Virtual currency developments continue to emerge, including state tax guidance, a court decision on deductibility of losses, and the Uniform Fiduciary Access to Digital Assets Act (the “Act”).
State Tax Guidance
The New Jersey Division of Taxation released Technical Advice Memorandum 2015-1 (the “NJ TAM”). The NJ TAM explains New Jersey’s treatment of virtual currency; that is, New Jersey treats virtual currency as property in conformance with Internal Revenue Service (IRS) Notice 2014-21 (detailed in a previous post). New Jersey takes its guidance two steps further than the federal guidance: (1) sales and use tax, and (2) corporation business tax and gross income tax.
First, a customer who uses convertible virtual currency to pay for property will be viewed as engaging in a barter transaction. In a barter transaction, if what is received in exchange is subject to sales tax, then sales or use tax is due from each party based on the value of the property or services given in a trade. The state statute provides that a sale includes a barter transaction. New Jersey imposes sales tax on the receipts from retail sales of tangible personal property, specified digital products, and enumerated services. The NJ TAM explains how, in a barter transaction, one party must forfeit something of value in order to receive something of value. If a customer purchases a good with convertible virtual currency, sales tax is due on the amount allowed in exchange for the virtual currency, or (put another way) the purchase price of the goods received. The NJ TAM imposes a record-keeping obligation on sellers who accept convertible virtual currency as a form of payment for goods. Among other things, sellers must record the regular selling price of the same or similar product when sold in United States dollars, and the amount of sales tax collected.
Second, the NJ TAM states that it will follow the federal treatment for determining New Jersey’s corporation and business tax, including gain or loss from the sale or exchange of property, wages, independent contractors, and reporting requirements. Perhaps state action will pave the way for more specific federal treatment such as estate and gift consequences, as referenced in the previous post.
Court Decision on Abandonment Losses
In 2014, Mt. Gox, a Tokyo-based Bitcoin exchange, had approximately $450 million worth of Bitcoins disappear (either by alleged theft, hacking, insolvency, or some other cause). The Mt. Gox matter has raised questions about the proper characterization of the loss. Capital loss limitations are prohibitive (limited to $3,000), and generally less beneficial than abandonment losses. An abandonment loss is an ordinary income loss, and is not limited to the $3,000 threshold.
Commentators opine that a recent case could be beneficial for the Mt. Gox investors. In Pilgrim’s Pride Corp. v. Commissioner, the seller company (Pilgrim’s Pride) sold the business to the buyer. To facilitate the purchase, the buyer obtained a loan secured by a commitment letter that permitted the buyer to require Pilgrim’s Pride to purchase certain securities from buyer. The buyer exercised the option, and Pilgrim’s Pride purchased securities for $98.6 million. Later, negotiations occurred whereby the buyer would redeem the securities from Pilgrim’s Pride, but the parties could not agree on a redemption price. Instead of settling for an unsatisfactory redemption price, Pilgrim’s Pride abandoned the securities and reported a $98.6 million ordinary loss deduction on its return. The IRS challenged the loss, asserting that it was not an ordinary loss, but a capital loss. The Fifth Circuit, which overturned the Tax Court, permitted the company to take a $98.6 million ordinary loss, rather than a capital loss. The Fifth Circuit framed the issue as whether IRC §1234A(1) applies to a taxpayer’s abandonment of a capital asset. IRC §1234A(1) states that gain or loss attributable to the cancellation, lapse, expiration, or other termination of a right or obligation (other than a securities futures contract, as defined in IRC §1234B) with respect to property that is (or an acquisition that would be) a capital asset in the hands of the taxpayer shall be treated as gain or loss from the sale of a capital asset. The Fifth Circuit ruled that IRC §1234A applies to the termination of rights or obligations with respect to capital assets (i.e. derivative or contractual rights to buy or sell capital assets), and not to the termination of ownership of the capital asset itself. Pilgrim’s Pride abandoned the security itself, and not a right or obligation with respect the securities. The court distinguished between IRC §165(g) worthless security as a capital loss and abandonment, indicating that the asset had value and was not worthless.
Whether Mt. Gox’s analogy to Pilgrim’s Pride Corp. is sustainable remains to be seen. Commentators opine that it would be difficult to prove abandonment for Mt. Gox because taxpayers may not have formally abandoned the asset. Pilgrim’s Pride sent letters to the buyer and its bank indicating its intent to abandon the security.
Fiduciary’s Ability to Access Virtual Currency
Finally, further developments relate to accessing electronic assets, namely: (1) whether a fiduciary may access virtual currency after the owner’s death, and (2) whether legislation, like the Act, will be enacted to facilitate a fiduciary’s actions. The Prefatory Note of the Act states that the purpose of the Act is to vest fiduciaries with the authority to access, control, or copy digital assets and accounts. The Act applies only to fiduciaries (personal representatives, conservators, agents acting through a power of attorney, and/or trustees), and is meant to remove barriers to a fiduciary’s access to electronic records. The Act defines a digital asset as a record that is electronic, but the term does not include an underlying asset or liability unless the asset or liability is itself a record that is electronic. The comments to Section 2 of the Act suggest that virtual currency would be covered by the Act because virtual currency is a product currently in existence, but only available electronically. There is no such thing as a physical, tangible Bitcoin to put in a purse or wallet. Thus, the fiduciary has the right to access all relevant online account information that provides ownership or similar rights. The fiduciary’s access to a record that is a digital asset, however, does not mean that the fiduciary is entitled to own the asset or otherwise engage in transactions with the asset.