Let’s say you had a friend that wanted to transfer some bitcoin to you to sell on their behalf – what does this mean for your U.S. tax obligations?
|In general, the idea of giving property (stocks or other securities, bitcoin, or real property) to another individual temporarily is a bad idea. Beware of “income shifting”.|
Let’s examine the various types of transfers. Remember, virtual currency is treated as cash or capital in the US.
|Scenario: Individual A (Alison Altuve) wishes to transfer the title on her brokerage account to Individual B (Bruce Breckenridge). Alison then asks Bruce to sell the assets and give the proceeds back to Alison, less tax paid on capital gains.|
Payment for goods or services
When transferred between individuals as payment for goods or services, a W-2 or 1099-MISC would be generated just like it would be if payment in exchange for good or services was made with real currency.
Transfer with no interest = Gift. Not a good strategy
As mentioned, virtual currency held for investment is treated as capital asset (stocks, bonds). The transfer of capital assets between two individuals with no interest would be a gift, taxable to the donor and requiring the filing of Form 709 to report the gift (if over $14k). To avoid gift treatment this transfer must have a repayment condition. Gift is a gift only when it is unconditional and may not be taken back.
We recommend to treat this transfer as a personal loan
Under this scenario, Bruce should write a promissory note stipulating that he will pay back the value of securities, minus capital gain from sales proceeds, plus interest. The interest is key, even if it is nominal. The promissory note must have a specific date when repayment is due. Failure to properly write this note increases the risk that the IRS will treat this as a gift taxable to Alison.
If both are U.S. persons then this transaction generally does not have foreign assets reporting consequences,
If Alison, who “temporarily” gave away her capital assets to Bruce (transferred title on brokerage account holding stocks or virtual currency), is not a U.S. citizen then this transaction will have additional reporting complications. Even if below the $100k threshold, it may be wise to file form 3520 anyway, as the question from your financial institution or the IRS about the source of foreign transfer may arise.
The main purpose of the entire paperwork described above is to prevent this transaction being treated as a gift. Even an informal promissory note indicating the time of repayment and interest on the loan will secure this will be treated as a loan.
Problems remain — Income shifting
The biggest problem with the entire scheme is what in IRS words is called income shifting. Bruce, the person selling the stocks (or virtual currency) will have higher gross income and move to the higher tax bracket. Whereas Alison, the individual loaning the stocks to a friend for the purpose of realizing the gain, avoids an increase in her taxable income. Alison does not move to the higher income bracket, potentially avoids the Net Investment Income Tax (NIIT). If the IRS determines that as a result of this transaction cumulative tax paid by two individuals is lower than it would be if stocks did not change hands – this may be treated as a tax evasion scheme. We understand there may be circumstances that may prevent Alison from selling her bitcoin, but it is important to understand the risks prior to undertaking such a transaction.
Ines Zemelman, EA
Founder of Taxes For Expats