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December 20th 2018

Receiving a 1099-K and How to Avoid the Taxes


Did you know that transactions between crypto-currencies are not re-portable by the exchanges in which they are held.  The 1099-K is deliberately erroneous so that people will mistakenly include the information on their Form 1040 and then be subject to paying taxes on property that was not subject to the tax.  It’s not because of a law, it’s because of how people are mistakenly reporting information on their 1040 that creates the tax situation.

There is no income tax between crypo-graphic currency exchanges; however,the IRS is mis-applying the “backup withholding” provisions under 26 U.S.C. §3406 to force the exchanges to sell 31% of the dollar value of your crypto holdings and pay it to the IRS unless you request a determination letter and file a current W-9 Certification. This is specific to personal accounts at the exchanges, not business accounts such as LLCs that do not file returns.

Why do you request a determination letter? Because backup withholding applies only to “re-portable payments”. Re-portable payments are only payments of interest or dividends in U.S. Dollars. Trading between crypto-currencies has nothing to do with receiving payments from interest or dividends. The IRS is doing this to escape the normal tax assessment procedures that would allow people to scrutinize what is being done and you will not find any accountant or attorney who understands this well enough to correct it.

How do you request a determination letter? You must request a determination from the Secretary and it must be in a particular format as described in the most recent IRS Revenue Procedures Manual. I’m not trying to be cryptic here, but the language of the request is fairly technical and specific to 26 U.S.C. §3406 and 26 C.F.R. §31.3406(a)-1. I’ve used this process for nearly 20 years and it is very effective.

This works whether or not you are using the limited liability company and Blockchain Tax Immunity Trust or not. Everyone who is filing a 1040 and receives a 1099-K reported in his or her name and his or her social security number or EIN can use this process to eliminate any taxes resulting from the amounts reported on the 1099-K. One request will need to be made with regard to each 1099-K.

This needs to be corrected immediately, do not try to use the falling prices of crypto-currencies to claim losses with the IRS because you will be on the hook for taxes as the currencies increase in price against the dollar. Don’t play this game, correct it now or it could cost you tens if not hundreds of thousands of dollars.

When people begin receiving 1099-K forms from their crypto-exchange accounts, for crypto trades that did not involve selling cryptos for dollars, all hell is going to break lose. They will probably, and mistakenly, report the information on their tax returns because they don’t know any better, or ask a CPA or attorney for advice, who will mistakenly tell them to report the amounts on their tax returns. This report pertains only to people who have personal accounts on the crypto-exchanges, and does not apply to tax deferred limited liability companies and those using the Blockchain Tax Immunity Trust.

There is no tax liability for trading crypto-currencies for other crypto-currencies; however, if you can be tricked into reporting what you believe to be taxable income on your tax return, then it becomes taxable.

If you want to keep your money, and legally avoid the taxes, you must EXclude the 1099-K information from your tax return and send the exchange an updated Form W-9 certifying the correctness of your social security number and that you are not subject to backup withholding for the most recent tax period. Additionally, you must request a determination letter from the Secretary regarding the issue of backup withholding. This is where almost no tax professional will understand what to do, including attorneys.

You must have filed your tax return for the same period, and filed a current Form W-9 with the exchange, retaining a copy for yourself and have kept a copy of the Form 1099-K from each exchange. These documents must be sent to the Secretary of the Treasury, to each of three mailing addresses, via certified mail, along with a properly written request for determination letter. You cannot simply send a letter to the IRS or to the exchange claiming that the Form 1099-K is incorrect, this will be ignored. You must use the proper administrative procedure, as published by the IRS, and request a determination as to backup withholding. This will allow you to exclude the Form 1099-K data from your tax return, minus the amounts of cash you took in your own name.

Please follow this blog for updates and information. You should expect a Form 1099-K from each exchange before January 31, 2019; and in response, you will need to prepare and send one request for determination letter for each.

The following is the legal analysis for the reason why no taxes are owed, but I must caution you that simply using this analysis in some kind of protest letter will do nothing, it must be part of a six-page request for determination letter as instructed within the Internal Revenue Bulletin.

STATEMENT OF LAW: The law is certain and unambiguous. Please be advised that 26 C.F.R. §1.1471-1through 7 is defined as:  “Reportable payment” to mean,“The term reportable payment means a payment of interest or dividends (as defined in section 3406(b)(2)) and other reportable payments (as defined in section 3406(b)(3)).”

ANALYSIS: The 1099-K incorrectly reports dollar amounts that were not remitted or distributed to the payee as stated on the form. The payor has retained ownership of the underlying property (amounts erroneously reported as payments in dollars on Form 1099-K) and never dispersed any payments to the payee, other than those reported on the payee’s filed tax form or statement (i.e. Form 1040). The “taxpayer”herein was not the “payee” of any interest, dividends or other re-portable amounts identified under 26 U.S.C. §3406(b)(3). Additionally, the dollar amounts erroneously stated on the disputed Form 1099-K do not represent dollars paid to the payee (settled transactions) and do not identify any amounts of interest or dividends paid to the payee and therefore, are not subject to backup withholding.

Specifically,“other re-portable payments” as they relate to this transaction,are identified in 26 C.F.R. §31.3406(b)(3)-5(a)“Payment card and third party network transactions subject to backup withholding.”

26 U.S. Code § 6050W(c) identifies a “reportable payment transaction”to mean “any payment card transaction and any third party network transaction”, and as it pertains to the transaction herein, Form 1099-K, “The term third party network transaction means any transaction which is settled through a third party payment network.”  Assuming for a moment that the reporting party (payor) is a third party payment network, the dollar amounts stated on the pertinent Form 1099-K were never “settled transactions” within the meaning of the regulation and the dollar amounts stated on the Form 1099-K are incorrect. No payments were made to the “payee” as erroneously stated on the disputed Form 1099-K.

CONCLUSION: I am not subject to backup withholding for the period ending December 31,2018.

Crypto-Currencies Are Not Taxable

Imagine for a moment that we had a taxing framework and did impose taxes upon the use and ownership of crypto-graphic currency. As all income tax systems operate, anywhere in the world, the taxpayer is the owner of the thing being taxed. We all understand very well that if we don’t own it, we don’t owe taxes on it. Even sales taxes are imposed upon retailers, not the actual customer. Itemizing the business expense of sales taxes on your receipt is a trick to make it appear as if the customer is paying the sales tax when in fact it is the retailer. The same is true of crypto-graphic currency. The owner of the currency in a central exchange such as Coinbase, is the taxpayer. If you don’t already know how the software for crypto-graphic currency functions, there is a blockchain, a ledger that keeps track of all transactions, a “mining” operation which is software that produces the units of currency or tokens through mathematical calculations, and then we have the actual unit of the currency, the “coins” that are held in wallets, individual databases where this data is stored for use. The individual units of the currency are controlled by keys, or lengthy codes that come in two parts. One part is the public key that allows anyone to see the value of the wallet or key and then the private key which is only known by the owner of the wallet or coin and which is used to “spend” or transfer the currency. The owner of the private key of a crypto-graphic currency is the owner of the currency.

In the case of central exchanges, the exchange is the owner of all of the private keys. Even if some tax was imposed on exchanges between currencies, the taxpayer would be the owner, or the central exchange, not the user such as the account holder, or the exchange customer (people using the exchange). This tells the whole story, and all the misleading news articles just play upon our lack of knowledge.

In the situation where the exchange owns the private keys for your wallet, we have a trust relationship. The customer is the grantor and the exchange is the trustee who owes the private keys back to the grantor on demand. The trust collapses at the point that the currency is transferred away from the exchange and into private keys held by the customer. The way to have this properly recognized, for example in a tax audit, is to declare the existence of the trust within a written declaration of trust.

Lacking this understanding, you’re probably setting yourself up to pay way too much in taxes from crypto exchanges because of all the misleading statements in recent articles published by mainstream periodicals and their attorneys. There has to be a specific taxing statute, and taxable activity and rate in the statute, and then the agency must have promulgated a regulation to implement this specific taxing statute.

Because people don’t understand the law, they report items that are not required to be reported and because the tax return is signed under penalties of perjury, the IRS just accepts that you are telling the truth and what was not taxable before, becomes taxable because it was reported incorrectly. For example, because people don’t read the definitions, nor do tax professionals, they act as though their business is a “trade or business”; however, the statute under Title 26 section 7701 defines “trade or business” as “the performance of the functions of a public office”. If you’re a Congressman, agency employee or federal judge, you’re involved in a taxable trade or business, but if you’re a plumber, you are not.

That is how the system works, and your accountants and attorneys help you make those mistakes. Here is an easy way to understand this one aspect being described in the news lately. It pertains to one word being added to limit the application of “1031 exchanges” to only “real property” and not just any property. If you sold real estate and made a profit, it was taxable unless you bought another similar property within so many days. If you took your taxable profits and bought another “like” property, you qualified for the “1031 exemption”. You went from property to “dollars” back to another like property. There is no such thing as a “crypto-exchange of like cryptos”. Adding the word “real” to the statute did not create a whole new legal framework that now imposes taxes on crypto-currencies of any kind or in any way.

This change simply limits the exemption to “real” property. Property has always been taxable to the extent that a gain is realized by a taxpayer. Here is an example you can ask any tax professional. “Does a taxpayer incur a tax debt when he buys gold, which is property?” “Does a taxpayer have a tax liability if he trades his gold for silver?” Or, “does a taxpayer have a tax liability when he sells his gold for dollars?” What if I exchange my gold bullion for gold coins? It’s the same question, and same answer.

In the cryptographic currency example, going from one crypto to another does not involve first going back into “dollars”, so this is a completely different situation, assuming it’s even taxable in the first place. Stay out of fiat, reinvest, and, even if you would personally have a taxable event, use a tax deferred structure such as an LLC in the states and use its EIN and not your name and SSN and you can defer the fiat tax liability, assuming there will ever be one. It can be deferred forever if you plan it correctly.

Even if there were eventually a taxing statute and regulation imposing a tax in a crypto currency, one or all, how would you pay the tax, in crypto? A taxing statute and its regulation would specifically apply to a taxable activity, and it would specify a rate along with the type, kind or class of tax. There is no such statute or regulation at this time. Even if there were, you could never pay the tax in the crypto-currency. It just isn’t taxable, anymore than words can be taxed, or taxing the use of words, no such thing, and no such tax on cryptos. This tax myth is based upon incorrect premises, read the statutes and regulations. I know that some people have good intentions, but everyone should really do some research first, and don’t just rely on a tax attorney or accountant as those are just agents of the system to get you to buy into the false premises.

True story: In the early nineties, my first debt collection case assigned to me by my partner involved a flower farmer who had spent 35 years building up an incredible seasonal flower farm business. When I got the case, the IRS and bankruptcy trustee were tagging every item in his home, his farm and had taken all of his equipment and vehicles. He only filed bankruptcy because he thought he could deal with the IRS better that way, but it just made it easier for them to take his property. After a few months of collecting facts in the case and corresponding with the IRS and different offices, I discovered that the IRS had been taxing this flower farmer for “manufacturing surface coal mines”. This is actually a crime, so I filed a formal report of my findings to the Federal Bureau of Investigation. It wasn’t 30 days later that my fax machine (remember this was back in the nineties) began spitting out page after page my client was sending, of notices from the IRS, releasing every lien and levy it had and returning all of his property. The IRS vanished and he never had another problem again. That’s when I began to realize what kind of a racket these pirates have been perpetrating. It should make you wonder about cryptos, because I can tell you from additional research I had done following that case, that the IRS is taxing people under Title 27 of the Code of Federal Regulations, for activities involving the manufacture of alcohol, tobacco products and firearms and related industrial activities such as mining.

Don’t be so quick to believe that there is some “new law” or “new rule” just because Forbes published an article with lots of misleading and erroneous conclusions. Adding a word to a statute does not create an entirely new taxing statute, or class of tax. The next thing we’ll probably discover is that the taxing authorities want to tax our brilliant, million-dollar ideas, before we even write them down on paper or make any money with them.