IRS guidance on bitcoin transactions will chill its use
By Robert A. Green, CPA
The IRS just issued guidance on bitcoin in time for the April 15th tax-filing deadline. Our Dec. 3, 2013 blog "Bitcoin is a hot commodity, but is it taxed like commodities, assets, or currencies?" was correct: bitcoin is considered property, not a currency.
That's good news for taxpayers with huge gains on using, investing or trading bitcoin, since it receives capital gains treatment and if they held it over one year, the lower long-term capital gains tax rate applies.
Conversely, it's bad news for those with large losses, with the recent price of bitcoin dropping significantly. According to the IRS guidance, bitcoin does not receive Section 988 ordinary loss treatment, which is unlimited; instead, its capital-loss treatment is limited to $3,000 per year.
The IRS guidance stresses a point — widely overlooked by many taxpayers — that using bitcoin to purchase an item or service triggers capital gain or loss recognition reflecting appreciation or depreciation of bitcoin. Compare the market price on the date bitcoin is used to make a purchase vs. the market price on the date you acquired that bitcoin, and the difference is a capital gain or loss on property. Few people or companies have filed Form 1099s on these transactions, as may be required, and taxpayers will have to scurry around to figure their cost basis and sales proceeds on each purchase where they used bitcoin as a digital currency. See the example of buying a cup of coffee with bitcoin in the Bloomberg article Bitcoin Is Property Not Currency in Tax System, IRS Says. The WSJ articles IRS Says Bitcoin Is Property, Not Currency and Q&A: The New IRS Rules on Bitcoin are good too.
Having to report a capital gain or loss on each purchase using bitcoin will have a chilling effect on bitcoin reaching its goal to be a widely used digital currency. Who wants to spend 30 minutes or more figuring out their capital gain or loss for a simple $3 cup of coffee? And who wants to risk getting audited by the IRS over bitcoin tax reporting to boot?
See the IRS Notice 201421 which includes many good FAQs that may strike a cord with taxpayers. March 24, 2014
SEC Large Trader Reporting Rule
By Robert A. Green, CPA
Some high-frequency-trader (HFT) clients are receiving email notices from their brokerage firms advising them to file SEC Registration Form 13H to obtain a SEC Large Trader ID number (LTID). The broker needs that LTID in order to comply with the SEC Large Trader Reporting Rule, a rule that has been in place since 2011. (Broker-dealers were required to comply with the rules by April 30, 2012.)
In my view, regulators are keen on tackling — but not necessarily blocking — HFT. They need a better handle on HFT for their own reporting and accountability to Congress. Regulators are still concerned about the flash crash from May 2010, which, along with Congress, they blame on HFT. The first step in regulation is often registration light. It’s not public so your friends won’t see what you are up to. But, it will give the SEC a means to analyze what you are doing in the markets and it may react accordingly. Perhaps the SEC can request a broker to analyze all activity for a given LTID. Bottom line, this is more government oversight for HFT, but it’s not a burden of compliance or cost. (I don’t see any fee required with Form 13H.) It would be worse to have financial-transaction taxes – something we continue to fight against – and HFT trading restrictions. (New York’s Attorney General just blocked a data provider from giving an edge to HFT customers.)
Interactive Brokers includes a helpful summary of these SEC rules at http://ibkb.interactivebrokers.com/article/1842. The summary describes what the SEC is after:
"Large Trader" is defined as a person or entity who, directly or indirectly, through the exercise of "Investment Discretion," effects transactions in exchange-listed equities and options that equal or exceed 2 million shares or $20 million during any calendar day, or 20 million shares or $200 million over the course of any calendar month … Calculating Options Traded. The Rule requires the calculation of shares and dollars of options traded as follows: Shares traded = option contracts traded * option multiplier (typically 100)… (similar option multiplier for ETFs and index options)…
… Initial Filing: A person must "promptly" file an initial Form 13H after its transactions reach the identifying activity level. The SEC states that under normal circumstances, "promptly" means 10 days.
The filing threshold is high and the filing requirement seems simple enough to do on your own. Of course, it’s always wise to consult a securities attorney with any questions. We recommend Brent Gillett JD of www.investmentlawgroup.com.
Take a look at a manual SEC Form 13H with instructions, but note you must file it electronically with the SEC EDGAR system. It asks for basic information and not much else.
If you or your broker determines you should file SEC Form 13H, don’t miss the very short 10-day deadline. Not acting can cause you a bunch of trouble. I wonder if all brokers are set up properly to make this filing analysis. March 3, 2014
Entities & Retirement Plans for Traders
Join noted CPA trader tax experts Robert A. Green & Darren Neuschwander, managing members of Green NFH, LLC, a leading tax compliance firm for traders and investors, as they explain all the details traders need to know about entity formation and retirement plans. (Webinar registration link at the bottom)
This Webinar will cover these important points:
* If you qualify for trader tax status (business treatment), we recommend an entity. Investors only need an entity to avoid wash sales in their IRA accounts.
* Trading gains are not earned income, so traders need to form an entity to create compensation required for health insurance and retirement plan deductions. (One exception: members of futures exchanges have earned income.)
* Choose an entity structure favorable to your family situation and resident state. Register out-of-state entities in your home state. Offshore entities don’t provide tax relief.
* S-Corp tax returns maximize health insurance and retirement plan contribution deductions versus underlying compensation — income tax savings versus payroll tax cost.
* Partnership tax returns with 50/50 spousal ownership require a higher administration fee* paid to the trader spouse to achieve target health insurance and retirement plan deductions. (Read our Jan. 14 blog.) While 1/99 trader/non-trader ownership may be attractive tax wise, it’s generally unfeasible. *Potential solution for 50/50 HW partnership returns. Pay administration fees during the year and if you need more cash flow, the husband and wife can reinvest capital to finance ongoing fee payments. Consult with us about your administration fee agreements and payment schedules.
* General partnerships and LLCs should consider S-Corp elections by March 15, 2014.
* An individual 401(k) retirement plan is generally the best plan for small-business traders. It has an elective deferral of $17,500, which is 100% deductible and a 20% deductible profit sharing plan. Plus, it has a $5,500 100% deductible catch-up provision for those over age 50.
* High deductible defined-benefit plans are an excellent choice for business traders generating high income consistently. They can deduct up to $210,000 per year.
* S-Corps require formal payroll tax compliance, but there are low-cost and easy options like paychex.com.
* Partnership tax returns use administration fees reported on 1099-Misc. While tax compliance is easier and more flexible, achieving target self-employment income (SEI) often requires greater cash-flow payments for compensation and that may be a burden.
* S-Corps should have entity-level retirement plans and partnerships should have individual-level plans.
* Health insurance plans can be individual policies whether using an S-Corp or partnership tax return structure. In both cases, health insurance premiums are an AGI deduction on the individual return. Entity group policies are possible, too.
* Rather than elect S-Corp status, entities filing partnership tax returns may consider adding a C-Corp as an owner to handle the health insurance and retirement plan deductions, and also avoid higher individual tax rates.
Questions & answers. What entity and retirement plan is right for you?
Webinar Thursday March 6 at 4:15 - 5:15 pm ET. Click here to register. February 27, 2014
Another trader tax court loss (Assaderaghi)
By Robert A. Green, CPA
Forbes blog (same article, but different heading): Knowing The Rules Keeps Traders Out Of Tax Trouble
The IRS is piling up victories in tax court against individual traders who inappropriately use Section 475 MTM business ordinary loss treatment for deducting large trading losses. Fariborz Assaderaghi & Miao-Fen Lin v. Commissioner is yet another IRS win that can be added to the list. According to Tax Analysts, “The Tax Court held that a husband's trading activity in securities didn't constitute a trade or business and, thus, he wasn't eligible for a mark-to-market accounting method election under section 475(f) and the couple was limited to a $3,000 deduction of losses from the purchase and sale of securities under section 1211(b) for each year at issue.”
Only traders who qualify for trader tax status (Schedule C business expenses) may elect and use Section 475. Lots is at stake since without trader tax status or a timely Section 475 MTM election, traders are forced to use a puny $3,000 capital loss limitation against other income.
We agree with the IRS that Assaderaghi did not qualify for trader tax status in any of the years examined. Assaderaghi had many day trades, and he used professional trading equipment and charts. But he had a demanding full-time career as an engineer/executive and the IRS is more skeptical toward part-time traders claiming trader tax status. Assaderaghi was unable to prove his hours spent in trading and his evidence lacked credibility in the eyes of the IRS and tax court.
Most importantly, Assaderaghi came up short on meeting our golden rules for 2008, the one year he had a chance to qualify for trader tax status. He had 535 trades and our golden rules call for 1,000 total trades. He traded just over 60% of available trading days and our golden rules call for trade executions on 75% of available trading days. In the other years examined, he came up far short of trader tax status and when you view the years together it’s especially weak.
Perhaps Assaderaghi could have fought harder to win trader tax status in 2008, and concede the other years, but that is generally not the main issue. A bigger issue is filing a timely Section 475 MTM election and Assaderaghi and his accountant did not do that. It’s significant since Assaderaghi’s CPA deducted $374,000 in trading losses for his 2008 Schedule C, but the IRS forced them to use a puny $3,000 capital loss limitation instead. Once again, a trader and professional go to tax court with a clear losing case on technical grounds, missing or botching a Section 475 MTM election, and there is nothing that can be done about it. They wasted their money and effort in tax court.
Assaderaghi made some tragic rookie tax mistakes which sealed his fate as a loser with the IRS. He made the common mistake of asking his local CPA tax preparer to elect trader tax status and Section 475 MTM, but after not getting an answer from his CPA, he didn’t do anything about it. His accountant was clueless about trader tax benefits and rules — which is sadly still often the case. When it comes to timely Section 475 elections, there is no excuse allowed for relying on an accountant, and there is no IRS relief. The IRS is lenient on many things, but not Section 475.
His accountant grasped the idea of trading as a business — filing a Schedule C — but he jumped to the tragic conclusion that he could simply report trading gains and losses on schedule C like other types of businesses. He should have filed a timely election for Section 475 and reported trading gains and losses on Form 4797 Part II with ordinary gain and loss treatment. It’s clear the accountant did not know that Section 475 MTM had to be elected by April 15, 2008 for 2008 or perfected with a 2008 Form 3115 change of accounting filed in 2009 with the 2008 tax returns. Had Assaderaghi known the golden rules, perhaps he would have traded more to meet them.
Assaderaghi’s tax return screamed for an IRS beat down. The IRS computers see trades on Schedule C and issue a tax notice because trades don’t belong on Schedule C. The IRS tries to match broker 1099-Bs to Schedule D (in 2008 and Form 8949 after 2010), Form 4797 Part II (section 475 MTM) and Form 6781 (Section 1256). The IRS agent asked the CPA preparer about his filing of a Section 475 MTM election and the CPA did not even know what the agent was talking about. Case closed — it’s a loser! You can never file a Section 475 MTM election late (or with hindsight).
Lessons learned: Learn trader tax benefits and rules with our content and hire a proven trader tax CPA like our firm Green NFH, LLC to assist you with the election, Form 3115, Form 4797 and tax return footnotes.
It’s important to note that 2014 Section 475 MTM elections are due by April 15, 2014 for individuals and existing partnerships, and March 15, 2014 for existing S-Corps. “New taxpayers” (new entities) file a Section 475 MTM election in their own books and records (internally) within 75 days of inception of the new entity formation. We recommend Section 475 MTM on securities only, so you retain lower 60/40 capital gains rates on Section 1256 contracts like futures. Section 475 MTM does not apply to segregated investment positions. If you have capital loss carryovers, you may want to wait until you generate more capital gains to use them up first. Section 475 is complex and nuanced, so read Green’s 2014 Trader Tax Guide Chapter 2 on Section 475 and Chapter 1 on trader tax status.
Make sure you meet our golden rules for trader tax status based on tax court cases. The Assaderaghi case does not change our golden rules. The Assaderaghi court reinforced the notion that business traders must be consistent in trading volume and frequency and avoid sporadic lapses in active trading. The tax law requires “regular, frequent and continuous trading based on daily market movements and not long-term appreciation.”
It’s wise to stop trading as an individual and form an entity that qualifies for trader tax status and files an entity business tax return that resembles many active trading hedge funds. As pointed out in Green’s 2014 Trader Tax Guide, a high ranking IRS person in the trader tax status and Section 475 area recently warned at a tax conference that the IRS is going after individual traders inappropriately using trader tax status and Section 475 MTM ordinary loss treatment. Get the help you need to be a winner.
See the Tax Analysts PDF file on this case with our yellow highlights.