Bitcoin Trusts Avoid Taxes, Including $10,000 SALT Deduction Cap

The IRS treats bitcoin and other crypto as property. That means each transfer can trigger taxes. There may be tax to the recipient, plus tax to the transferor. The latter catches many people by surprise. A key tax question on each transfer is the market value on transfer. With the wild swings in value, that can be frightening. Some crypto investors use legal entities such as corporations, LLCs or partnerships. They can face the same transfer issues, but it is often possible to contribute the crypto to the entity without triggering taxes.

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Another avenue now being considered is a crypto trust. This is really just a trust that holds crypto assets. Trusts can be taxed in several different ways, depending on their type. There are living trusts that people usually use for estate planning, and they are not separately taxed. If you transfer Bitcoin to your living trust, it usually isn’t a taxable transfer, since your living trust isn’t really a separate taxpayer. It is still you. The trust is not separately taxable, typically until you or your spouse die.

There are also non-grantor trusts, where the transferor is not taxed on them. These are separately taxed, and they file a separate trust tax return. The trust itself pays taxes, and there can be another tax on the distribution to beneficiaries. But leaving distribution issues aside, where does the trust pay taxes? Some trusts are foreign, set up outside the U.S. Those rules are complex, but if you are U.S. person, you should not assume that you can avoid U.S. tax with a foreign trust.

What about state taxes? Some trusts are being set up with an eye to reducing or avoiding state taxes. Remember, there’s a new federal tax deduction cap of $10,000. Say you are in California and don’t want to move to Nevada before you sell your Bitcoin. You want to cut the sting of California’s high 13.3% state tax, but you aren’t willing to move, at least not yet. You could consider setting up a new type of trust in Nevada or Delaware. A ‘NING’ is a Nevada Incomplete Gift Non-Grantor Trust. A ‘DING’ is its Delaware sibling. There is even a ‘WING,’ from Wyoming. Some marketers of NING and DING trusts offer it as an alternative or adjunct to a physical move. The idea is for the income and gain in the NING or DING trust not to be taxed until it is distributed. At that point, the distributees will hopefully no longer be in California.

Let’s say you can’t move quite yet, so you wonder if a trust in another state might work? The idea of a Nevada or Delaware Incomplete Gift Non-Grantor Trust is for the donor to make an incomplete gift, with strings attached. The trust has an independent trustee outside of California. When this was tried in New York, New York lawmakers changed the law to make the grantor taxable no matter what. California’s Franchise Tax Board has not yet ruled on the issue.

If the NING or DING trust is formed to facilitate a business sale and the proceeds will be capital gain, there is the federal tax of up to 20%. Then, there is also the 3.8% Obamacare tax on net investment income. It makes the current federal tax burden on capital gain up to 23.8%. California taxes all income at up to 13.3%, and there is no lower rate for long term capital gain. It is one reason Nevada, Texas, Washington, Florida and other no tax states may be tempting for California sellers.

Most non-grantor trusts are considered taxable where the trustee is situated.  For NING and DING trusts, one common answer is an institutional trust company in Delaware or South Dakota. For trust investment and distribution committees, the committee members should also not be residents of California. Even if you jump through all the requisite hoops, the NING or DING trust may still pay some California tax. For example, if the trust has California source income, it will still be taxable by California. Gain from California rental properties or the sale of California real estate is sourced to California no matter what.

Outside of New York residents, the jury is still out on NING and DING trusts. The facts, documents, and details matter. California  rarely takes moves that short the state lying down. State tax fights in California can be protracted and expensive. But if one is careful, willing to bear some risk, and there is sufficient money at stake, the calculated risks may be worth considering.

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Bitcoin Options And Other Tax Dangers

There is considerable talk today about crypto investments for everyone, for individual retirement accounts, via index funds, and more. There are also plenty of crypto-related start-ups, some of which have gotten big and valuable. That means options, crypto bonuses, restricted crypto, etc. All of these raise tax issues, and they can be confusing. Before we address crypto itself that is awarded to workers in connection with services, let’s start with stock options, and options to acquire crypto.

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Options can be either incentive stock options (ISOs) or non-qualified stock options (NSOs). ISOs (only for stock) are taxed the most favorably. There is generally no tax at grant, and no “regular” tax at exercise. When you sell your shares, you pay tax, but hopefully as long-term capital gain. The usual capital gain holding period is more than one year. But to get capital gain treatment for shares acquired via ISOs, you must: (a) hold the shares for more than a year after you exercise the options; and (b) sell the shares at least two years after your ISOs were granted. Even though exercise of an ISO triggers no regular tax, it can trigger alternative minimum tax (AMT).

Non-qualified options are not taxed as favorably as ISOs, but there is no AMT trap. There is no tax when the option is granted. But when you exercise, you owe ordinary income tax (and, if you are an employee, payroll tax) on the difference between your price and the market value. Example: You receive an option to buy stock at $5 per share when the stock is trading at $5. Two years later, you exercise when the stock is trading at $10 per share. You pay $5 when you exercise, but the value at that time is $10, so you have $5 of compensation income. If you hold the stock for more than a year and sell it, any sales price above $10 (your new basis) should be long-term capital gain.

Options to buy crypto are treated just like nonqualified options to buy stock. Usually the tax comes when you exercise the option, not when you are given the option. Restricted stock or crypto means delayed tax. Suppose you receive stock or other property—including crypto—from your employer with conditions attached? Say you must stay for two years to get it or to keep it. Special restricted tax rules in Section 83 of the Internal Revenue Code kick in.

As a carrot to stay with the company, your employer says if you stay for 36 months, you will be awarded $50,000 worth of crypto. You don’t have to “pay” anything for them. You have no taxable income until you receive the crypto. When you receive the crypto, you have $50,000 of income, or more or less, depending on how the crypto has done in the meantime. The income is taxed as wages.

With restrictions that will lapse with time, the IRS waits to see what happens before taxing it. Yet some restrictions will never lapse. With such “non-lapse” restrictions, the IRS values the property subject to those restrictions. Example: Your employer promises you crypto if you remain with the company for 18 months. When you receive it, it will be subject to permanent restrictions under a company buy/sell agreement to resell it for a fixed price if you ever leave the company’s employ. The IRS will wait and see (no tax) for the first 18 months. At that point, you will be taxed on the value, which is likely to be stated fixed price in the resale restriction.

The restricted property rules generally adopt a wait-and-see approach for restrictions that will eventually lapse. Nevertheless, under what’s known as an 83(b) election, you can choose to include the value of the property in your income earlier (in effect disregarding the restrictions). It might sound counter-intuitive to elect to include something on your tax return before it is required. Yet you might want to include it in income at a low value, locking in capital gain treatment for future appreciation. To elect current taxation, you must file a written 83(b) election with the IRS within 30 days of receiving the property. You must report on the election the value of what you received as compensation (which might be small or even zero).

Example: You are offered crypto by your employer at $5 per coin when it is worth $5. You must remain with the company for two years to be able to sell them. You are paying fair market value for the crypto. So filing an 83(b) election could report zero income. Yet by filing it, you convert what would be future ordinary income into capital gain. When you sell the crypto more than a year later, you’ll be glad you filed the election.

If the restricted property rules and stock options rules were each not complicated enough, sometimes you have to deal with both sets of rules. You may be awarded options that are restricted–your rights to them “vest” over time if you stay with the company. The IRS generally waits to see what happens in such a case. But be careful, these rules can be complex.

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Sexual Harassment Tax Law That Double-Taxes Victims Needs Fixing

The “Repeal the Trump Tax Hike on Victims of Sexual Harassment Act of 2018” has not yet been passed, and it is not clear that it will be passed. But it certainly should be passed. Most observers looking at the big tax reform law that passed at the end of 2017 note the potential confusion–or worse–caused by the so-called Harvey Weinstein provision. The provision was meant to stop defendants in sexual harassment cases from being able to deduct their legal fees and their settlement payments where they require confidentiality from their accusers in legal settlement agreements.

In this March 2, 2014 photo, Harvey Weinstein arrives at the Oscars in Los Angeles. The recent sexual harassment and assault allegations against Weinstein set off a wave of charges against other men and led to an obscure provision in the Senate tax cut bill. (Photo by Jordan Strauss/Invision/AP)

But the law actually reads that the accusers too cannot deduct their legal fees. That means if a plaintiff recovers $500,000 but must pay her lawyer 40%, the full $500,000 is taxable income. It means that the victim is paying tax on money she never receives. And if the legal fees and costs combined climb to say 50%? That means paying taxes on twice the money you collect. That sure sounds like double taxation. Section 162(q) of the tax code provides:

(q) PAYMENTS RELATED TO SEXUAL HARASSMENT AND SEXUAL ABUSE. — No deduction shall be allowed under this chapter for — (1) any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or (2) attorney’s fees related to such a settlement or payment.”

It doesn’t say whose legal fees can’t be deducted, so it means everyone’s. Of course, virtually all legal settlement agreements have some type of confidentiality or nondisclosure provision. It is true in virtually any kind of legal case, and perhaps especially so in sexual harassment cases. The basic tax rules for legal fees surprises many people. Plaintiffs who use contingent fee lawyers are treated for tax purposes as receiving 100% of the settlement amount, even if their lawyer takes 40% off the top. So ruled the U.S. Supreme Court in Commissioner v. Banks, 543 U.S. 426 (2005).

That means the plaintiff must figure a way to deduct the 40 percent fee. In 2004, Congress provided an above the line deduction for legal fees in employment cases. Since then, plaintiffs in employment cases have been taxed on their net recoveries, not their gross. Yet a glitch in the tax law seems to mean that the plaintiffs–the very people the new law was presumably meant to help protect–cannot deduct their legal fees either. There is a movement to amend the law to correct this ridiculous and unjust result.

But sexual harassment victims who must settle in the meantime may be worried. In the topsy-turvy world of Congress, it is not clear that the law will pass. Even if it does eventually, it is not clear that will be anytime soon. Any mention of sexual harassment is a legal case could trigger the law. It could bar any tax deduction, even if the sexual harassment part of the case is minor. Plaintiff and defendant may agree on a particular tax allocation, perhaps allocating only a small amount to sexual harassment. However, the IRS is never bound by an allocation in a settlement agreement.

Hopefully the Repeal the Trump Tax Hike on Victims of Sexual Harassment Act of 2018 will be passed, and passed swiftly. Of course, there are many other parts of the new tax law that require technical corrections or other fixes too. But this one should be corrected without delay. 

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As Fox Settles Suits Without Confidentiality, Will Nondisclosure Provisions Disappear?

The news that Fox settled discrimination lawsuits involving 18 former employees for roughly $10 Million without confidentiality provisions may seem to reflect a new openness after past Fox scandals. It may well be. But given the tax laws, it could also suggest a trend in favor, not necessarily of publishing the details, but of not affirmatively precluding disclosure. That may be good business. It also may be good for the defendants’ tax bills. It could be good for plaintiffs too.

This Aug. 1, 2017, photo shows the 21st Century Fox sign outside of the News Corporation headquarters building in New York. (AP Photo/Richard Drew)

The massive tax bill passed at the end of 2017 included a provision that was a direct outgrowth of the #MeToo movement. The tax code now denies tax deductions in confidential sexual harassment or abuse settlements. Notably, this “no tax deduction” rule applies to the lawyers’ fees, as well as the settlement payments. New Section 162(q) of the tax code provides:

(q) PAYMENTS RELATED TO SEXUAL HARASSMENT AND SEXUAL ABUSE. — No deduction shall be allowed under this chapter for — (1) any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or (2) attorney’s fees related to such a settlement or payment.”

The provisions does not cover race, gender or age discrimination, but only sexual harassment or abuse. Yet sexual harassment allegations feature as at least part of the claim in many employment disputes. The new law is broad enough that it could apply to all of the money, even though only a relatively minor amount might be for sexual harassment. Traditionally, of course, almost all legal settlement agreements have some type of confidentiality or nondisclosure provision.

It is unclear whether any mention of sexual harassment will trigger the Weinstein provision. If it does, it might bar any tax deduction, even if the sexual harassment part of the case is minor. Plaintiff and defendant may want to agree on a particular tax allocation, attempting to head off the provision. In a $1M settlement involving numerous claims, could one allocate $10,000 to sexual harassment? Legal settlements are routinely divvied up between claims, though being reasonable is important. At the least, there could be additional reasons for the parties to address allocations. The IRS is never bound by allocations in settlement agreements, but the IRS often respects them.

We may start seeing explicit sexual harassment allocations where sexual harassment was the primary impetus of the case, and where the claims are primarily about something else. Perhaps the parties will allocate $50,000 of a $1M settlement to sexual harassment. Alternatively, the parties might agree that no portion of the settlement is allocable to sexual harassment. But an even safer way to make sure tax deductions are available may be to simply not require confidentiality. This does not mean that there has to be a public disclosure of anything.

The plaintiff and defendant may both have their own reasons for not wanting to trumpet details of the case or the settlement. But by omitting confidentiality and nondisclosure provisions, tax deductions for settlement payments and for legal fees are unaffected. Plaintiffs may be better off too. As written, the Weinstein provision could even cut off tax deductions for legal fees paid by the plaintiff in a sexual harassment case. This result surely was not intended, but the wording could cover plaintiff’s legal fees too. We do not yet know how this will be read by the IRS, or whether a technical corrections bill might address this. But omitting the usual confidentiality or nondisclosure provisions from the settlement agreement will obviate the issue entirely. At the very least, we are seeing sexual harassment settlements and legal fees in a new era.

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As Prince Harry & Meghan Markle Wedding Arrives, So Do Taxes

As American actress Meghan Markle prepares to wed Britain’s Prince Harry, most people will not focus on the tax problems complex U.S. tax laws inevitably seem to bring. Early in their engagement, Buckingham Palace announced that Markle will become a British citizen after marriage. Yet tax lawyers quickly pointed out that Meghan Markle’s U.S. citizenship could cause tax headaches for Britain’s royal family. Unless she renounces her American citizenship, she must continue to file U.S. tax returns, plus FBARs, every year, reporting her worldwide income, and disclosing her assets. Even if the couple try to keep their assets separate, disclosing assets may be a particular worry.

WINDSOR, ENGLAND – MAY 03: Souvenirs featuring Britain’s Prince Harry and his fiance US actress Meghan Markle are displayed in a gift shop on May 3, 2018 in Windsor, England. St George’s Chapel at Windsor Castle will host the wedding of Britain’s Prince Harry and US actress Meghan Markle on May 19. The town, which gives its name to the Royal Family, is ready for the event and the expected tens of thousands of royalists. (Photo by Christopher Furlong/Getty Images)

More recent reports underscoring Markle’s coming British citizenship have noted that she may well decide to give up her American citizenship. At least this royal couple will be very well advised. Many a dual country couple innocently starts filing U.S. taxes together, and then are both caught forever in the U.S. tax net. 95% of married couples file joint tax returns, making each spouse liable for everything on the return–and anything that might not be on the return. Markle will surely be advised to file taxes separately, so Prince Harry will hopefully not be caught within the U.S. tax net. But if they have children, what about them?

FATCA, the Foreign Account Tax Compliance Act, was passed in 2010, and was ramped up worldwide. It requires an annual Form 8938 filing with the IRS that could end up involving royal assets. FATCA‘s unparalleled network of reporting requires foreign banks and governments to hand over secret bank data about depositors. Non-U.S. banks and financial institutions around the world must reveal American account details or risk big penalties. Markle could follow London’s former Mayor Boris Johnson, now Britain’s Foreign Secretary. Having been born in New York but raised in Britain, Johnson was a dual citizen of the U.S. and U.K. A run-in with the IRS eventually led him to renounce his American citizenship.

According to recently released numbers, for the first time in five years, the number of Americans who renounced their citizenship fell slightly in 2017 (5,133) from the previous year (5,411)which had been a record. The total for the first quarter of 2018 was 1,099. The total for calendar 2016 was 5,411, while 2015 had 4,279 published expatriates. Despite the official list, many who leave are not counted, although both the IRS and FBI track Americans who renounce. America’s global income tax compliance and disclosure laws can be a burden, especially for U.S. persons living abroad. Many foreign banks do not want American account holders.

Americans living and working in foreign countries must generally report and pay tax where they live. But they must also continue to file taxes in the U.S., where reporting is based on their worldwide income. A foreign tax credit often does not eliminate double taxes. Annual foreign bank account reports called FBARs carry big civil and even criminal penalties. The civil penalties alone can consume the entire balance of an account. Ironically, even leaving America can be costly.

What if Markle renounces her U.S. citizenship? America charges $2,350 to hand in your passport, a fee that is more than twenty times the average of other high-income countries. Previously, there was a $450 fee to renounce, and no fee to relinquish, but the U.S. hiked the fee by 422%. Now, there is a $2,350 fee either way. Moreover, to exit, one generally must prove 5 years of IRS tax compliance. And getting into IRS compliance can be expensive and worrisome. For some, a reason to get into compliance is only to renounce, which itself can be expensive.

Markle is said to have a net worth of $5 million, which would mean also paying an exit tax to the U.S. if she renounces. If you have a net worth greater than $2 million, or have average annual net income tax for the 5 previous years of $162,000 or more, you can pay an exit tax. It is a capital gain tax, calculated as if you sold your property when you left. A long-term resident giving up a Green Card can be required to pay the exit tax too. Sometimes, planning and valuations can reduce or eliminate the tax, but the tax worry can be real, even for those who will not face it.

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Fewer Americans Renounce Citizenship, But Taxes Still Drive Them

For the first time in five years, the number of Americans who renounced their citizenship fell slightly in 2017 (5,133) from the previous year (5,411), which had been a record. The total for the first quarter of 2018 was 1,099. In recent years there has been a marked upswing in expatriations, and tax considerations are often at least a part of the equation. Moreover, these published numbers are probably lower than the actual number of those who expatriated. How complete these lists are remains unclear. Despite the official list, many leavers are not counted, and both the IRS and FBI track Americans who renounce

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The figures for recent years show an important trend. The total for calendar year 2016 was 5,411, up 26% from 2015, which had 4,279 published expatriates. The 2015 total was 58% more than in 2014. The reasons for renouncing can be family, tax and legal complications, and some renouncers write why they gave up their U.S. citizenshipExpats have long clamored for tax relief. One law motivating some is FATCA, the Foreign Account Tax Compliance Act. FATCA has been ramped up worldwide, and requiring an annual Form 8938 filing if your foreign assets meet a threshold.

FATCA was enacted in 2010, and over five years, was painstakingly implemented worldwide by the U.S. Treasury Department. In now spans the globe with an unparalleled network of reporting. America requires foreign banks and governments to hand over secret bank data about depositors. Non-U.S. banks and financial institutions around the world must reveal American account details or risk big penalties. Some renounce because of global tax reporting and FATCA. Dual citizenship is not always possible, as this infographic  shows. America’s global income tax compliance and disclosure laws can be a burden, especially for U.S. persons living abroad. Their American status can make them untouchable by many banks.

Americans living and working abroad must generally report and pay tax where they live. But they must also continue to file taxes in the U.S., where reporting is based on their worldwide income. A foreign tax credit often does not eliminate double taxes. Moreover, enforcement fears are palpable for the annual foreign bank account reports called FBARs. They carry big civil and even potential criminal penalties. The civil penalties alone can consume the entire balance of an account.

Ironically, even leaving America can be costly. America charges $2,350 to hand in your passport, a fee that is more than twenty times the average of other high-income countries. The U.S. hiked the fee to renounce by 422%, as previously there was a $450 fee to renounce, and no fee to relinquish. Now, there is a $2,350 fee either way. The State Department said raising the fee was about demand and paperwork, but the number of American expatriations kept increasing. Moreover, to exit, one generally must prove 5 years of IRS tax compliance. And getting into IRS compliance can be expensive and worrisome. For some, a reason to get into compliance is to renounce.

However, if you have a net worth greater than $2 million, or have average annual net income tax for the 5 previous years of $162,000 or more, you can pay an exit tax. It is a capital gain tax, calculated as if you sold your property when you left. A long-term resident giving up a Green Card can be required to pay the exit tax too. Sometimes, planning and valuations can reduce or eliminate the tax, but the tax worry can be real, even for those who will not face it.

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Stormy Daniels, Michael Cohen, Giuliani, Trump & Taxes

At first it appeared that Michael Cohen had paid off Stormy Daniels with his own money, and without President Trump’s knowledge. Then, Rudy Giuliani said President Trump had reimbursed him. Then, there was some reshuffling about who knew what when. There were some awkward questions about whether President Trump knew of the deal at the time, or only learned of it later. The timing and mechanics of the reimbursement seem a little confused. From a tax viewpoint–which surely isn’t the most important part of this story–many of these details may not matter. Even so, the tax issues are an interesting side show. Just about every kind of payment has tax consequences, to both the recipient and to the one who paid the money. That latter point has now been partially clarified.

President-elect Donald Trump meets with former New York City Mayor Rudy Giuliani at the clubhouse of the Trump National Golf Club November 20, 2016 in Bedminster, New Jersey. – Rudy Giuliani, US President Donald Trump’s new lawyer, said Wednesday, May 2, 2018, on Fox News Channel’s Hannity, that Trump repaid $130,000 to his personal attorney Michael Cohen for payment to porn star Stormy Daniels, contradicting the president’s past comments on the controversy. (Photo by Don EMMERT / AFP) (Photo credit should read DON EMMERT/AFP/Getty Images)

There’s no question that Stormy Daniels would have to pay tax on the $130,000 payment. Settlement money is almost always taxable to the recipient, unless it is for personal physical injuries or physical sickness. That is one of the rules about taxes on legal settlements. But on the payer side of the equation, it isn’t so clear whether someone paying her could deduct the payment, leaving aside the question of who effectively paid the money. Michael Cohen may have expected reimbursement at the time or only learned of the reimbursement later. Someone else was ultimately paying the bill.

For tax purposes, that suggests that Mr. Cohen was an agent, not the principal. Cohen may or may not have deducted the $130,000 payment as some kind of business expense. But should he have? When you pay for a business expense and your employer reimburses you, you might treat it as a wash, money in and money out with tax consequences. Or, you might claim the deduction, and report the income on the repayment. Most people prefer the former, so their taxes are easier, cleaner, and lower. It is really the principal who has the tax issue, the beneficial owner, not the agent who may be paying for someone else.

Federal income tax liability is generally allocated based on ownership under local law. In the case of bank accounts, there may be one nominal owner, but the money might effectively be held in trust for someone else. The IRS can try to tax the beneficial owner of an account, regardless of that person’s rights to the funds under prevailing local law. The IRS and the courts often look beyond local law to impose taxes on the party who is the beneficial owner. People can and do become embroiled in tax disputes over such issues, and if you are the owner or principal, you are likely to be taxed.

Conversely, if you are just holding something as an agent for someone else, you generally should not be taxed. A nominal owner is not the owner for federal income tax purposes. In Bollinger, 485 U.S. at 349, the Supreme Court said that “the law attributes tax consequences of property held by a genuine agent to the principal”. The Court enunciated a three-part agency safe harbor. Under it, you should not be treated as the owner for tax purposes if:

  • A written agency agreement is entered into with the agent contemporaneously with the acquisition of the asset;
  • The agent functions exclusively as an agent with respect to the asset at all times; and
  • The agent is held out as merely an agent in all dealings with third-parties relating to the asset.

What if you don’t meet all three conditions? The Tax Court has said that these Bollinger factors are non-exclusive. See Advance Homes, Inc. v. Commissioner, T.C. Memo. 1990-302. Even an oral agency agreement might suffice, although you surely want it in writing. Assuming a true agency, the agent should not face taxes on income over which he has no control and no beneficial right. As for Mr. Cohen and President Trump, the unfolding details are likely to matter. Of course, most people are not going to be too worried about the tax issues.

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