Written by: TaxDAO
1. Introduction
With the rapid rise of crypto assets, crypto assets have become a core component of the global financial sector. However, its unique decentralization and anonymity also bring unprecedented tax challenges. As a global leader in financial technology, the United States has established a strict system for the tax management of crypto assets. According to the regulations of the U.S. Internal Revenue Service (IRS), cryptocurrencies are regarded as property, so their purchase, sale, exchange and trading may trigger capital gains or losses and must be reported according to capital gains tax. In addition, income from mining, airdrops and hard forks must also be taxed.
However, due to the rapid iteration of crypto asset technology and the lag in tax supervision, taxpayers and tax authorities often have disputes over taxes payable or tax liabilities in this emerging field. At this time, tax settlement provides both parties with an efficient solution. Through negotiation and consultation, taxpayers can reach an agreement with the tax authorities to end the dispute and avoid more severe penalties.
2. Overview of the U.S. Tax Settlement System
2.1 The development history of the U.S. tax settlement system
The U.S. tax settlement system is rooted in the Taxpayer Bill of Rights. According to U.S. law, while taxpayers bear the obligation to pay taxes, they are protected by the Taxpayer Bill of Rights and enjoy ten rights, including the right to know, the right to enjoy quality service, the right to final determination, the right to confidentiality, the right to question the IRS's position and appeal. One of them is "the right to a fair and just tax system", which clarifies that taxpayers have the right to require the tax system to consider facts and circumstances that may affect their potential liabilities, ability to pay or ability to provide information in a timely manner. If taxpayers encounter financial difficulties, or the Internal Revenue Service (IRS) fails to properly and promptly resolve taxpayers' tax issues through its normal channels, taxpayers have the right to receive assistance from the Taxpayer Advocate Service (TAS). Under this right protection, in certain circumstances (for example, taxpayers are unable to repay tax debts in full, or repaying tax debts in full will cause financial difficulties), they can submit a settlement agreement (Offer in Compromise) to reduce the amount of unpaid taxes to ensure that taxpayers can afford basic living expenses.
2.2 Implementation conditions of the US tax settlement system
The tax settlement system is a way to resolve disputes through non-litigation when taxpayers encounter tax disputes with authorities (such as the IRS, state governments, etc.), but encounter difficulties in determining the amount of tax payable during the tax audit process. In the United States, alternative dispute resolution (ADR) was introduced into the field of administrative procedures in the 1990s and was later established as permanent law by Congress, encouraging federal administrative agencies to apply other informal procedures such as mediation and negotiation, and settlement is the most commonly used means.
The IRS's tax settlement system refers to a binding agreement between taxpayers and the IRS on administrative and criminal liabilities (including penalties, interest and other tax surcharges) and tax payable when the taxpayer is unable to fulfill his or her tax obligations, so that the taxpayer can resolve his or her tax problems with an amount lower than the amount owed. However, the premise of this agreement is that the taxpayer completes the application and meets certain conditions:
a. The IRS may accept a settlement when the existence or amount of a debt is disputed.
b. The IRS may accept a settlement if there is concern about whether the full amount owed can be collected, that is, when the taxpayer’s assets and income are less than the full amount of the tax debt.
c. The IRS may accept a settlement when the taxes are legally owed and can be collected in full, but full payment would cause a financial hardship to the taxpayer or would result in an injustice under the circumstances.
In order to successfully reach a tax settlement (OIC) agreement with the IRS, individuals or companies need to go through the following specific steps to complete the application to the IRS and finally obtain approval:
Step 1: Collect personal financial information (including cash, investments, personal assets, expenses, etc.)
Step 2: If you are an individual, fill out Form 433-A; if you are a company, fill out Form 433-B and calculate a reasonable tax bill.
Step 3: Attach copies of relevant documents to support the contents of Form 433-A/433-B
Step 4: Fill out Form 656, select the tax settlement plan, and ensure that the tax amount of the plan is greater than or equal to the calculation result of Form 433.
Step 5: Pay the initial tax payment and $205 application fee
Step 6: Send your application to the IRS
Step 7: If the application fails, the taxpayer can appeal to the IRS Independent Office within 30 days.
In addition to OIC, the IRS also provides other alternative dispute resolution mechanisms (ADR), including Fast Track Mediation and Fast Track Settlement: When taxpayers cannot reach an agreement with the reviewing authority on tax matters, the reviewing authority should prepare Form 14717 and attach both parties’ problem statements and valuation reports for appeal. After the appeal department accepts it, a mediator will be assigned to promote reconciliation between the two parties through a mediation meeting. If the two parties fail to reach an agreement in the appeal, they may enter into Post-Appeals Mediation according to the circumstances, and the case will be assigned to another appeals office for retrial.
2.3 Characteristics of the U.S. tax settlement system
The United States is influenced to a certain extent by the trend of pragmatism and administrative democratization. Although there are certain provisions in legislation on the scope of application of settlement, the tax court encourages settlement, and in the Administrative Dispute Resolution Act (ADAR) passed by the U.S. Congress in 1990, legislators also proposed "authorizing and encouraging federal administrative agencies to use mediation, negotiation, arbitration or other informal procedures to quickly resolve administrative disputes." When it comes to the field of tax administration, about 80% of small tax litigation cases can be settled out of court before the trial, thus ending the litigation process.
3. Tax settlement example between FTX and MicroStrategy
3.1 FTX tax settlement case
FTX was once a well-known global digital asset spot and derivatives (crypto assets) trading platform. It was founded in 2019 and became the world’s second largest virtual currency trading platform in a short period of time.
In 2022, due to financial fraud committed by Sam Bankman-Fried, former CEO of FTX, and Alameda Research, another trading company he founded, FTX’s funding chain was broken. FTX, Alameda Research and more than 134 other affiliated companies filed for bankruptcy in the United States, and investors lost billions of dollars.
During the bankruptcy process, the Internal Revenue Service (IRS) filed a preliminary tax claim of $44 billion against FTX and its subsidiaries (including FLX Trading ltd., Alameda Research, etc.), which was later revised to $24 billion, stating that it was related to income taxes, employment taxes, and penalties owed during the period 2018–2022. However, FTX lawyers filed documents with the bankruptcy court in December 2023, objecting to the claims and asking the IRS to provide relevant documents to confirm its claims against FTX and explain how to estimate the back taxes it should pay. In the document, FTX lawyers stated that FTX "never received anything close to the IRS's $24 billion tax claim" and lost a lot of money, and refused to assume the income tax liability and compensation employment tax liability for the so-called "misappropriated income" generated by Sam Bankman-Fried's misappropriation of FTX customer funds. At the same time, FTX lawyers emphasized in the statement that "the only source of recovery for the IRS is compensation taken from victims." Based on this, FTX filed a settlement application, willing to pay the IRS $200 million in priority tax debts and $685 million in lower priority claims.
In June 2024, FTX and the Internal Revenue Service (IRS) finally reached a settlement agreement, under which the IRS will receive $200 million in priority claims in the FTX bankruptcy case, which will be paid within 60 days after the company's proposed restructuring plan takes effect. In addition, the agency will also receive $685 million in lower priority claims to pay customers and other creditors.
3.2 MicroStrategy tax settlement case
In 2022, Washington Attorney General Karl Racine filed charges against Michael Saylor, the founder of MicroStrategy and cryptocurrency billionaire, accusing him and his company of "not paying income tax for at least 10 years while living in the District." His company MicroStrategy helped him evade more than $25 million in income tax in the District by filling out false W-2 form information. In the tax return, Saylor claimed that he lived in Florida, which does not impose personal income tax, but he actually lived in a seaside apartment in Washington. At the same time, Saylor reduced the risk of tax evasion by receiving only $1 in salary plus a large number of welfare arrangements (such as private jet travel, the use of car drivers and security teams), and the company borne federal taxes for the benefits. Because his address was in Florida, the benefits received by Saylor were not considered taxable remuneration. In August 2022, Saylor resigned as CEO of MicroStrategy due to this case and became executive chairman.
This is the largest income tax fraud recovery case in the history of the District of Columbia and the first lawsuit after the district amended the False Claims Act, which encourages whistleblowers to file tax evasion charges against residents who allegedly conceal their actual place of residence. According to the charge, anyone who knowingly submits or causes a false claim to be submitted to the government shall be liable for damages three times the government's losses and a fine linked to inflation, so experts once believed that Saylor should be fined at least $75 million. However, in the face of the lawsuit, Saylor insisted that he moved from Virginia to Florida more than ten years ago and bought a house in Miami Beach. His life center is in Florida, where he lives, votes, and performs jury duties. MicroStrategy clarified that the company has no right to regulate and influence Saylor's personal tax issues, so it refuses to assume responsibility for Saylor's "tax fraud" problem. With each party insisting on its own words, both parties expressed their hope to avoid the time, cost and inconvenience required for any further litigation and resolve all disputes and potential legal claims based on covered behavior. As a result, on June 3, 2024, Saylor settled with the Washington Attorney General for $40 million over tax fraud.
4. Lessons from the U.S. tax settlement system
4.1 Tax implications from the FTX case
FTX, once the world’s second largest virtual currency trading platform, has suffered a sudden collapse that has damaged the market’s confidence in crypto assets. The tax settlement in this case not only involves the dispute between the IRS and FTX over the amount of tax, but also involves the bankruptcy of the FTX exchange and compensation for victims of fraud. The settlement agreement avoids debtors from spending a lot of time and money on litigation, helps institutions prioritize customer repayment issues in bankruptcy proceedings, and protects the rights and interests of multiple parties. Therefore, in the face of high debt claims, companies in the United States have a certain opportunity to reach a settlement with the IRS at a relatively low claim cost through multi-angle appeals.
4.2 Tax implications from the MicroStrategy case
The United States implements a dual legal system of federal law and state law. Therefore, in addition to understanding federal law, we must also always pay attention to changes in state law. The policy differences between different states do provide taxpayers with certain benefits (such as the Florida state government exempting personal income tax) and room for reasonable tax avoidance. However, there are greater risks in tax avoidance by falsely reporting one’s place of residence, especially under certain strict laws and regulations. Therefore, companies should assist employees in making reasonable tax planning in accordance with the law to ensure that tax behavior is compliant and transparent.
At the same time, it is worth noting that in this case, Saylor avoided a fine of up to US$75 million under the False Claims Act through tax settlement, and ended the Washington government's lawsuit at a cost of US$40 million. It can be seen that tax settlements can avoid further litigation burdens and avoid lengthy and expensive legal proceedings, while also helping taxpayers minimize the burden of fines.
5. Conclusion
Due to the characteristics of cryptocurrencies such as decentralization, anonymity, and global liquidity, individuals or companies holding crypto assets face tax risks such as difficulty in supervision and evidence collection for the tax authorities, which can easily become tax loopholes, and cryptocurrencies will inevitably become a means of tax evasion.
In the case discussed in this article, the IRS filed a claim for a high tax debt against FTX. Faced with FTX’s questioning of the amount of its debt, the IRS failed to conduct a more rigorous investigation of the crypto asset trading platform and provide rigorous evidence. Instead, it chose to accept the settlement proposal of the FTX legal team and settle with FTX with a compensation that was nearly 100 times lower than the “US$24 billion” tax amount previously demanded by the IRS. The case of “cryptocurrency billionaire” Saylor’s tax evasion did not go through legal procedures to the end, but instead compensated the Washington, D.C. government through a tax settlement. Judging from the results of the two cases, the application of the tax settlement system in the crypto industry is feasible and effective. For the current “immature” crypto industry and “imperfect” crypto asset tax policies, the tax settlement system is highly practical, which is conducive to improving tax administration, effectively resolving tax disputes, and reducing the pressure of tax audits. It also provides taxpayers with an effective means to deal with tax compliance supervision and make up for tax errors.
References
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