Tag: Advisory

The increased use of digital assets as currency and electronically stored items (such as, nonfungible tokens – NFTs – which can be digital artwork and images) has caused the IRS and other government agencies to examine the regulation of these assets. Moreover, on an international level, banking and tax enforcement agencies are reviewing the challenges and opportunities of digital marketplace.

Based on main street businesses and investors increasing interest in digital assets, The Wall Street Journal recently reported that US banks and securities firms are exploring processes to safeguard and handle their clients’ digital asset requirements. Money managers and investors are pressing traditional financial institutions such as Fidelity Investments, Bank of New York Mellon and State Street Corporation to develop capabilities to store and trade Bitcoin, NFTs and other digital currencies. Money managers and investors want these transactions to be tracked and safeguarded by these established firms as opposed to anonymous blockchains and miners that have dominated this role.

While bank and securities administrators are beginning to examine the regulation of digital assets, the IRS has been issuing guidance in this area since 2014. Since that time, the IRS has updated their Frequently Asked Questions and has added a question to tax returns regarding virtual currency transactions. In addition, President Biden’s Infrastructure Investment Jobs Act (“IIJA”), signed into law on November 15, 2021, contained provisions affecting the crypto marketplace. Moreover, on March 9, 2022, the President issued an Executive Order regarding the regulation of digital assets. Additionally, on March 28, 2022, the Administration released its fiscal agenda for 2023 (The Green Book) that has provisions regarding digital assets.

This article will discuss the basic tax treatment of digital assets. RVG and Company will issue a follow up on this topic that will outline recent developments in this area and what taxpayers and practitioners can expect as the use of digital assets grows.

Established IRS Guidance – IRS Notice 2014-21 and Published FAQs on Virtual Currency Transactions

Tax Treatment of Crypto Currency & Virtual Currency

In 2014, the IRS issued Notice 2014-21, which provides a series of questions and answers regarding the tax treatment of virtual currency transactions. This notice was supplemented in 2019 by Revenue Ruling 2019-24. Also, the IRS regularly updates the FAQs on its website regarding virtual currency. Currently, there are 46 FAQs published by the IRS. The first notice, 2014-21, contained only 16 Q&As. As a result of wider use of virtual currency, the IRS has increased the rate and scope of publishing guidance on this emerging issue. The FAQs were recently updated on March 23, 2022.

Initially, the FAQs dealt with determining the gain, loss, and basis from the use of virtual currency. As the use of virtual currency has expanded, the guidance under the FAQs has become more complex and now addresses topics such as charitable contributions, the transfer of digital currencies among a taxpayer’s wallets, peer to peer transactions and the consequences of hard and soft forks.

According to the IRS, cryptocurrency is a type of virtual currency that “uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain.” Stable coins, or “convertible virtual currencies,” like Bitcoin that have an equivalent value in fiat currency. At the time of this writing, for instance, one Bitcoin is worth approximately $30,000. However, despite the implication of the word “currency,” the key takeaway from the IRS Notices and guidance, is that for federal tax purposes, virtual currencies are considered property, to which general tax principles for property transactions apply.

Thus, a taxpayer may realize a gain subject to capital gains tax in various transactions, such as selling cryptocurrency for cash, paying for goods and services, or exchanging one form of cryptocurrency for another (like-kind exchange rules do not apply). Like other capital assets, the tax rate depends on how long the cryptocurrency is held. It should also be noted that when a taxpayer receives virtual currency as a wage from an employer, the fair market value of the virtual currency paid as wages is subject to federal income tax withholding. The subsequent sale or use of the virtual currency by the employee to purchase other goods and services may result in a gain related to the disposition of the virtual currency.

Short-term capital gains apply to transactions involving assets held less than a year and are taxed at the

same rate as ordinary income. Long-term capital gains are subject to tax rates of either 0%, 15%, or 20%,

depending on the taxpayer’s income and filing status. The basis of the cryptocurrency is determined at the time of receipt. As a result, taxpayers must maintain records of the date and fair market value at the time the digital currency is acquired. Similarly, the taxpayer must record the date and value of the virtual currency when it is sold or disposed of.

Tax Treatment of NFTs

At present, the IRS has not issued a Notice or FAQ regarding NFTs. NFTs are unique digital assets derived from blockchain technology that can take various forms, such as artwork, music, or in-game items. NFTs are property but they are not mediums of exchange and do not function as currency.

Although their purpose and function are distinct from a “currency,” tax treatment rules for purchasing an NFT are similar. The act of purchasing an NFT is not a taxable event. If an NFT, like any asset is purchased with cash – the transaction is not a taxable event. However, if an NFT is purchased with cryptocurrency, there could be a taxable event because using the digital currency as payment (for the NFT) is treated as a disposition of the digital currency. Consequently, the taxpayer may realize a gain or loss based on the use of the cryptocurrency / digital currency used to acquire the NFT.

In addition, if the NFT is later sold for gain, the taxpayer may have to report two potential layers of gain. One gain related to the sale of the NFT and the second gain from the disposition of the cryptocurrency.

If you are engaging in business or have investments in digital assets, RVG and Company can guide you through the tax and business issued related to this emerging issue.

Conclusion

If you are engaging in business or have investments in connection with digital assets, RVG and Company can guide you through the tax and business issues related to this emerging issue. In our next article on this topic, we will examine recent regulatory steps taken by the Administration and the IRS concerning virtual currency.

In our first article regarding digital assets, we discussed the basic taxation of virtual currency. We examined the guidance issued by the IRS related to cryptocurrency, virtual currency, and other digital assets such as nonfungible tokens (NFTs). In this installment we will review recent legislation contained in the President’s Infrastructure Investment Jobs Act (“IIJA”), signed into law on November 15, 2021, and proposed policies and regulations concerning virtual currency and digital assets.

IIJA – Impact on Virtual and Cryptocurrency

The IIJA contains two provisions that affect the cryptocurrency industry. The first provision is that IRC § 6045 was amended to require brokers, or anyone “responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person,” to report digital asset transactions on Form 1099-B in a way similar to many securities. Reported details include sale proceeds, basis, and dates. The Act defines a “digital asset” as any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology. The issue related to Form 1099-B is whether the IRS regulations will be revised to define who meets the definition of “broker” for reporting purposes.

The second modification contained in the IIJA requires digital assets to be treated as cash for $10,000 reporting purposes. Under IRC § 6050, crypto transactions in excess of $10,000 must be reported on Form 8300. Thus, digital assets are treated like cash. Both of these reporting changes take effect for transactions occurring after January 1, 2023, and for reports due after December 31, 2023.

Additional Policies from the Biden Administration

Executive Order – On March 9, the president signed an executive order outlining his digital asset plan, calling for more oversight over cybersecurity and bad actors by effectively centralizing the digital asset world. This begins with a review of a potential Central Bank Digital Currency (CBDC). Biden instructed a concert of top agency officials to, within 180 days, submit a report on “the future of money and payment systems.” This review will examine digital payment technologies, the interplay of related market forces, and the effect upon the U.S. economy.

Green Book – In March the Administration released the Green Book, which serves as a platform for outlining the President’s budget proposals for the next fiscal year. The Green Book contains three items related to cryptocurrency.

The first item relates to crypto lending and would provide that securities loan nonrecognition rules apply to loans of actively traded digital assets recorded on cryptographically secured distributed ledgers if the loan terms are similar enough to securities loans. This would apply to tax years beginning after December 31, 2022.

The second requirement relates to foreign digital assets. Under the Foreign Account Tax Compliance Act, US taxpayers holding an aggregate value of over $50,000 in cryptocurrency in a foreign digital asset account would report this information to the IRS. This would focus on tax avoidance behavior by crypto investors and apply to returns filed after December 31, 2022.

The third provision states that the US would bolster its automatic information sharing with other countries. Specifically, U.S. digital asset exchanges would have to disclose information on substantial foreign owners of some passive entities. Certain financial institutions would also need to report the account balance “for all financial accounts maintained at a U.S. office and held by foreign persons.” This includes digital asset brokers, likely under the definition provided by the IIJA. The proposal would be integrated with existing law and be effective for returns filed beginning 2024.

Global Tax Enforcement

The Joint Chiefs of Global Tax Enforcement (J5) issued a statement on May 10, 2022, regarding NFTs. The J5 is designed to combat transnational tax crimes and avoidance. It is comprised of tax officials from the US, Canada, Australia, Great Britain and Netherlands. The J5 issued a warning regarding the use of NFTs and cryptocurrencies. The J5 is convening a meeting to review money laundering, scams and counterfeit NFTs in the digital asset marketplace.

State Taxation of NFT Transactions

As the market and landscape for NFTs develops, it is only a matter of time before states seek to tax these transactions. However, one of the complications with imposing sales tax on NFT transactions is that blockchain transactions are not only transparent and immutable (the data can be seen by everyone and cannot be changed), but they are pseudonymous (under a false or unknow name). Even though the authenticity of blockchain transactions can be verified, the parties involved in the transaction are not generally identified. As a result, the sellers of NFTs may lack the information regarding the location of the buyer to collect and remit sales tax. However, since the IIJA as noted above, will require brokers and persons with trade or business who receive $10,000 or more of digital assets to collect information on parties to a digital asset transaction, information may become more readily available for states to source these transactions for purposes of sales tax and income tax apportionment.

Conclusion

If you are engaging in business or have investments in connection with digital assets, RVG and Company can guide you through the tax and business issues related to this emerging issue.

Recently, the New York State Department of Taxation and Finance (DTF) and the California Franchise Tax Board (FTB) issued guidance related to internet sales activities that are no longer protected by the income tax exemption under P.L. 86-272. On April 29, 2022, the New York State DTF issued “Final Draft Regulations” that place limitations on the tax income exemption provided to taxpayers. Prior to that, the California FTB issued a Technical Advice Memorandum (TAM) on February 14, 2022, that outlined similar limitations on P.L. 86-272 for e-commerce and online sellers of tangible personal property. New York and California are the first states to adopt the guidance issued by the Multistate Tax Commission (MTC). In August of 2021, the MTC published a “Statement of Information Concerning P.L. 86-272” that provides guidelines and examples of internet and e-commerce activities that are no longer protected by P.L. 86-272. New York and California’s adoption of the MTC’s measures represents a shift in the application of P.L. 86-272 for digital and online businesses.

Background on P.L. 86-272 and the Wayfair Decision

P.L. 86-272 is a 1959 federal law that prohibits a state from imposing a net income tax on an out-of-state business for income derived from business activities within the state if their activities are limited to “mere solicitation” of orders for the sale of tangible personal property and the orders are then approved and filled from outside the state. If the orders are accepted, they must be filled by shipment or delivery from outside the state.

Since the enactment of P.L. 86-272, sales of tangible personal property have evolved from primarily occurring in-person or over the phone – to taking place remotely through the internet. However, Congress has not updated P.L. 86-272 to reflect changes in technology and sales activities.

After the 2018 U.S. Supreme Court decision in South Dakota v. Wayfair, Inc., the MTC conducted hearings regarding P.L. 86-272 in the context of internet sales. The MTC’s guidance follows the Supreme Court’s acknowledgement that the internet transformed modern sales practices and that the application of state taxes required a similar transformation. In Wayfair, the Court held that remote internet-based sellers were responsible for collecting sales tax even though they were not physically present in the buyer’s state. Wayfair overturned prior Supreme Court cases that required the seller to have physical presence in the taxing state to be liable to collect sales taxes.

The Court stated that in the digital economy, the physical presence test was no longer sound – and did not align with the modern e-commerce economy. The MTC used Wayfair as an opportunity to revise the application of P.L.86-272. The MTC noted that e-commerce sellers may be engaging in activities through the internet that go beyond the solicitation and approval of an order for purposes of the P.L. 86-272 exemption.

P.L. 86-272 Activities That Remain Protected Under Revised New York and California Guidance

The guidance issued by New York and California follows the MTC’s Statement of Information. It should be noted that the MTC did not alter the P.L. 86-272 exemption for non-internet-based sales. Below is a list of internet / e-commerce activities that would still be protected under P.L. 86-272 in both New York and California:

• Providing post-sale assistance to customers by posting a list of static frequently asked questions (FAQs) with answers on the company’s website.
• Placing internet “cookies” onto the computers or other devices of the customers that gather information only used for purposes entirely ancillary to the solicitation of orders for tangible personal property.
• Offering for sale only items of tangible personal property on the website, with the website allowing customers to search for items, read product descriptions, purchase items, and select delivery options.

Internet and E-Commerce Activities that Would Not be Protected by P.L. 86-272 Under New York and California Guidance.

The items listed below are the types of business activities and practices that will unwind the P.L. 86-272 exemption for online and e-commerce-based sales. This list is not exhaustive and may evolve as technology advances.

• Providing post-sales assistance to customers by electronic chat or email those customers initiate by clicking on an icon on an internet website.
• Soliciting for and receiving online applications for a business-branded credit card via the website from customers.
• Enabling internet website viewers to apply for non-sales positions through submission of an electronic application and an upload of a cover letter and resume.
• Placing internet “cookies” onto the computers or other electronic devices of customers to gather customer information that is used to adjust production schedules and inventory amounts, develop new products, or identify new items to offer for sale.
• Remotely fixing or upgrading products previously purchased by customers by transmitting code or other electronic instructions to those products over the internet.
• Offering and selling extended warranty plans via internet website to customers who purchased the business’s products.
• Contracting with a marketplace facilitator that facilitates the sale of the business’s products on the facilitator’s online marketplace.
• Contracting with customers to stream videos and music to electronic devices.

Conclusion

The effective date for the New York modification is uncertain because the DTF requested timely feedback on the Draft Regulations by June 30, 2022. Presumably, the rules will be effective after that date. The effective date for the California TAM is less certain. While the FTB issued the TAM on February 14, 2022, the TAM indicates that the basis for the new guidance is the Supreme Court’s decision in Wayfair. As a result, it is possible that the FTB could apply the new guidance under the TAM retroactively to tax year 2018, when Wayfair was decided.

Lastly, since New York and California are influential state tax jurisdictions, it is likely that other state will adopt the guidance issued by the MTC.

If you would like to discuss the potential impact that revisions to P.L. 86-272 may have on your business, please call RVG & Company at 954.233.1767.

The IRS publishes Informational Releases regarding scams that are directed at taxpayers and tax professionals. Many of these scams attempt to impersonate the IRS. To raise awareness of fraud, this article will cover some of the characteristics and deceptions used by these scammers. Below is a brief description of the various deceptions used by criminals.

Currently, twenty-nine states and one city have enacted State and Local Tax (SALT) Cap Workaround Laws (SCWLs) that enable the owners of pass-through entities (PTEs), such as Partnerships, S-Corporations, and LLCs, to minimize their federal tax liability by circumventing the $10,000 cap on state and local tax deductions (SALT Cap) for individuals.

The SALT Cap was part of the 2017 Tax Cut and Jobs Act (TCJA) that is effective for tax years 2018 through 2025. It primarily affects individuals who itemized their deductions and pay significant state taxes. The SALT Cap impacts high-income individuals that reside or do business in states that impose high taxes, such as California, Connecticut, and New York. Recently, states with lower rates of tax are also adopting SCWLs to benefit their high-income residents.

Even taxpayers that reside in states that have no income tax can recognize the federal tax benefit from the SCWLs if their business operates in states that impose income taxes.

The SCWLs reduce the SALT Cap’s effect on owners of PTEs. However, individuals earning wages generally cannot take advantage of the SCWLs. In short, this strategy converts a business owner’s personal state income taxes, which are attributable to the PTE, into deductible business taxes that escape the $10,000 cap on state and local tax deductions. The SCWLs, provide PTE businesses the same state tax deduction that C corporations have.

Federal Tax Impact of SCWL

In response to the Tax Cut and Jobs Act (TCJA) SALT Cap, several states adopted an elective PTE level tax as a workaround to provide a federal tax benefit to their residents without costing the states any tax revenue.

The benefit of the PTE paying the tax is that owners can re-characterize a non-deductible state income tax expense to a deductible tax expense for federal tax purposes. If these taxes were attributed to the owner, the SALT limitation would apply if the owner’s itemized state tax deductions for state taxes exceeded $10,000.

It should be noted that the IRS has approved the enactment of the SALT Cap Workarounds passed by the states. In November of 2020, the IRS announced in Notice 2020-75, that it will issue proposed regulations that confirm that the entity-level state taxes imposed on PTEs are not subject to the $10,000 SALT Cap limit to their owners.

Federal Tax Impact Without SCWL

Without the enactment of SCWLs, taxes paid by PTEs are treated as paid on behalf of their owners (partners and shareholders) and must be separately stated on their individual tax returns. Internal Revenue Code §164(b)(2) and §1366(a)(1), respectively require that a partner or shareholder of an S corporation take into account separately their pro-rata share of taxes paid by the partnership or S corporation that is included in their share of K-1 income. The deductibility of the tax is determined at the partner or shareholder level. These taxes include nonresident tax withholding and composite tax payments.

State Tax Impact

While each state’s SCWL may vary slightly, they generally permit the owners of the PTE to take a credit for the taxes paid by the entity to avoid double taxation. However, PTE owners that reside in states that did not enact a SALT Cap Workaround, may not receive a credit for the taxes paid by the PTE in another state. As a result, there may be a disparity among the owners of a PTE with respect to receiving a state benefit.

Conclusion

The potential benefit of the SALT Cap Workaround election must be evaluated on a case-by-case basis. There is an added complexity to this analysis where the PTE conducts business in multiple states and has owners that reside in different states as well. Since only twenty-eight states (see below for a list*) have enacted SCWLs, it is possible that there will be a difference between the overall benefit to each of the owners based on whether their state allows them a credit or deduction for taxes paid by the PTE. As noted above, each state may have nuances to the SCWL that must be considered. For example, Wisconsin imposes a higher rate of tax on a PTE than an individual.

RVG & Company

If you would like to discuss the potential impact that the SALT Cap Work Around may have on your business, please call RVG & Company at 954.233.1767.

*Jurisdictions that have adopted SCWLs: AL, AK, AZ, CA, CO, CT, GA, ID, IL, KA, LA, MD, MA, MI, MN,MO, MS, NJ, NY, New York City, NM, NC, OH, OK, OR, SC, RI, UT, VA, and WI.