Month: January, 2018

The Taxation of Crypto Virtual Currencies – IRS Enforcement Initiative

Data from CoinMarketCap.com shows that the market capitalization for all crypto virtual currencies is currently at approximately 300 billion dollars.  Of that amount Bitcoin’s market share represents about 158 billion dollars, and the second largest cryptocurrency, ethereum/ether has about a 50 billion dollars market share.  Furthermore, virtual currency (ex. Bitcoin, ethereum/ether) trading and the related block chain trading technology platforms have been dominated by retail investors which has played a significant role in pushing cryptocurrencies to record highs in 2017.  In that regard, Coinbase, the world’s largest on line crypto wallet, adds about 100,000 new users every week.

It is estimated that millions of U.S. taxpayer Bitcoin/transactions have occurred, yet the IRS has stated that only 800 to 900 taxpayers had reported their Bitcoin gains from 2013 through 2015 by electronically filing IRS Form 8949 – the IRS form used for reporting sales and other dispositions of capital assets. (https://www.thestreet.com/story/14257905/1/bitcoin-investors-must-report-gains-to-the-irs.html)

Taking notice of what appears to be widespread tax noncompliance, the IRS is pursuing enforcement actions, and the IRS Criminal Investigation Division believes that virtual currency has increasingly become a tax evasion issue.  Consequently, the tax defense community can expect more enforcement actions in the future.

In that regard, on November 29, 2017 the IRS in connection with its investigation of allegedly underreporting of income and failure to pay taxes on crypto currency transactions caused the U.S. District Court for the Northern District of California U.S. v. Coinbase 17-01431 to issue an order enforcing a “John Doe Summons” to the Coinbase virtual currency exchange.  Coinbase, as one of the world’s largest platforms for exchanging virtual currencies, has approximately 5.9 million customers and has facilitated approximately $6 billion exchanged to Bitcoin. The Coinbase summons seeks a wide variety of records including, for example, taxpayer identities for all of its customers who have bought, sold, sent or received crypto currency worth $20,000 or more in any tax year from 2013 to 2015, transaction logs, and correspondence.  Accordingly, taxpayers using virtual currency transactions involving Coinbase who are not in tax compliance should consult experienced criminal tax counsel as soon as possible for advice.

With respect to the substantive tax aspects of crypto virtual currency, the IRS addressed emerging issues of the growing digital economies and how existing fundamental U.S. federal income tax principles apply to transactions using virtual currency to pay for goods or services, or held for investment when it issued IRS Notice 2014-21.

IRS Notice 2014-21 begins by acknowledging that virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as convertible virtual currency.  Bitcoin is one example of a convertible virtual currency – Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.

The Notice goes on to state that in general, the sale or exchange of convertible virtual currency or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction has tax consequences that may result in a tax liability.

Specifically, the IRS has taken the position for federal tax purposes, that virtual currency should be characterized as property, not as a foreign currency recognized by any government.

Accordingly, when using Bitcoins for example, to purchase products, if the Bitcoin appreciated in value since it was acquired, there may be tax owed on the gain if the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency.

The character of the gain or loss depends on whether the virtual currency is a capital asset in the hands of a taxpayer.  A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer.  For example, stocks, bonds, and other investment property are generally capital assets.  A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer.  Investors and other property held mainly for sale to customers in a trade or business are example of property that is not a capital asset.  Thus, since characterized as property, normal tax consequences flow.  Therefore, if an employer pays an employee in virtual currency the employee must report the fair market value of the virtual currency measured in U.S. Dollars as compensation income as of the date of the virtual currency payment and the employer must report that value on a Form W-2.  Moreover, the fair market value of virtual currency paid as wages is subject to federal employment taxes paid by the employer and income tax withholding (FICA) and FUTA.  Similarly, if virtual currency is received by a business in exchange for goods or services, then any such payments received are reportable as ordinary income.

When a taxpayer successfully “mines” virtual currency (for example, uses computer resources to validate Bitcoin transactions and maintain public Bitcoin transaction ledger), the fair market value of the virtual currency as of the date of receipt is includible in gross income.

Also, if a taxpayer’s “mining” of virtual currency constitutes a trade or business, and the “mining” activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment resulting from those activities constitute self-employment income and are subject to the self-employment tax.

As to crypto currency and information reporting requirements, payments made in virtual currency appear to be subject to the same information reporting requirements as payments made in property, real currency or instruments denominated in real currency.  For example, gains and losses attributable to virtual currency transactions may need to be reported on Form 8949 which is attached to Schedule D of Form 1040; payments made by a person engaged in a trade or business to an independent contractor using a virtual currency for the performance of services may require reporting of such payments to the IRS and to the payee on Form 1099 MISC.

Many questions though remain unanswered such as for example, whether virtual currencies need to be reported on FBARs foreign bank account reports – a U.S. taxpayer’s accounts at a foreign binary Bitcoin options exchange or a foreign Bitcoin options exchange could be reportable on an FBAR as a foreign financial account, and on IRS Form 8938, and whether the exchange of crypto currencies can qualify as Section 1031 like exchanges.

Unfortunately, the IRS has not issued any further guidance up to date beyond IRS Notice 2014-21, but instead is pursing enforcement actions.  Furthermore, State tax authorities will no doubt adopt the IRS’ characterization of crypto currency as property with resultant state tax consequences and concerns.

If you have invested in, traded, and/or spent convertible virtual currency, we encourage you to contact the Firm.

 

The New Tax Law – A Good Deal for Estates. . .or Maybe Not so Good

Most of the buzz surrounding the new tax law effective this year has been on corporate income tax rate reductions, treatment of pass through entities, limitations on state and local deductions and other higher profile income-tax related changes.  For estates, the one big change is the increase of the Estate, Gift and Generation Skipping Tax exemption to $10 million, $20 Million for married individuals. This is a good thing for very high net worth families, but for the vast majority of Americans, the $5 million plus exemption already in place worked just fine.  The new tax act, however, has another provision relating to trusts and estates which doesn’t work out so well for anybody, and that’s the suspension of the deduction for miscellaneous expenses subject to the 2% floor.

Heretofore, individuals could take as itemized deductions on their 1040 certain miscellaneous expenses to extent they exceed in the aggregate 2% of the taxpayers adjusted gross income. These expenses include employee business expenses, investment management fees, tax preparation fees and many others. In this group of expenses one relating directly to trusts and estates is excess deductions on termination of estates and trusts that can be passed through to estate and trust beneficiaries.

Estates and trusts are taxpayers and must report and pay tax on net income earned or pass that income through to estate or trust beneficiaries.  To arrive at net income estates and trusts may deduct among other items attorney fees and fiduciary fees like executor and trustee commissions.  In the estate context attorney and fiduciary fees are very often the largest expenses of an estate and can exceed income by a wide margin, especially where there are few income producing assets or they have been sold or distributed during the tax year. If this disparity occurs in the final tax year of the estate, the excess deductions can be passed through to the beneficiaries and added to their other miscellaneous expenses and deducted to the extent they all exceed 2% of AGI.  That is until 2018.

Note attorney and fiduciary fees are also deductible against Federal  Estate Tax as well as against estate income, but not both.  An estate must choose between deducting them on the Estate Tax return, or on the income tax return. In past years, when the many more estates were subject to Federal Estate Tax and the estate tax rates were higher, the choice was more often to deduct against estate tax. Now, with increase in the estate tax exemption to $5 million in 2011 and now $10 million, many more estates will deduct these fees against income.  However, the added tax benefit of excess deductions on termination passed through to estate beneficiaries enjoyed by many more of them in recent years, is now, unfortunately, lost.

The Tax Cuts and Jobs Act is a Major Change to Estate Planning

The Tax Cuts and Jobs Act is a major change to estate planning.  We encourage you to contact the Firm to review and update your estate plan.  We recommend that clients review their estate plan at least every five years, or sooner if there are changes in your financial or personal life, changes in your relationship with your fiduciaries or beneficiaries, or changes in the state or federal estate tax law.

Federal Estate and Gift Taxes.  On January 1, 2018, the federal estate tax exemption doubled to $11.2M per person ($22.4M for married couples).  The exemptions are set to expire and revert back to $5M per person, adjusted for inflation, after 2025.  Your beneficiaries will continue to receive the benefit of a “step up in basis” to the date of death value on assets included in your estate.  If a new administration is elected after the 2020 federal elections it is possible the exemptions may be reduced back to current levels.  Thus, consideration should be given to utilizing the large estate and gift tax exemptions while they are available.  However, clients must also weigh the potential estate tax savings against the loss of a “step up in basis” at death.  The Act provides for regulations to be implemented to prevent the gifts which utilized the additional exemptions from being “clawed back” at death in the event the exemption sunsets (as it is scheduled to do in 2025).

Federal Gift Tax Annual Exclusion.  The federal gift tax annual exclusion is $15,000 per recipient for 2018 (increased from $14,000 due to an adjustment for inflation).  There is an unlimited gift tax marital deduction for U.S. citizen spouses.  The annual exclusion for gifts to non-citizen spouses is $152,000 for 2018.

State Estate and Gift Taxes.  States that impose their own estate tax will not be affected by the Act.  Clients in Connecticut must consider the impact of the state gift tax (the only state with a gift tax).

  • Connecticut Estate and Gift Tax: The Connecticut estate and gift tax exemption rose to $2.6M in 2018.  The exemption is scheduled to rise to $3.6M in 2019 and then match the federal exemption in 2020.   In addition, beginning January 1, 2019, the cap on the maximum estate tax imposed on the estates of decedents dying on or after January 1, 2019, and the maximum gift tax imposed on taxable gifts made on or after January 1, 2019, will lower from $20M to $15M.
  • Massachusetts Estate Tax: The Massachusetts estate tax exemption remains at $1M per person.
  • New Jersey Estate and Inheritance Tax: Effective January 1, 2018, New Jersey eliminated its estate tax, but the inheritance tax remains in effect.  Transfers to spouses, children and grandchildren will remain inheritance tax-free, however, any transfers to a sibling, aunt/uncle, niece/nephew, friend, etc., would be subject to the inheritance tax.
  • New York Estate Tax: The New York Estate Tax exemption is $5.25M for 2018 and it is scheduled to match the federal exemption starting January 1, 2019.

Update Your Estate Planning Documents:  Many estate plans provide for the creation of a Family Trust (or Credit Shelter Trust) upon the first spouse to die.  In older estate plans, the formula for funding that trust may continue to reference funding it with the maximum amount that can pass free of federal estate tax.  The doubling of the federal estate tax exemption could result in significant state estate tax.  In newer plans, the funding formula may have been based upon the maximum state estate tax exemption.  With the larger state estate tax exemptions this may no longer be necessary or a desired result.  Estates below the state and federal exemption may be suitable for a simplified estate plan.  Clients should contact the Firm to review and update their estate plans.

New Jersey Court Recognizes ‘Wrongful Prolongation of Life’ Cause of Action

New Jersey’s Advance Directive for Health Care Act (the “Act”) guarantees the right of an individual to make decisions regarding his or her healthcare.  But what happens if those decisions and wishes are ignored?  Morris County Superior Court Judge W. Hunt Dumont recently recognized a cause of action for wrongful prolongation of life against a Defendant hospital, doctor, and several nurses, for their alleged failure to follow a patient’s healthcare wishes.

Suzanna Stica was admitted to the hospital after complaining of breathing problems. She had signed “do not resuscitate” and “do not intubate” orders ahead of her admission.  Despite those orders, the Defendants resuscitated Ms. Stica after she went into cardiac arrest. She lived an additional six months before she ultimately passed away.  During that time, Ms. Stica was intubated, had difficulty breathing, was confined to a wheelchair, suffered from depression and dementia, and had trouble speaking.

The court explained Ms. Stica’s wishes were “simply ignored” by the hospital and its staff.  “Ms. Stica lived an additional six months in a diminished condition that included unwanted pain and suffering,” and the Defendants “violated Ms. Stica’s fundamental right to refuse unwanted medical treatment.”

The court held that its ruling was a logical extension of the New Jersey Supreme Court’s 1979 ruling in Berman v. Allan, which recognized the doctrine of wrongful birth.  New Jersey, the court explained, has taken a leadership role in recognizing patients’ rights regarding treatment options.  These rights include “a well-established right to reject lifesaving treatment.”

By denying the Defendants’ motion for summary judgment, the court extended a legal cause of action against those who ignore a person’s decisions regarding his or her healthcare.  To ensure that your healthcare decisions and end-of-life wishes are properly integrated into your estate planning instruments, or if you have any questions regarding this recent ruling, we encourage you to contact the Firm.