Our colleague Ernest Badway writes about a recent decision in a federal criminal case rejecting the defendant’s argument that there was no securities fraud because he was selling digital tokens. The case involved charges that the defendant had defrauded investors in an initial coin offering. Ernie writes that “[o]ne of the big takeaways from this case is that courts, at least, initially, seem to be reluctant to claim crypto instruments are not securities. It almost appears that, like everyone else, courts such as the one in the EDNY are looking for more guidance, and are reluctant to make any major pronouncements about the status of such items as digital tokens.” You can read Ernie’s article, which is posted to the Securities Compliance Sentinel blog, here.

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BitcoinEarlier this week the Internal Revenue Service announced creation of a virtual currency compliance initiative that will focus on tax compliance by taxpayers engaging in virtual currency transactions. The IRS intends to address non-compliance in this area by conducting audits and engaging in taxpayer outreach, and by issuing future guidance. As part of this announcement, the IRS urged taxpayers with unreported virtual currency transactions to correct their tax returns, but also cautioned that it has no plans to offer a voluntary disclosure program in this area.

As we have previously reported, the IRS is focusing significant attention on tax compliance with respect to cryptocurrency transactions. Last year, the IRS prevailed in its long-running litigation with Coinbase seeking the names of clients who engaged in cryptocurrency transactions during 2013-2015, and Coinbase announced that it was disclosing transaction data to the IRS for 13,000 of its customers. In addition, the IRS-Criminal Investigation Division is ramping up its scrutiny of cryptocurrency transactions by assembling a team of specialized investigators in this area. And earlier this year, the IRS issued a very public “reminder” to taxpayers about reporting cryptocurrency transactions and threating audits, penalties, and even criminal prosecution for non-compliance.

The virtual currency announcement by the IRS Large Business and International Division (LB&I) was part of its roll-out of five additional “compliance campaigns” which are targeted at specific issues presenting risks of non-compliance. In early 2017, LB&I announced that it would be moving toward a risk-based approach to taxpayer examinations, and to date has identified 35 compliance issues that will guide its examination strategy moving forward.

The IRS described its newly-announced virtual currency campaign as follows:

U.S. persons are subject to tax on worldwide income from all sources including transactions involving virtual currency. IRS Notice 2014-21 states that virtual currency is property for federal tax purposes and provides information on the U.S. federal tax implications of convertible virtual currency transactions. The Virtual Currency Compliance campaign will address noncompliance related to the use of virtual currency through multiple treatment streams including outreach and examinations. The compliance activities will follow the general tax principles applicable to all transactions in property, as outlined in Notice 2014-21. The IRS will continue to consider and solicit taxpayer and practitioner feedback in education efforts, future guidance, and development of Practice Units. Taxpayers with unreported virtual currency transactions are urged to correct their returns as soon as practical. The IRS is not contemplating a voluntary disclosure program specifically to address tax non-compliance involving virtual currency.

The four other new compliance campaigns unveiled by LB&I this week include (1) restoration of sequestered AMT credit carryforward; (2) S corporation distributions; (3) repatriation via foreign triangular reorganizations; and (4) Section 965 transition tax. These campaigns are decribed in more detail as follows:

  • Restoration of Sequestered AMT Credit Carryforward

LB&I is initiating a campaign for taxpayers improperly restoring the sequestered Alternative Minimum Tax (AMT) credit to the subsequent tax year. Refunds issued or applied to a subsequent year’s tax, pursuant to IRC Section 168(k)(4), are subject to sequestration and are a permanent loss of refundable credits. Taxpayers may not restore the sequestered amounts to their AMT credit carryforward. Soft letters will be mailed to taxpayers who are identified as making improper restorations of sequestered amounts. Taxpayers will be monitored for subsequent compliance. The goal of this campaign is to educate taxpayers on the proper treatment of sequestered AMT credits and request that taxpayers self-correct.

  • S Corporation Distributions

S Corporations and their shareholders are required to properly report the tax consequences of distributions. We have identified three issues that are part of this campaign. The first issue occurs when an S Corporation fails to report gain upon the distribution of appreciated property to a shareholder. The second issue occurs when an S Corporation fails to determine that a distribution, whether in cash or property, is properly taxable as a dividend. The third issue occurs when a shareholder fails to report non-dividend distributions in excess of their stock basis that are subject to taxation. The treatment streams for this campaign include issue-based examinations, tax form change suggestions, and stakeholder outreach.

  • Repatriation via Foreign Triangular Reorganizations

In December 2016, the IRS issued Notice 2016-73 (“the Notice”), which curtails the claimed “tax-free” repatriation of basis and untaxed CFC earnings following the use of certain foreign triangular reorganization transactions. The goal of the campaign is to identify and challenge these transactions by educating and assisting examination teams in audits of these repatriations.

  • Section 965 Transition Tax

Section 965 requires United States shareholders to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States. Taxpayers may elect to pay the transition tax in installments over an eight-year period. For some taxpayers, some or all of the tax will be due on their 2017 income tax return. The tax is payable as of the due date of the return (without extensions).

Earlier this year, LB&I engaged in an outreach campaign to leverage the reach of trade groups, advisors and other outside stakeholders to raise awareness of filing and payment obligations under this provision. The external communication was circulated through stakeholder channels in April 2018.

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BitcoinOur colleague Kristen Howell has published an alert reporting on an important development in the cryptocurrency industry. The U.S. Securities and Exchange Commission has declared that Bitcoin, Etherium and other coins operating on truly decentralized platforms are not securities. The agency’s reasoning was revealed in remarks by William Hinman, Director of the SEC’s Division of Corporate Finance, at the Yahoo Finance “All Markets Summit: Crypto” on June 14. Hinman explained that since the value of cryptocurrency is not based on the expectation of profits resulting from the success or failure of the issuer, it does not compare to a typical security. You can read Kristen’s alert here.

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BitcoinThe American Institute of Certified Public Accountants – the world’s largest association of accounting professionals – yesterday asked the Internal Revenue Service to issue immediate, updated guidance regarding the tax treatment of cryptocurrency transactions. The AICPA call for tax guidance was prompted by “the rapid emergence of virtual currency [which] has generated several new questions on how the tax rules apply to various transactions involving virtual currency and activities and assets related to it.” The AICPA further noted that “the development in the number of types of virtual currencies and the value of these currencies make these questions both timely and relevant to a growing number of taxpayers and tax practitioners.”

Fours years ago, the IRS issued Notice 2014-21, its first and only guidance regarding the tax treatment of cryptocurrency transactions. The AICPA requests that the IRS issue immediate guidance to address issues from the original notice as well as new developments, such as chain splits, that have arisen since Notice 2014-21 was published.

The AICPA’s submission to the IRS includes suggested Frequently Asked Questions (FAQs) that address the following areas:

  • Expenses of obtaining virtual currency;
  • Acceptable valuation and documentation;
  • Computation of gains and losses;
  • Need for a de minimis election;
  • Valuation for charitable contribution purposes;
  • Virtual currency events;
  • Virtual currency held and used by a dealer;
  • Traders and dealers of virtual currency;
  • Treatment under Sec. 1031;
  • Treatment under Sec. 453;
  • Holding virtual currency in a retirement account; and
  • Foreign reporting requirements for virtual currency.

The AICPA notes that “[v]irtual currency transactions, in which taxpayers increasingly engage, add a new layer of complexity to the analysis of a client’s reporting requirements” and that “[t]he issuance of clear guidance in this area will provide confidence and clarity to preparers and taxpayers on application of the tax law to virtual currency transactions.”

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BitcoinWith the April 17 deadline for filing individual tax returns just around the corner, individuals who engaged in cryptocurrency transactions during 2017 must take care to properly report them on their tax returns. As we have previously reported, the IRS is focusing significant attention on tax compliance with respect to cryptocurrency transactions. Last year, the IRS prevailed in its long-running litigation with Coinbase seeking the names of clients who engaged in cryptocurrency transactions during 2013-2015, and Coinbase recently announced that it was disclosing transaction data to the IRS for 13,000 of its customers. In addition, the IRS-Criminal Investigation Division is ramping up its scrutiny of cryptocurrency transactions by assembling a team of specialized investigators in this area. And most recently, on March 23, the IRS issued a very public “reminder” to taxpayers about reporting cryptocurrency transactions and threating audits, penalties, and even criminal prosecution for non-compliance.

Four years ago, the IRS issued its only guidance to date regarding its view of the tax treatment of cryptocurrency transactions. Despite the explosion of interest in cryptocurrencies (currently more than 1,500 such currencies exist) and the monumental increase in Bitcoin’s value last year (an uptick of more than 1,400 percent before year’s end), the IRS has not updated its views or issued further guidance to investors, thus leaving individuals scrambling to make sure that their 2017 tax returns are properly capturing cryptocurrency transactions. This is especially critical for investors who sold Bitcoin during its rocket-like trajectory last year.

The IRS considers cryptocurrency transactions taxable just like transactions in any other property, and general tax principles that apply to property transactions apply. As a consequence, the following rules apply:

– A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

– Payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply.  Normally, payers must issue Form 1099-MISC.

– Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2 and are subject to federal income tax withholding and payroll taxes.

– Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third Party Network Transactions.

– The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

In an article published by Bloomberg today, Lily Katz and Lynnley Browning write that many investors, and even tax professionals, are struggling to properly report their cryptocurrency transactions on their 2017 tax returns, due to be filed in four days:

If you thought trading Bitcoin was wild, try figuring out how to pay taxes on it.

Cryptocurrency investors are wrestling with spotty records, tangled blockchain addresses and rudimentary guidelines issued back in the ancient days of 2014. After last year’s boom in values, many people are likely disclosing transactions for the first time, adding to confusion.

The Bloomberg article further reports that the IRS is advising individuals to look for tax guidance in analogous areas:

An IRS spokesman said that in addition to the agency’s 2014 guidance, taxpayers should look at other rules governing an exchange or transfer of property and find the “factual scenarios that most closely resemble their circumstances.”

Individuals who fail to properly report their cryptocurrency transactions can face harsh consequences, including civil audits, penalties, and even criminal prosecution, as the IRS warned in a recent press release reminding taxpayers to report such transactions:

Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest.

In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.

Despite the lack of up-to-date IRS guidance, and the uncertainly surrounding the tax consequences of recent developments in this area (such as “hard forks”), cryptocurrency investors would be well-advised to exercise caution with their income tax returns due next week.

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BitcoinWith “tax day” fast approaching, the Internal Revenue Service on Friday reminded taxpayers that income from virtual currency transactions is reportable on their income tax returns. As we have previously reported, the IRS has for some time been focusing significant attention on tax compliance with respect to virtual currency transactions. Last year, the IRS prevailed in its long-running litigation with Coinbase seeking the names of clients who engaged in virtual currency transactions during 2013-2015, and Coinbase recently announced that it would be disclosing transaction data to the IRS for 13,000 of its customers. In addition, the IRS-Criminal Investigation Division is ramping up its scrutiny of virtual currency transactions by assembling a team of specialized investigators in this area. With increased attention to virtual currency transactions, taxpayers who engaged in such transactions during 2017 must take care to ensure they are compliant with reporting obligations on their federal income tax returns.

The text of the IRS press release follows:

Virtual currency transactions are taxable by law just like transactions in any other property. The IRS has issued guidance in IRS Notice 2014-21 for use by taxpayers and their return preparers that addresses transactions in virtual currency, also known as digital currency.

Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest.

In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.

Virtual currency, as generally defined, is a digital representation of value that functions in the same manner as a country’s traditional currency. There are currently more than 1,500 known virtual currencies. Because transactions in virtual currencies can be difficult to trace and have an inherently pseudo-anonymous aspect, some taxpayers may be tempted to hide taxable income from the IRS.

Notice 2014-21 provides that virtual currency is treated as property for U.S. federal tax purposes. General tax principles that apply to property transactions apply to transactions using virtual currency. Among other things, this means that:

– A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

– Payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply.  Normally, payers must issue Form 1099-MISC.

– Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2 and are subject to federal income tax withholding and payroll taxes.

– Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third Party Network Transactions.

– The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

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The Wall Street Journal reports today that the Securities and Exchange Commission has recently issued multiple subpoenas and requests for information in a widening investigation of cryptocurrency firms.

According to the article, the subpoenas seek information about the structure for token sales and initial coin offerings:

The SEC scrutiny is focused in part on “simple agreements for future tokens,” or SAFTs, which are used in some of the most prominent crypto-fundraisings, according to people familiar with the matter.

The agreements allow big investors and relativity well-off individuals to buy rights to tokens ahead of their sale.  The rights can be traded, or flipped for profits, even before the sale begins.

The SEC is concerned that such agreements are potentially being used to trade like securities without conforming to the strict rules that apply to securities.

The SEC’s latest actions follow its creation last fall of a dedicated Cyber Unit to focus the Enforcement Division’s cyber-related expertise on misconduct involving distributed ledger technology and initial coin offerings, the spread of false information through electronic and social media, hacking, and threats to trading platforms.  In December, the SEC’s Cyber Unit filed its first-ever charges, obtaining an emergency asset freeze to halt a “fast-moving” ICO fraud that raised up to $15 million from thousands of investors since August by falsely promising a 13-fold profit in less than a month.  Several days later, the SEC announced that a California-based company selling digital tokens to investors to raise capital for its blockchain-based food review service halted its initial coin offering (ICO) and agreed to a cease-and-desist order in which the SEC found that its conduct constituted unregistered securities offers and sales.  Then in late January, the SEC announced that it has obtained a court order halting an allegedly fraudulent ICO that targeted retail investors to fund what was claimed to be the world’s first “decentralized bank” offering its own cryptocurrency.  In addition to these enforcement actions, the SEC’s Office of Investor Education and Advocacy has issued an Investor Alert warning investors about potential scams and frauds involving ICOs.

The Wall Street Journal article reports that Robert Cohen, head of the SEC’s Cyber Unit, said last week that at least one dozen companies have placed their ICOs on hold after the SEC raised questions.  The article further reports that coin offerings have already raised about $1.66 billion this year.  According to a forthcoming study of the ICO market by MIT, approximately $270 million to $317 million of the funds raised by ICOs have “likely going to fraud or scams.”

The Wall Street Journal article is available here (subscription required).

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