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IRS Releases Memorandum on Deducting Cryptocurrency Donations

by John T. Lutz, William R. Pomierski and Andrew Granek | Jan 20, 2023 | IRS Guidance

On January 13, 2023, the Internal Revenue Service (IRS) released a memorandum (CCA 202302012) concluding that a qualified appraisal is required when a taxpayer claims a charitable contribution deduction exceeding $5,000 for donated cryptocurrency. Valuations reported by cryptocurrency exchanges do not qualify as “qualified appraisals.” The memorandum is relevant to any taxpayer who has donated (or plans to donate) cryptocurrency if they also intend to claim a charitable deduction.

SUBSTANTIATION REQUIREMENTS FOR CHARITABLE CONTRIBUTION DEDUCTIONS

Internal Revenue Code Section 170 generally allows deductions for charitable contributions in the taxable year that the contributions are made. However, these deductions are allowed only if they are verified under US Department of the Treasury (Treasury) regulations. Deductions may be denied if the taxpayer does not meet certain substantiation requirements outlined in Section 170(f)(11).

The substantiation requirements for charitable contribution deductions generally require that, for contributions of property for which a deduction of more than $5,000 is claimed, the taxpayer must obtain a “qualified appraisal” of the property.

MEETING THE QUALIFIED APPRAISAL REQUIREMENT

An appraisal can only be qualified if it is conducted by a qualified appraiser in accordance with generally accepted appraisal standards. To be qualified, an appraiser must (1) be an individual, (2) have earned an appraisal designation from a recognized professional appraiser organization or meet minimum education and experience requirements set by the Treasury or the IRS, and (3) regularly perform appraisals for which he or she receives compensation.

Furthermore, the appraisal must not be made and signed by the appraiser sooner than 60 days before the donation or later than the due date (with extensions) of the tax return on which the deduction is claimed. The qualified appraiser must sign and date the appraisal report and include a declaration that such person (1) understands the appraisal will be used in connection with a return or claim for refund, (2) understands that such person may be subject to a penalty if the appraisal contains a substantial or gross valuation misstatement of the value of the property and the taxpayer claims a deduction based on the appraisal, and (3) has not, within the past three years, been barred from presenting evidence or testimony before the Treasury or the IRS. The appraiser may not receive a fee that is based to any extent on the appraised value of the property.

EXCEPTIONS TO THE QUALIFIED APPRAISAL REQUIREMENT

While the qualified appraisal requirement may seem to impose an onerous burden on taxpayers, given the philanthropic purpose of charitable donations, this is mitigated by rules excepting certain readily valued property from the qualified appraisal requirement. For example, a taxpayer is not required to obtain a qualified appraisal for cash donations, stock in trade, inventory, inventory property, publicly traded securities and certain vehicles.

Notably, “publicly traded securities” for this purpose is limited to mean corporate stock; a right to subscribe for or to receive a share of corporate stock; or a bond, debenture, note, certificate, or other evidence of indebtedness issued by a corporation, a government or [...]

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Infrastructure Bill Provision Expands Cryptocurrency Reporting Requirements

by John T. Lutz, William R. Pomierski, Le Chen and McDermott Will & Emery | Aug 6, 2021 | Tax Reform

On August 1, 2021, the US Senate unveiled the draft text of the Infrastructure Investment and Jobs Act (Bill), a highly anticipated $1 trillion infrastructure package negotiated by the White House and a bipartisan group of senators. As discussed below, the Bill includes a provision (Section 80603) that, if enacted in its current form, would amend the Internal Revenue Code (Code) to extend certain reporting requirements for transactions involving digital assets, including cryptocurrencies such as Bitcoin and Ether and other forms of digital tokens. The provision, which would generally go into effect on January 1, 2023, is intended to address a “tax gap” resulting from the underreporting of cryptocurrency transactions.

BROKER REPORTING

Code Section 6045 generally imposes reporting requirements on “every person doing business as a broker” with respect to sales affected by the broker on behalf of its clients. Under current law, such reporting is currently limited to sales of corporate stock, interests in trusts and partnerships, debt obligations, certain commodities and various associated derivatives. Pursuant to regulations, such sales are reported by the broker on Form 1099-B and the information required to be reported includes identifying information about the taxpayer and the property sold, the sale date and gross proceeds of the sale—and only with respect to the sale of a “covered security,” the adjusted basis of the property sold and the character of the gain or loss on the sale (i.e., long- or short-term capital gain).

For purposes of 1099-B reporting, a “broker” is defined to include a “dealer, a barter exchange, and any other person who (for a consideration) regularly acts as a middleman with respect to property or services.” A typical example of a broker subject to 1099-B reporting is a brokerage firm that facilitates transactions for customers in stocks, bonds and/or commodities.

The Bill expands the definition of a broker to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Unless otherwise provided by the US Department of the Treasury’s regulations, a “digital asset” means “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by [Treasury].” A cryptocurrency exchange would be considered a broker under this language.

The “basis” reporting under Section 6045 only applies to “covered securities.” Under current law, the term covered securities generally includes corporate stock shares, debt obligations, certain designated commodities (and derivatives thereof) and other financial instruments. The Bill would expand the definition of covered securities to include any “digital asset.” Accordingly, brokers subject to Section 6045 will be required to report the adjusted basis and the character of the gain or loss upon the sale of digital assets, including utility tokens, stablecoins and asset-backed tokens.

BROKER-TO-BROKER AND BROKER-TO-NON-BROKER TRANSFER REPORTING

Under current law, Code Section 6045A imposes additional reporting requirements that are generally applicable to the transfer of covered securities by one broker to another. Specifically, the transferor broker must [...]

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Key Takeaways | Cryptocurrency Global Tax Enforcement: What Investors and Companies in the Industry Need to Know NOW

by Simon Airey, Kevin Spencer and Katharine Suominen | Jul 27, 2021 | IRS Guidance, Tax Reform

During a recent program discussing the latest government enforcement efforts related to cryptocurrency, we spoke with Gary Alford, one of the leading Internal Revenue Service (IRS) agents in their crypto enforcement efforts, Perry Carbone, Chief of the White Plains Office (US Attorney’s Office – SDNY) and Andy Cole, former Director of Specialist Investigations at HM Revenue & Customs in the United Kingdom, about how investors and companies in the virtual currency industry should address enforcement actions. Below are key takeaways from the conversation.

ENHANCED ENFORCEMENT – UNITED STATES

The time to act is now. The IRS and the US Department of Justice (DOJ) are collecting virtual currency data at a rapid pace while simultaneously moving forward with tax enforcement cases. The IRS Criminal Investigation (IRS-CI) revamped its operations to “do more with less” using new technology that will move investigations at a faster pace.
The IRS joined its civil and criminal units through Operation Hidden Treasure and is also working with outside experts in the field—along with specially-trained IRS agents—to pursue tax enforcement and asset seizure. This is a key agenda item for the US Department of the Treasury and is not going away any time soon.
The IRS and the DOJ expect taxpayers to comply voluntarily with all tax obligations. Despite these recent developments, US taxpayers have limited guidance from the IRS. Engaging with professionals in the space to evaluate the options available to taxpayers is crucial to assessing and ensuring compliance with cryptocurrency taxation.

INTERNATIONAL EFFORTS

Global collaboration is nothing new, but it is now on the rise. Agencies around the world are enhancing their cross-border information and resource sharing to investigate tax crimes efficiently and effectively. The J5, an important component of this global collaboration, is prepared to pool some of the world’s most sophisticated data analytical tools so that intelligence can be screened, searched and/or identified.
The Organisation for Economic Co-operation and Development (OECD) and its governing body will likely start requiring cryptocurrency exchanges to collect customer due diligence information. The window of anonymity around cryptocurrency transactions has closed rapidly in recent years.
The global Common Reporting Standard (CRS) has been in force since 2017. Under the CRS, tax authorities of over 100 countries (including most of the traditional “tax havens”) automatically exchange tax, account and payment information with each other in order to assist in tax collection and enforcement action.

FOR INDIVIDUALS

Moving forward, the “knowledge and willfulness” element needed for criminal cases will be much easier for the DOJ to prove because the “virtual currency question” is now at the top of Form 1040. The prominent location of this question is “a game changer” for criminal tax prosecutions.
Cryptocurrency tax crimes are no longer “add on” charges to other criminal prosecutions, such as narcotics or fraud crimes. The DOJ expects to bring independent cryptocurrency criminal tax cases and take these prosecutions to “the next level,” including prosecutions of more routine tax matters.
Individuals serving as board members on behalf [...]

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Cryptocurrency Global Tax Enforcement: What Investors and Companies in the Industry Need to Know NOW

by Kevin Spencer, Simon Airey and McDermott Will & Emery | Jun 30, 2021 | IRS Guidance, Tax Reform

On June 28, 2021, McDermott held a webinar presentation titled “Cryptocurrency Global Tax Enforcement: What Investors and Companies in the Industry Need to Know NOW.”

Topics during this webinar included:

How to address the tax consequences of past virtual currency transactions, including potential voluntary disclosure considerations.
How to protect your business from a US Department of Justice (DOJ) or UK investigation, including compliance updates to address this risk.
Law enforcement perspectives and updates from the IRS, DOJ and a former high-level director at HM Revenue & Customs.
How to respond to an IRS letter, including potential civil resolutions.
How to respond to a DOJ or a UK Serious Fraud Office (SFO) inquiry, summons, subpoena, search warrant or a whistleblower complaint.

A link to the webinar is available here. A link to the webinar’s slides is available here.

Biden Administration Proposals Will Greatly Enhance IRS’ Ability to Identify Cryptocurrency Transactions

by Julian André, Kevin Spencer and Katharine Suominen | May 26, 2021 | IRS Guidance, Tax Reform

The Biden Administration and the Internal Revenue Service (IRS) continue to focus heavily on cryptocurrency tax enforcement issues. On May 20, 2021, the US Department of the Treasury (Treasury) released the American Families Plan Tax Compliance Agenda, a 22-page report detailing tax compliance measures that are to be included as part of US President Joe Biden’s American Families Plan. The report sets forth a number of initiatives designed to “close the tax gap,” identify the underreporting of tax liabilities and detect tax evasion. These measures, which are part of an $80 billion proposal for the IRS, would significantly enhance the agencies’ ability to address the challenges involved with finding taxes that result from virtual currency transactions.

The Treasury’s report notes that “[c]ryptocurrency already poses a significant detection problem by facilitating illegal activity broadly including tax evasion.” To address this issue, the Biden Administration is proposing “additional resources for the IRS to address the growth of cryptoassets.”

Most notably, the Biden Administration is proposing enhanced reporting requirements for domestic and foreign financial accounts that specifically address cryptocurrency. Financial institutions, including “cryptoasset exchange accounts and payment service accounts that accept cryptocurrencies” would be required to submit third-party annual reports of all “gross inflows and outflows” from business and personal accounts to the IRS using a form similar to the IRS 1099-INT. Additionally, “businesses that receive cryptoassets with a fair market value of more than $10,000 would be reported on” in a manner similar to how cash transactions are reported on Currency Transaction Reports. These new reporting requirements would dramatically increase the IRS’ ability to identify and detect unreported cryptocurrency transactions.

The report also reemphasizes the need to devote additional funding to the IRS. The Biden Administration is seeking $80 billion in additional funding so that the Treasury and IRS can, among other things, hire “new specialized enforcement staff” and “revitalize[e] the IRS’s examination of large corporations, partnerships, and global high-wealth and high-income individuals.”

Additionally, the Biden Administration plans to overhaul the IRS’ IT systems and capabilities. These IT enhancements are designed to “help support a staff capable of deploying new analytical techniques” and “developing machine learning capabilities [that] will enable the IRS to leverage the information it collects to better identify tax returns for compliance review.” Given the inherent difficulties in identifying cryptocurrency users who have failed to comply with the internal revenue laws, increased data collection and analytics capabilities would be invaluable for the IRS.

The IRS has already been ramping up its cryptocurrency tax enforcement efforts by issuing John Doe summons to various cryptocurrency exchanges, working with industry experts and foreign law enforcement. If implemented, the American Families Plan Tax Compliance Agenda would provide the IRS with extensive new tools and resources for these ongoing enforcement activities.

Practice Point: If you have engaged in cryptocurrency transactions, now is the time to analyze whether you have any civil or criminal exposure and prepare for a government inquiry by gathering all of your transaction records. For [...]

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IRS Releases Guidance on Cryptocurrency Hard Forks

by John T. Lutz, William R. Pomierski, Kevin Spencer and McDermott Will & Emery | May 6, 2021 | IRS Guidance, Tax Reform

On April 9, 2021, the Internal Revenue Service (IRS) released Chief Counsel Advice memo 202114020 (Hard Fork CCA), which details the potential tax consequences for taxpayers who held Bitcoin prior to the August 1, 2017, Bitcoin hard fork. While the Hard Fork CCA concerns the taxation of a particular cryptocurrency transaction, it has additional significance because it adds to the limited guidance available regarding the proper taxation of cryptocurrency more generally.

IN DEPTH

A cryptocurrency hard fork occurs when the blockchain on which cryptocurrency transactions are recorded permanently splits. The holder of the cryptocurrency generally has no control or notice that the hard fork is about to occur. The result is two separate blockchains with two separate sets of rules for recording transactions.

Bitcoin underwent a hard fork on August 1, 2017, and resulted in two separate sets of protocols for Bitcoin, as well as a new cryptocurrency called Bitcoin Cash. The result of this hard fork was that individuals holding Bitcoin in a distributed ledger now held a unit of Bitcoin Cash for each unit of Bitcoin previously held.

The Hard Fork CCA reached two conclusions concerning the Bitcoin hard fork. First, it determined that a taxpayer who received Bitcoin Cash because of the hard fork has gross income pursuant to Internal Revenue Code (IRC) section 61. Second, it determined that the date of receipt and fair market value of the income depends on when the taxpayer obtains dominion and control over the Bitcoin Cash. The Hard Fork CCA relies on the statutory language of IRC Section 61(a)(3) and the well-established case law of Commissioner v. Glenshaw Glass Company (348 U.S. 426, 431 (1955) in reaching this result. Those sources define gross income as “all income from whatever source derived,” and provide that all gains or undeniable accessions to wealth, clearly realized, over which a taxpayer has complete dominion are included in gross income. The Hard Fork CCA also concludes that an impacted taxpayer gains dominion over Bitcoin Cash when they have the ability to sell, transfer or exchange the Bitcoin Cash.

Despite the fact that the Hard Fork CCA deals specifically with the consequences of the Bitcoin hard fork, the dearth of IRS guidance on the taxation of cryptocurrencies means the Hard Fork CCA will likely have broad importance to taxpayers who invest in other cryptocurrencies and similar digital assets. Most taxpayers hold cryptocurrencies through a cryptocurrency exchange platform. Coinbase, for example, which recently underwent a highly publicized initial public offering (IPO) and IRS summons for information concerning its participants, is one of the most popular cryptocurrency exchanges. (Additional detail regarding the Coinbase summons is available on our Tax Controversy 360 blog.) After a hard fork, some exchanges immediately adopt the new cryptocurrency and permit its use on the exchange; however, others only do so after a period of evaluation, if ever. The Hard Fork CCA takes the position that a taxpayer who privately holds their Bitcoin using a private key to [...]

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DOJ and IRS’ Analysis of Crypto Records and Work with Private Experts and International Partners Leads to Arrest

by Katharine Suominen and McDermott Will & Emery | Apr 30, 2021 | IRS Guidance, Uncategorized

US law enforcement continues to make no secret of their efforts to work closely with experts and overseas partners to prosecute those involved in virtual currency transactions who attempt to rely on its purported anonymity to commit financial crimes. Tuesday’s arrest of Roman Sterlingov, a dual citizen of Russia and Sweden and alleged operator of Bitcoin Fog, in Los Angeles is a clear case that these efforts are paying dividends. In a criminal complaint filed by the US Attorney’s Office for the District of Columbia, Sterlingov is accused of laundering hundreds of millions of dollars’ worth of bitcoin. According to a statement of facts accompanying the complaint filed in the District of Columbia, Sterlingov was allegedly running “an illicit bitcoin money transmitting and money laundering service.” (Case 1:21-mj-00400-RMM Document 1-1 Filed 04/26/21.) Notably, investigators from the Internal Revenue Service (IRS) and Federal Bureau of Investigation (FBI) were able to obtain records of Sterlingov’s True Name accounts at several cryptocurrency exchanges. Investigators also analyzed bitcoin transactions, email records, financial records and internet service provider records. The investigation and arrest come at a time when the IRS, together with other enforcement agencies, are taking a hard look at cryptocurrency activity and have recently issued John Doe summonses to two virtual currency exchanges.

The collaboration with private experts and international partners is clear from the press release issued by the US Department of Justice (DOJ). In recognizing the many agencies that assisted in the investigation, the DOJ specifically stated that essential support was provided by Excygent, which is described on its website “as a highly specialized, professional services firm that assists organizations in both the public and private sectors with cybercrime investigative and analysis capabilities.” The DOJ also listed several US agencies that provided invaluable assistance and went on to include international partners: Europol, the Swedish Economic Crime Authority, the Swedish Prosecution Authority, the Swedish Police and the General Inspectorate of Romanian Police, Directorate for Combatting Organized Crime and the Directorate for Investigating Organized Crime and Terrorism. This ability to collaborate successfully will most likely serve as a blueprint for future investigations.

Practice Point: As we noted in our blog post, “Finding John Doe: IRS Steps up Enforcement Efforts to Take the Anonymity Out of Virtual Currency,” the time is now for those who have engaged in a virtual currency transaction to assess any potential tax and criminal implications, and businesses in this industry should carefully review their policies and processes to ensure that they address potential tax avoidance and anti-money laundering risks associated with their operations. The IRS is working closely with its new partners (i.e., industry experts and foreign law enforcement) to address any noncompliance. As announced recently by US President Joe Biden, he plans to give them the resources to do more on enforcement.

Are Crypto Loans Taxed as Loans?

by McDermott Will & Emery | Sep 18, 2020 | IRS Guidance, Tax Reform

Transactions involving the borrowing and lending of units of virtual currency (or crypto loans) are increasing in number and type. Lacking Treasury or IRS guidance with respect to crypto loans, potential tax issues that arise from these transactions must be analyzed and understood in accordance with broad, general tax principles established by case law and based on government guidance developed in other tax areas.

Access the full article here.

Finally the IRS Clarifies Its Position on Cryptocurrency

by Kevin Spencer and McDermott Will & Emery | Oct 10, 2019 | Court Procedure Matters, IRS Appeals, IRS Audits, IRS Guidance, Uncategorized

It took five years, but the Internal Revenue Service (IRS) has finally released some guidance on the taxation of cryptocurrencies! On October 9, 2019, the IRS released Revenue Ruling 2019-24 and several “frequently asked questions” (and answers) which deal with some (but not all) of the federal income tax issues involved with cryptocurrencies.

Over the years, we have reported on the issues involved with cryptocurrencies, including the potential controversies that have ensued because of a lack of guidance.

The new guidance is welcomed by tax professionals and taxpayers. The guidance adopts traditional tax principles to deal with some of the unique aspects of cryptocurrencies. For example, the guidance addresses the tax treatment of so-called “hard forks” and whether the value of the “fork” which is “airdropped” into the taxpayer’s wallet constitutes taxable income.

Practice Point: Cryptocurrencies are a brave new world for most of us. Having thoughtful, current guidance is helpful to tax professionals and taxpayers, and will (hopefully) lead to better and more efficient administration of our tax system.

Watch Your Mailbox: IRS Letters Warning of Cryptocurrency Non-Compliance on Their Way

by McDermott Will & Emery | Jul 30, 2019 | IRS Guidance, Uncategorized

On July 26, 2019, the Internal Revenue Service (IRS) issued a press release informing the public that it is sending more than 10,000 letters to taxpayers with potentially unreported (or misreported) virtual currency transactions. The letters will inform them of the possible reporting requirements that may apply to these transactions and advise them of the need to correct past errors. (more…)

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