One of the amazing things about U.S. tax practice is the amount of dialogue that takes place, whether it is between the IRS and industry, among tax practitioners or even between Congress and the tax agency. For this month’s tax update, we showcase some of these conversations, theoretical and practical, overheard over the transom.
Among the topics of conversation: cryptocurrency, section 1446(f), the annual Taxpayer Advocate report, a new practice unit released by the IRS on withholding agent Form 1042-S audits and a relief notice relating to year 2020 IRA required minimum distribution (RMD) reporting.
(a) Congressional Letter. The crypto tax guidance issued by the IRS in October 2019 continues to generate questions, so much so that Congress in late December sent another letter to the IRS Commissioner seeking clarification on several points. The letter stated, in particular, that the hypotheticals the IRS used in its October guidance relating to hard forks and airdrops did “not appear to bear a close resemblance to actual forks or airdrops as they have occurred in the cryptocurrency ecosystems” and asked the IRS for clarification. The issue relates to the fact that the IRS in Rev. Rul. 2019-24 appears to conflate hard forks with airdrops.
In addition, the Congressional letter questioned the application of the “dominion and control” standard for determining when the receipt of cryptocurrency is taxable and whether some of its current or future cryptocurrency guidance should be applied retroactively vs. prospectively and asked for clarification on these points.
We suspect there will be a response from the Service at some point.
(b) NYSBA Tax Section Report. More in-depth commentary on the IRS’s October cryptocurrency guidance was also provided by the New York State Bar Association Tax Section in its report titled, “Report on the Taxation of Cryptocurrency.” Dated January 26, 2020, the report provided comments to the IRS on current topics relating to crypto taxation, including, well, revisiting how hard forks should be taxed.
The NYSBA Tax Section report argues that the IRS should distinguish between contentious vs. non-contentious hard forks. According to the report, non-contentious hard forks (where most of the developer community surrounding a cryptocurrency agrees to the protocol update) should be treated much like soft forks – with the cryptocurrency resulting from the fork treated as a continuation of the legacy currency.
For contentious hard forks, the report highlighted four possible approaches: 1) tax the new cryptocurrency received as an “accession to wealth” (this appears to be the approach of the October 2019 guidance); 2) treat the fork as a nontaxable transaction with basis split between the legacy cryptocurrency and the new cryptocurrency; 3) treat the fork as a nontaxable transaction with the new cryptocurrency having an initial cost basis of zero; or 4) treating the hard fork as a taxable exchange of the old cryptocurrency for the coins resulting from the fork. The report discusses the arguments for and against each approach.
Beyond forks, the report also provides comments on a myriad of other crypto tax issues from dominion and control considerations to how fair market value of cryptocurrencies should be determined to such other issues as cryptocurrency loans, token swaps, stable coins and staking. It extends the crypto tax dialogue beyond the October 2019 guidance.
(c) Additional FAQs. The IRS also hasn’t been silent during the past month on crypto. Representatives have been at industry conferences fielding questions, and the Service has also added two new FAQs (FAQs 35 and 36) to the list of cryptocurrency taxation FAQs. These two new FAQs considers the donation of cryptocurrency to charities.
2. Section 1446(f) Broker Withholding on Disposition of PTPs by Non-US Persons
Conversations are also on-going in the section 1446(f) space. Section 1446(f), added by the Tax Cuts and Jobs Act of 2017, would, pursuant to proposed regulations issued last year, require brokers to withhold on certain sales by non-U.S. persons of publicly traded partnership (PTP) interests.
SIFMA had written a comment letter on the proposed regulations last July to the IRS and apparently had conversations with the IRS on the comments in August 2019. In a letter dated December 20, 2019, SIFMA provided the IRS follow-up comments that touched on issues that had arisen during its prior conversation with the Service. The letter discusses DVP transactions and why they should be exempted from section 1446(f) withholding, argues that nonqualified intermediaries that disclose all their underlying non-U.S. beneficial owners should not have to conduct section 1446(f) withholding (withholding should be conducted by the upstream withholding agent), and recommends improving current PTP nominee reporting processes, exempting distributions from section 1446(f) withholding, applying section 1446(f) only to “physical” (vs derivative) PTP interests, and having PTPs provide qualified notices to registered holders.
These conversations remain important ones for the broker community to follow since the impact of a section 1446(f) withholding regime, if finalized in the form of the proposed regulations, could require significant changes to broker diligence, withholding and reporting processes.
3. National Taxpayer Advocate Report
We should also mention that the Taxpayer Advocate has issued her 2019 annual report covering issues that remain concerns for taxpayers as well as those pertaining to fair and efficient tax administration. Among the issues raised is one that is not new: the need for the IRS to continue modernizing its technology infrastructure together with a need for funding it. The report also discusses the importance of coupling technological enhancements with due attention to the customer service culture within the organization.
There’s not much in the report on information reporting per se, but the report’s references to the Taxpayer First Act passed into law last year and enhancements to IRS IT infrastructure remind us that among the Taxpayer First Act provisions was one for the IRS to create a web-based Form 1099 filing platform. This mandate for a 1099 filing platform should be monitored.
4. Practice Unit on Sampling Procedures in Form 1042-S Audits
Sometimes, the IRS can tell us things even when it is really talking to itself. In January, the IRS released an international practice unit for its exam agents relating to the use of sampling and associated projection procedures as part of U.S. withholding agent Form 1042-S audits. Sampling might be used in environments where there is significant volume in terms of Form 1042-S transactions. The practice unit discusses procedures for selecting and using samples, including risk-based assessments and random sampling. The practice unit allows us to listen in on IRS exam agent conversations and better understand these audit processes.
5. Notice 2020-06 RMD Reporting Relief
Finally, the IRS issued Notice 2020-06 which extends relief for financial institutions that must provide a statement of required minimum distributions (RMDs) to IRA owners. For prior years, such reporting is required (by January 31) if an account holder is to attain age 70 ½ in that year. However, the SECURE Act passed with budget bills at the end of 2019 changed the RMD requirement to begin at age 72. For financial institutions that are unable to change their reporting systems in time (and thus end up providing their RMD notice by January 31, 2020 to account holders reaching 70 ½ in 2020), the IRS is allowing such institutions to provide an amended notice by April 15, 2020 to let such account holders know that RMD for 2020 would in fact not be required. Those who attain age 70 ½ in 2019, however, remain required to take RMD by April 1, 2020.
In the notice, the IRS stated that it was considering what additional guidance should be provided with respect to the SECURE Act, including guidance for plan administrators, payors, and distributees if a distribution to a plan participant or IRA owner who will attain age 70½ in 2020 was treated as an RMD. It may be a good opportunity for industry participants to connect with the IRS if they see the need for other helpful guidance.
Conversations continue, and that is likely good for overall tax administration and compliance.