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With the cryptocurrency economy now worth more than $ 500 billion, the IRS is waking up with massive tax revenues in play. L & # 39; Calling the IRS to Coinbase for their customer data is a warning shot. A large-scale and coordinated IRS / DOJ enforcement campaign will surely come.
Nobody likes to pay taxes, but simply hopes that the IRS will not know who owes what is a dangerous game. Is there any hope for those who want to legally plan around cryptocurrency taxes, while covering their substantial gains? There could be, but the joker is the way the IRS will approach these transactions.
With the recent emergence of futures and options, it should become more common for parties to design cryptocurrency loans, swaps and futures. and more. An explosion of financial cryptocurrency financial product innovation is coming. Whether this innovation is a blessing or a curse may depend on your point of view. What you can rely on, however, is that the IRS will hide.
Lend me a bitcoin
What if I lent my Bitcoin, either as a hedge, or to raise funds for other investments? Do I have to pay tax on the money I receive? That's a good question, and a lot of tax dollars are now at stake in some Bitcoin loans. The catch, is that the IRS has to accept that what happened is actually a loan. The mere fact of calling a loan is unfortunately not enough
Indeed, proper documentation and execution are essential. And even so, there may still be complications. For example, the IRS could say that borrowed bitcoin must be the same bitcoin returned at the end of the loan term. Indeed, if I loan someone a painting, and that they make me a different painting, the IRS would probably say that it was not at all a loan. The IRS could rather tax me as if I had sold the first chart.
It might seem silly that the IRS takes such a technical stance on Bitcoin loans. Most people treat a Bitcoin as fungible with any other Bitcoin. And what would mean "the same bitcoin" even mean?
But with so much money involved, one has to wait for some posture on the part of the IRS, and no argument is too technical for the taxman. The IRS has a variety of legal tools to attack a loan and claim that it is actually a sale.
Futures Contracts also?
Another approach could involve a prepaid futures contract. The IRS said that these transactions can work for publicly traded shares if they are designed properly. In other words, they can allow parties to receive money without triggering the tax.
How do prepaid services work? Someone who owns appreciated shares receives a set amount of money in advance (often 70-90% of the stock value). In exchange, the shareholder may agree to deliver a variable number of shares at a later date (or an equivalent amount in cash), for example five years in the future. The idea is that the title will be transferred years later, so there is no current tax now.
So why not pre-paid futures for Bitcoin? Again, wait a little bit of hindsight on the part of the IRS. How much hindsight can depend on how the futures contract is documented. The more a Bitcoin is similar to a stock transaction that the IRS has approved in the past, the more likely it is to survive the IRS exam.
But past performance does not guarantee future results, especially in an IRS audit. Indeed, the IRS has attacked the prepaid futures that it considers abusive, such as when the shares were lent during the transaction.
As for loans, a lot will depend on how a Bitcoin futures the IRS has already blessed. While the IRS is used to view IBM prepaid payments on stock, they can be quick to punch holes in cryptocurrency versions. Again, plan carefully
The Future of the Future
The emergence of futures and options on Bitcoin is a potential game changer for these deals. While they can not change the mind of the IRS on how to impose particular financial instruments, they offer participants many more options.
Just a year ago, finding a counterparty to a Bitcoin loan or a prepaid prepaid contract was not easy. Now, institutional investors should step in, not to mention the hedge funds of cryptocurrency. A futures market allows larger players to gain a foothold and can allow them to reduce risk when they take the long or short side of a particular trade.
Whether the IRS likes it or not, cryptocurrency financial instruments are here to stay. But, as with ICO, the wary buyer is on order. Some innovations will create tremendous value and allow the parties to protect themselves effectively. Financial instruments can also help investors obtain targeted exposure to certain assets, which can not be achieved otherwise.
But financial innovation comes with risks and it goes without saying that leverage can magnify these risks. If properly designed, financial instruments could offer early adopters a way to lock in profits now and postpone tax until later. Still, thoughtful planning is crucial, and the IRS will first approach these transactions with skepticism (and, possibly, some serious confusion). We should expect interesting conversations.
Dashiell C. Shapiro is a partner at Wood LLP
Disclaimer . The opinions and interpretations of this article are those of the author and do not necessarily represent those of Cointelegraph.