How does ownership impact taxation on cryptocurrency?

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Despite its ephemeral, somewhat enigmatic origins, cryptocurrency like Bitcoin is subject to the harsh truths of life and, though impervious to biological death, even cryptocurrency can’t escape the taxman. On a less cynical, but, equally philosophical level, the entire issue asks us to examine the very concept of ownership itself.

Bitcoin and other cryptocurrency is classified as a form of property per federal tax code.

The greater implication here is that since any transfer or liquidation of property is taxable, transferring cryptocurrency is also taxable. This issue was reviewed in depth previously in the article titled “Bitcoin income is considered taxable in 2018,” if you wanted more detailed information on the subject.

For tax purposes, transfers of cryptocurrency are treated as sales unless you specifically employ a way of transferring cryptocurrency tax-free. Note that even exchanging one form of digital token for another does not qualify as a tax-free 1031 exchange, according to the law.

Taxation of cryptocurrency brings up the issue of ownership. Do cryptocurrency assets you hold for someone else belong to you or the lender?

More pertinent to the IRS: Who pays the taxes? At its most basic level, federal income tax liability is generally allocated based on ownership under local law.  Who owes the taxes can depend on who has control over and benefits and burdens of a property or even a bank account.

For example, there may be one nominal owner of an asset, but, the money involved is held in trust for someone else. Who has to pay tax on the interest is not a cut and dried issue. Furthermore, local law ownership and beneficial ownership are not always identical. The IRS can tax the beneficial owner of an account regardless of that person’s rights/access to the funds under the prevailing local law.

The IRS and the courts often look beyond the local law in order to impose taxes on the party who is the beneficial owner of cryptocurrency or other taxable property and income. 

In one case, an individual was subject to income tax as the beneficial owner of a bank account, but, was not the owner of the account under local law.

When someone “holds legal title to property as an agent, then for tax purposes the principal and not the [agent] is the owner,” one tax case put it.  A nominal owner is not the owner as far as federal income tax is concerned.

In general, income, from cryptocurrency or otherwise, is taxed to the principal even if the agent is a joint signatory.

The Supreme Court ruled that “the law attributes tax consequences of property held by a genuine agent to the principal.” The Court enunciated a three-part agency safe harbor under which one won’t be treated as the owner for tax purposes if:

  1. “A written agency agreement is entered into with the agent contemporaneously with the acquisition of the asset;
  2. The agent functions exclusively as an agent with respect to the asset at all times;
  3. The agent is held out as merely an agent in all dealings with third-parties relating to the asset.”

Even if you don’t meet all three of these conditions, the Tax Court has said that these factors are non-exclusive. Even an oral agency agreement might suffice, although, it’s always best to get everything in writing.

An agent should not incur taxes on income over which they has no control and no beneficial right. The Tax Court defines beneficial ownership as the “freedom to dispose of the accounts’ funds at will.” Courts can also consider the factors: (1) which party enjoys the economic benefit of the property; (2) which party has possession and control; and (3) the intent of the parties.

Holding cryptocurrency for someone else may still leave the holder responsible for the related taxes.

For example, one taxpayer opened four bank accounts in the names of his four children. He deposited money into them only to later withdraw it for his own business ventures. He continued to claim that the children owned the accounts in order to avoid reporting any of income generated.

The IRS said taxes were due, but, the father claimed the accounts were for the benefit of his children and the withdrawals were mere loans to be repaid.  The Tax Court determined that the father was, in fact, the beneficial owner and did owe taxes.

“Our finding here is based on the identity of the true owner of the income-producing property. In such an inquiry, we look not to mere legal title, but, to beneficial ownership. It is command over the property or the enjoyment of its economic benefits that marks the real owner. When transactions are between family members, special scrutiny of the arrangement is necessary, lest what is in reality but one economic unit be multiplied into two or more,” said the court.  The taxpayer’s “access to, and use of, the money in the children’s bank accounts to facilitate his own business ventures establish him as the constructive owner of those funds. As such, we hold that he is subject to tax on any income earned on the children’s accounts…”

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