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When Clients Say Bitcoin...

On February 8, 2021, Elon Musk announced that Tesla, the seventh of the 10 largest companies in the world, purchased $1.5 billion worth of bitcoin (ticker symbol “BTC”) and planned to accept Bitcoin as payment for its cars in the near future. In October 2020, PayPal began allowing customers to purchase and sell Bitcoin and other crypto assets. MasterCard recently announced that it will start supporting cryptocurrency on its payment processing network. Many larger charities, such as the United Way, Save the Children, and Feeding America, have accepted cryptocurrency donations for years, and the IRS now asks a question about virtual currency on the very first page of every single 1040 individual income tax return.

The world economy is at an inflection point where knowledgeable investors, companies, and professionals cannot ignore Bitcoin, crypto assets, and Blockchain technology. If Tesla, MasterCard, PayPal, and the United Way are integrating Bitcoin into their operations, won’t other entities be forced to consider it or risk being left behind? Just a few years ago, the idea of major companies accepting Bitcoin was unthinkable.

In this article, we’ll discuss the various legal, business, accounting, and tax issues that you need to understand to stay competitive in the modern world. While many companies are just now getting on board, Citrin Cooperman has been at the forefront of digital asset industry developments every step of the way. Feel free to click on the links throughout this article for more information on various topics presented via Citrin Cooperman’s thought leadership articles, presentations, and media quotes.  

Cryptocurrency and Litigation
Cryptocurrency has become a hot topic in litigation. Many companies have used Blockchain technology to create new crypto assets known as “tokens,” which the companies have sold to investors to raise capital. This process is referred to as an Initial Coin Offering (“ICO”). Since companies sold these tokens to investors, many of the ICOs fall under the purview of the Securities and Exchange Commission (“SEC”). The SEC and securities attorneys are currently grappling with the applicability of securities laws to digital assets.

Divorcing spouses now need to consider taking steps to verify that their spouse has disclosed all crypto assets. Will spouses need to split the crypto assets, or will they instead settle for cash? Those questions will surely be litigated in the future. Furthermore, with crypto assets fluctuating wildly in value, the date/time of valuation can become a major issue. This is particularly true if a spouse claims, but is unable to prove, that the crypto assets in question were previously sold.  

Business Issues
Since Bitcoin operates on Blockchain technology and public/private key cryptography, the loss of cryptocurrency keys (“private keys” effectively act as a password for spending one’s crypto assets) means a total loss of one’s investment. As Tesla and other companies are beginning to use and invest in digital assets, companies need to take steps to make sure that their investments and transactions are secure, legal, and fully integrated into their accounting, record keeping, and internal control systems. 

As companies begin to transact in digital assets and use Blockchain technologies, additional legal questions and challenges will begin to arise for those companies and their advisors. If a company receives as payment a bitcoin that represents proceeds from a criminal activity, what is that company’s responsibility to investigate the source of their customer funds? When transactions are conducted using cash, there is no way to determine how many times a particular $20 bill was used to purchase heroin. A bitcoin’s history, however, can be readily viewed by anyone with an internet connection.  

There are many other legal and regulatory issues that companies may need to consider, including:

  • Whether a company’s cryptocurrency holdings are appropriately covered under its insurance policies;
  • Exchanges and other financial institutions may need to comply with state-by-state “Money Service Business” statutes;
  • The Commodities Futures Trading Commission has declared Bitcoin to be a commodity, and therefore the CFTC regulates the Bitcoin Futures market;
  • Financial services entities may need to consider how their usage of cryptocurrency fits into their requirement under the Bank Secrecy Act;
  • Some states have passed their own laws related to cryptocurrency, such as New York State’s “Bit-License.”

Fraud & Criminal Activity
Until recently, Bitcoin and other digital assets have had trouble shaking their bad reputation. Physical currencies such as the US dollar have had significant problems with fraud and money laundering, and Bitcoin is no different. Any crime that can be committed using dollars can also be committed using cryptocurrency. As such, cryptocurrency fraud criminal activity has reached all areas, ranging from ransomware to tax fraud and terrorist financing.

Cryptocurrencies have been of particular interest to criminals because of its semi-anonymous nature. Individuals can hold and transact in Bitcoin and other cryptocurrencies without the use of third-party banks or financial institutions, allowing for an increased level of secrecy. Although Bitcoin is sometimes said to be “untraceable,” that is far from accurate since forensic accountants can use many techniques to gather information from the publicly available Blockchain data and other sources.

In 2014, the IRS released IRS Notice 2014-21 announcing that cryptocurrency is to be treated as property for income tax purposes. Since then, the IRS issued subsequent guidance through Revenue Ruling 2019-24 and answers to some frequently asked questions. The IRS has stated that they intend to pursue additional enforcement efforts against individuals who have not reported their cryptocurrency transactions.

More recently, the IRS added the question, “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” to Schedule #1 of the 1040 tax return. In 2020, the IRS moved the question front and center on the first page of all individual income tax returns, right above the section where the taxpayer lists dependents.

Cryptocurrency owners should know that hiding their transactions will open them up to potential criminal action by the IRS. However, with the right tax advice and proper planning, there are legal ways to reduce one’s taxes. For example, Bitcoin is not a stock or security, so it is not subject to “wash sale” rules. In addition, there is a substantial tax break for donating appreciated assets to charity.

The Road So Far
In October 2008, an individual (or group of individuals) working under the moniker “Satoshi Nakamoto” published a whitepaper that set the stage for the creation of Bitcoin. This was accomplished through the novel use of a nearly 30-year-old technology called “Blockchain,” which is essentially a historical record of data, grouped into sequential “blocks.”

In January 2009, the first Bitcoin was created through a process called “Mining,” which is the process of creating new blocks for the Blockchain. Bitcoin was then used in its first recorded transaction on May 22, 2010, to purchase two pizzas. This resulted in the first known Bitcoin market price of approximately 4/10ths of one cent per bitcoin (approximately $41 divided by the 10,000 BTC purchase price). Bitcoin later received a major popularity boost in 2011 when an online drug marketplace called “Silk Road” adopted it as its currency of choice.

While Bitcoin’s early growth in popularity was certainly nefarious, Bitcoin began to earn the attention of a more significant number of legitimate investors during a meteoric run up in price during 2017 (the asset that started with a value of approximately 4/10ths of a penny reached a high of approximately $20,000). The price bubble burst in early 2018, as Bitcoin experienced a price drop exceeding 80%. Since then, the industry has matured and many mainstream companies are beginning to move towards a future with digital assets, bringing Bitcoin’s prices to fresh all-time highs in 2021. Since the creation of Bitcoin, thousands of other crypto assets have been created. Companies have also found other uses for Blockchain technology, including record retention, inventory management, and “decentralized finance” or “DeFi” applications.

The Road Ahead
Bitcoin has progressively evolved from a tech nerd hobby, to a favored currency for illegal drugs, to a fringe investment asset class, to a mainstream investment. As more and more individuals and entities start to transact in digital assets, professionals in the legal and accounting field will need to evolve to understand and address new issues and challenges.

With hindsight, the rise of Bitcoin is not terribly surprising. As Mark Cuban recently blogged, “The New Generation that has grown up in a digital world has known their entire lives that what has been of greatest value to them has been digital.” Today, the largest companies in the world are technology based.

In the past, the US economy has shifted from farming, to manufacturing, to a service based economy. This technological shift is a natural continuation of those developments, and as a result, companies and individuals are starting to see the true value of digital assets. Attorneys and accountants are powerless to stop this change from occurring, and therefore must adapt to the evolving needs of their clients.

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