release:

The superseding indictment alleges that the co-conspirators prepared false individual income tax returns which did not disclose the clients’ foreign financial accounts nor report the income earned from those accounts. In order to conceal the clients’ ownership and control of assets and conceal the clients’ income from the IRS, the co-conspirators incorporated offshore companies in Belize and elsewhere and helped clients open secret bank accounts at the Luxembourg locations of two Israeli banks, Bank A and Bank B. Bank A is a large financial institution headquartered in Tel-Aviv, Israel, with more than 300 branches across 18 countries worldwide. Bank B is a mid-size financial institution also headquartered in Tel-Aviv, with a worldwide presence on four continents.

The federal government has aggressively pursued offshore tax evaders since 2008, when Swiss-based financial firm UBS was accused of assisting U.S. residents with committing tax evasion by shielding assets in offshore accounts. In 2009, UBS agreed to pay $780 million to the U.S. in fines, penalties, interest and restitution.

Over the four years since then, the IRS has run three offshore voluntary disclosure programs (in 2009, 2011, and 2012) to encourage taxpayers with undisclosed financial accounts to come forward and pay stiff penalties.

A benefit to participating in the program, if eligible, is that criminal charges will not be pursued against taxpayers making complete and truthful disclosures. Read more about the pros and cons of a voluntary disclosure here.

Undoubtedly the IRS and DOJ have collected a lot of information from these programs. “Enablers” such as those indicted above have not been eligible for the programs, however. It’s very possible these enablers were discovered through disclosures of their own clients.

CNBC is reporting the recent indictment may be the first of a series involving U.S. tax evasion by shielding assets in Israeli banks via “cash-transfer banking,” by which an offshore banker is set up with an American taxpayer seeking to withdraw and deposit the same amount of cash with the foreign bank:

The bankers appear in the U.S., typically at a hotel, and arrange for couriers to bring the cash to the hotel from the depositing customer, and later turn it over to the withdrawing customer, only later crediting each account for the transaction back in the foreign bank offices.

In somewhat related news, yesterday Israeli authorities arrested nine individuals and questioned fifteen more in connection with the possibly largest tax fraud scheme in Israeli history. I don’t see any connections aside from the nature and location of the crimes, however.

Hat tip: Federal Tax Crimes

Trapped by the IRS

June 14th, 2012 No comments

TMZ is reporting American singer-songwriter R. Kelly owes the IRS over $4.8 million in back taxes. The balances due:

via Wikipedia

2005 - $1,472,366.77
2006 - $710,520.51
2007 - $376,180.11
2008 - $1,122,694.90
2009 - $173,815.18
2010 - $992,495.24

Kelly is probably best known for his hit “I Believe I Can Fly,” which was featured on the soundtrack to the 1996 film Space Jam.

More recently, Kelly wrote and directed the popular hip hopera series “Trapped in the Closet.” Last March Kelly confirmed a new set of videos for the series will be released later this year.

Kelly’s representative said the artist “is in the process of working everything out with the government and is confident that all his obligations will be satisfied.”

A revenue-sharing agreement with the IRS on proceeds received from the new “Trapped in the Closet” videos would not be the first of its kind. See Willie Nelson.

Categories: IRS, Music Tags:

No “Finders Keepers” with IRS Refunds

May 31st, 2012 No comments

Suppose your filed 2011 Form 1040 reflected a refund due of $754. You elect to receive the refund by paper check in the mail. Six weeks later, you receive an envelope from the IRS, open it, and find inside a refund check in the amount of…

$434,712

Wowza!

That’s exactly what happened to Cleveland waitress Ginny Hopkins, reports USA Today.

What did she do with the check? Cash it and then hop on a plane to Las Vegas to participate in the 2012 World Series of Poker?

No. She returned the check to the IRS. As she should have.

Painful, I know. But a taxpayer who cashes an erroneously issued refund is liable to repay the erroneous refund, plus interest. That would be a far more painful situation.

(Hat tip: TaxProf Blog)

Categories: IRS Tags:

Miccosukee Tribe: Bingo with Taxes

May 22nd, 2012 No comments

The tax problems of the Miccosukee Tribe continue.

In January, I wrote about the tribe’s malpractice suit against its former attorney that claimed he had provided erroneous legal advice with respect to its ongoing IRS matter.

The Miami New Times is reporting two patrons of the Miccosukee Resort & Gaming Indian casino have recently filed suit against the tribe for failure to remit to the IRS taxes withheld from their gambling winnings.

The patrons, John Ricone and Francys Tolon-Ricone, claim they won just under $5,500 from bingo play during two trips in 2008. The tribe withheld approximately $1,500 for federal income tax, and issued two W-2Gs reflecting such.

On their 2008 tax return, the Ricones reported the bingo income and the withheld funds. The IRS then sent a notice to the Ricones demanding payment of income tax on the bingo winnings because the funds withheld by the tribe were not remitted to the IRS.

Sure, it’s a relatively small amount at stake. And it’s possible the IRS issued the notice in error. But when approximately $26 million from over 100 members of the tribe is owed to the IRS for distributions received from the casino, there’s little to no benefit of the doubt.

The “we’re trying to show good faith towards addressing outstanding liabilities” statement to the IRS doesn’t sound too convincing as new tax issues arise, regardless of the amount.

Categories: Gambling, IRS Tags:

If You Owe Uncle Sam, You Might Stay with Uncle Sam

April 9th, 2012 2 comments

On March 14, Senate Bill 1813 was passed by the U.S. Senate. The bill is described as “[a]n Act to reauthorize Federal-aid highway and highway safety construction programs, and for other purposes.”

One of the “other purposes” is far from insignificant. Reported by Fox Business, taxpayers who have “a seriously delinquent tax debt in an amount in excess of $50,000″ could be prohibited from obtaining a passport to leave the country.

Some exceptions are built in. Taxpayers who are on a repayment plan or are not subject to active collection action may fall outside the bill’s scope.

Despite the exceptions, the bill’s language is too poorly worded. It’s easy to come up with scenarios for which placing the virtual handcuffs on U.S. residents seems far too excessive.

For example, suppose I am a banker making $200,000 per year. Suddenly, I am laid off. I live off savings for some time, but for several months am unable to obtain a new job paying even half my previous salary. Eventually, I am compelled to take an early distribution from my 401(k), and have a large tax liability as a result. The IRS then files a lien. I finally land a new job to cover basic living expenses but I can’t afford to address the growing tax liability.

I may be denied a passport pursuant to S. 1813 if the liability exceeds $50,000.

Although the intent of the bill likely is to keep more pronounced tax delinquents from escaping U.S. jurisdiction, the possible net casts far wider.

Unfortunately, that may not be enough to prevent the bill from passing. When it comes to taxes, we’ve seen before the federal government shooting the jaywalkers[1] while at the same time also punishing the more serious offenders.

Although S. 1813 passed the Senate by a 74 – 22 margin, the bill is expected to face more opposition in the House. Stay tuned.


[1] Credit to fellow tax blogger Joe Kristan for coining this phrase.

Categories: IRS, Travel Tags:

IRS “Reopened” Offshore Voluntary Disclosure Program: 2012-?

April 4th, 2012 1 comment

In January, the IRS announced it reopened indefinitely its offshore voluntary disclosure program.

It’s no surprise. After all, the IRS has collected more than $4.4 billion from the previous two programs than ran in 2009 and 2011.

Yes, that’s billion, as in $4,400,000,000.

While there’s a comprehensive FAQ regarding the 2011 program, I could not locate any information for the current program other than the press release linked above. Strange, I thought, considering the release said more details would be released “within the next month.” And that was in January.

So I called the offshore voluntary disclosure hotline, and left a message. Apparently, they never pick up. But that’s okay, because an IRS representative returned my message within one hour. Impressive.

He said the IRS hasn’t gotten around to posting the current program’s details yet. Great. He added, however, that the 2011 OVDI program parameters are the same as the current program, except the general miscellaneous offshore penalty is now 27.5% instead of 25%, and that the lookback period will change from 2003 through 2010 to 2004 through 2011.

Although I was pleased to receive an answer, I’m left unsatisfied. I would much rather have published IRS guidance to rely on when counseling clients than oral IRS guidance.

And in this case, it’s especially so because the terms of the program could change at any time.

That’s the lovely IRS for you. After a while, you just begin to expect these administrative inadequacies.

Comparing Form 8938 and FBAR Requirements

April 2nd, 2012 No comments

Form 8938 is a new form for the 2011 tax year. Taxpayers are required to disclose on the form “specified foreign financial assets” if the total value of the taxpayer’s interests in such assets exceeds certain thresholds.

I’ve written before about the requirements here. The Form 8938 instructions may also be helpful.

The IRS has realized Form 8938 is creating a fair bit of confusion. That’s because the FBAR (TD F 90-22.1) requirements were already in place. And they still are.

Form 8938 has not replaced the FBAR. They are two separate reporting requirements that have some similarities and some differences. To assist taxpayers with figuring it all out, the IRS recently posted a chart comparing them. View it here.

Categories: International, IRS Tags: ,
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