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Monthly Archives: April 2014

Annual Reports for Florida Business Due May 1, 2014

Posted on April 29, 2014 by Richard Berkowitz, JD, CPA

Annual Reports for Florida Business Due May 1, 2014

Florida businesses have until May 1 to file their annual reports with the Florida Division of Corporations. Failure to file after that date will result in a $400 late-fee penalty imposed on all for-profit corporations, limited liability companies, limited partnerships and limited liability limited partnerships. Failure to file by September 19, 2014, will result in the administrative dissolution or revocation of the business entity.

Annual reports may be filed online at www.sunbiz.org.

Record Rentention Guidelines

Posted on April 25, 2014 by Richard Berkowitz, JD, CPA

There are no hard and fast rules regarding the amount of time taxpayers should keep important legal and financial documents. However, the following list of guidelines aims to help taxpayers ensure they retain documents for appropriate periods in accordance with federal, state and local requirements.

Taxpayers should remember that the IRS has the right to assess additional taxes for three years after the filing of a return. This period increases to six years after the filing date if taxpayers understate gross income by 25 percent or more. When taxpayers file a fraudulent return or fail to file any return in a given year, the statute of limitations is indefinite.

When disposing of documents containing personal information, such as Social Security Numbers, account numbers or other sensitive details, taxpayers should take extra care to protect their identities and shred these records.

Berkowitz Pollack and Brant maintains a portal, which provides clients with secure storage and easy access to proprietary records 24-hours-a-day, seven-days-a-week in perpetuity.

 

Click here to read our records retention recommendations. Records Retention Recommendations

Pre-Planning Transfers of Business Ownership Helps to Ensure a Smooth Future by Eric Zeitlin

Posted on April 22, 2014 by Richard Berkowitz, JD, CPA

Too often, business owners take a wait-and-see approach to their exit strategy. They delay efforts to plan for the transfer of business assets until they are ready to retire or until the occurrence of a triggering event, such as a partner’s departure, divorce or bankruptcy. The tax and financial implications of these events, which could include disability and death, are staggering, especially when business owners do not invest the time and resources to plan for them in advance.

Buy-sell agreements enable business owners to pre-plan the ways in which they intend to pass their professional legacies onto future generations or transfer ownership interest in their businesses onto their partners. They provide a ready-made policy that details how involved parties may finance future transactions while protecting the integrity of the business structure and its ongoing viability. Because these instruments are prepared in advance of unanticipated events, they help to eliminate the turmoil and disruptions that might occur during highly emotional times.

Relying on standardized buy-sell agreements is an insufficient method for transferring business ownership because they exclude specific details and issues that are relevant to the particular business and its ownership structure. For example, business owners who are 65, 45 and 40 years of age will have equally dissimilar goals regarding how they will retire or buy out a retiring partner’s shares in the business. The eldest partner may be most concerned with securing his or her retirement, whereas the younger partners may object to paying for the upkeep of the older partner’s lifestyle through a buy-out scenario. Similarly, should one partner pass away, his or her spouse and child may have rights to the business for which the others are unaware. In this situation, the other partners may wish to buy out the family members and will need to negotiate a price at that snapshot in time when the business may not be fairing well or may be experiencing an anomalously profitable quarter. Would any agreement on terms at this time satisfy either party?

To work through these and other potential dilemmas, partners should address a complete range of triggering events and consider funding options and what-if scenarios specific to their particular needs and desires. This must include answering some tough questions, such as how do the parties determine the future price or value of a business, how do they define a disability and for how long must one be disabled before they are no longer allowed to draw a salary from the business. By tackling these issues while the business is running smoothly, the partners will avoid tense negotiations that can occur after a contestable event takes place.

Pre-Plan Trigger Events and Funding Agreements

Triggering events can include the death, disability, divorce or departure of a retiring shareholder. They may also occur when partners cannot come to an agreement and one or more partners force another out of the business. Each of these events has unique consequences that will require different funding methods for transferring ownership and ensuring the ongoing financial stability and smooth operation of the business.

When one partner leaves a business, the remaining partners may buy out the stock of the departed partner’s shares through a cross-sell agreement. These types of arrangements may require the remaining partners to reach into their own pockets to buy out the departing partner, either with cash or through installment payments. More commonly, however, the partners may consider take out insurance policies on each other and use the proceeds upon one’s death to fund a buy out the descendant’s stock. In these instances, the surviving partners receive a step-up in cost basis and avoid exposure to future capital gains tax on those shares.

Alternatively, in a stock-redemption agreement, the business itself purchases the departing partner’s shares of stock. In turn, the surviving shareholders have an immediate capital appreciation for which they will be required to pay capital gains tax, if and when they sell the company.

Finally, a wait-and-see agreement allows the shareholders to choose between a stock redemption and cross purchase at the time of the triggering event, when the parties may assess the prevailing tax consequences of their actions.

Transfers of business ownership can be rife with emotions. When a buy-sell agreement does not exists between parties, or when the agreement is not well-written, significant discord between business partners and family members may result and drag on the transfer for years to come. It is in the best interest of business owners to work with experienced legal and financial counsel to develop a well-thought out and carefully crafted plan that addresses these realistic events and enables partners to negotiate agreeable terms before they happen.

The financial professionals with Provenance Wealth Advisors have deep experience working with lawyers and accountants to help business owners evaluate a range of issues and opportunities relating to the planning and financing of exit strategies.

About the Author: Eric P. Zeitlin is a registered representative of Raymond James Financial Services. He is managing director of Provenance Wealth Advisors, an independent financial services firm affiliated with Berkowitz Pollack Brant Advisors and Accountants. For more information, call 305-379-8888 or email ezeitlin@provwealth.com.

Provenance Wealth Advisors, 515 E. Las Olas Blvd., Ft. Lauderdale, FL 33301 (954) 712-8888.

Securities offered through Raymond James Financial Services, Inc., Members FINRA/SIPC. Raymond James is not affiliated with and does not endorse the opinions or services of Berkowitz Pollack Brant Advisors and Accountants.

The Vital Role of Computer Forensics When the Feds Take Over by Martin Prinsloo and Gabriel Campos

Posted on April 18, 2014 by Martin Prinsloo

Raids on businesses, individuals’ homes and even political offices are becoming increasingly common as fraudsters develop new and unique schemes for deceiving the public. Leading these heart-pounding search and seizures are court appointed receivers, agents with regulatory bodies and armed federal agents, U.S. Marshalls and local police officers. Next to arrive on the scene is the forensics team, which includes forensic accountants and computer forensic investigators, dressed in business suits and armed only with the skills and techniques they have honed to follow the money and find proof of alleged frauds.

Regardless of the timing of their arrival, members of the forensics team serve paramount roles in raids. They seize records, office equipment and personal belongings that hold the keys to unlocking sources and evidence of fraudulent activities. In today’s digital society, forensic accountants need assistance, and much of these responsibilities will fall to the computer forensic investigators who have the expertise to secure, identify, extract and analyze a treasure trove of buried digital information stored electronically on a variety of media sources. Typically, the phases of a fraud investigation do not involve distinct components but rather an overlapping series of steps that happen in parallel as documentation and discovery progresses.

Computer forensic investigators possess a keen understanding of tech jargon that enables them to communicate effectively with businesses’ IT staff in a shared language that may seem foreign to most lay people. With this specialized skill, they can quickly identify and lock down all electronic entry points to a company and cut off Internet access to ensure the integrity of evidence and protect it from becoming compromised. They can identify and access a variety of sources where data may be stored, including computers, network servers, firewall logs, flash drives, external hard drives, and cloud and online storage applications. In receivership scenarios, forensics investigators also have the task of maintaining technology infrastructures, which include voicemail systems, computer networks, remote access and proprietary applications, from which they may cull and prioritize data and refine it into useful and useable information.

With access to all forms of electronically stored information (ESI) obtained and processed by the computer forensic investigators, forensic accountants may begin the fraud investigation stage, which includes searching, locating and collecting relevant financial evidence that will stand up to scrutiny in a case against an alleged fraudster. With the voluminous amount data individuals and their organizations store electronically, one could assume that it could take days, weeks and even months to comb through all the information to identify anomalies or other elements that could point to fraud. However, teams of forensic accountants and computer forensic investigators understand that concealment is a key component of all frauds and perpetrators will often go to extreme lengths to hide their activities. For this reason, the computer forensic investigator is adept at wading through a complicated maze of data and piecing together portions of information to identify the sources and extent of alleged frauds. They rely on proven scientific techniques and tools to mine electronically stored data and search through millions of records to recover even deleted, hidden or encrypted files. Through these processes, they aim to link together seemingly unconnected activities and transactions to unravel all the elements of a fraud and the far-reaching effects of these deceptions.

The work of the forensic investigation team begins before and continues long after an initial raid. Their knowledge of the Federal Rules of Evidence and experience in preparing reports for trial, responding to interrogatories and providing expert testimony to support their findings could make or break a case.

Berkowitz Pollack Brant’s Forensics practice has extensive experience working on the front lines with state and federal authorities to identify, preserve, validate, extract and analyze evidence of fraud. Our team has been instrumental in high-profile fraud raids and cases, including those of ponzi schemer Scott Rothstein and the law firm of Rothstein Rosenfeldt Adler and criminal racketeers Mutual Benefits Corp. and its subsidiary Viatical Services.

 

About the Authors: Martin Prinsloo, CPA, CFE, CISA, CITP, CFF, and Gabriel Campos are members of Berkowitz Pollack Brant’s Forensic and Business Valuation Services practice.  For more information, call 305-379-7000 or email info@bpbcpa.com

 

Establishing or Challenging Causation Claims with Forensic Experts by Scott Bouchner

Posted on April 15, 2014 by Scott Bouchner

To recover lost profits or other economic damages in a civil law suit, a plaintiff must not only be able to establish liability and show that a defendant perpetrated a wrongful act, but as the Florida Supreme Court decided in W.W. Gay Mechanical Contractor, Inc. v. Wharfside Two, Ltd., 545 So.2d 1348 (1989), a plaintiff must also prove that:

1) the defendant’s action caused the damage, and

2) there is some standard by which the amount of damages may be adequately determined.

While the plaintiff’s burden to establish causation is clear, the damages expert’s role is less certain and may vary by both jurisdiction and the specific facts and circumstances of the case. In most matters, the damages expert will, to some degree, assume that the plaintiff will successfully prove its liability case.

If counsel asks the damages expert to assume that the wrongful acts caused the plaintiff’s damages, does the expert need to consider this issue any further? The answer to this seemingly simple question is not always clear. Consider the following example:

Defendant was accused of tortuous interference after hiring the Plaintiff’s top salesperson. In the year following the loss of this employee, Plaintiff’s sales declined by 30 percent. Plaintiff retained a damages expert, who counsel instructed to assume that the loss of the salesperson caused this decline in sales.

Based on these limited facts, it seems intuitive that the Plaintiff could have experienced a loss due to the departure of this individual. From the expert’s perspective, is this enough? Because the facts are rarely this clear, assume further that:

As depositions were taken, it became apparent that a patent on Plaintiff’s most popular product had expired around the time of the salesperson’s departure. The related product accounted for nearly 35 percent of Plaintiff’s annual sales. The market was subsequently flooded with generic alternatives. Plaintiff argued that it had countered the effect of this technology change when it developed, patented and introduced a new and improved product that, but for Defendant’s theft of its key salesperson, would have more than offset any reduction in sales.

At a hearing to exclude the expert testimony, Plaintiff’s expert acknowledged that he had not investigated or performed any analysis of these issues, as counsel instructed him that it was not his responsibility to prove or establish causation.

• Is it likely that Plaintiff’s financial expert would be excluded for not considering causation?

• Would it matter if Plaintiff offered the testimony of its director of marketing to address how the introduction of its newly patented product would have impacted sales?

• Would it make a difference if Plaintiff retained an industry expert to address directly these causation issues?

Depending upon the jurisdiction and, in some cases, the judge assigned to the case, the outcome of this hypothetical Daubert challenge could vary. In one court, the judge may rule that a damages expert is allowed to assume causation. Another Court, however, may exclude this expert for failing to consider how the expiration and loss of an important patent would have impacted Plaintiff’s sales.

The Florida Courts are no exception to these seemingly conflicting opinions. The BK Cypress Log Homes, Inc. v. Auto Owners Insurance Co. case (2012 U.S. Dist. LEXIS 73773) involved a bad faith claim brought against an insurance company. The Court ruled that the damages expert, who counsel asked to assume that the liability caused the Plaintiff’s damages, could simply assume causation:

It remains within the province of the jury to consider and weigh such evidence and determine whether in fact some or all of the damages determined by [Plaintiff’s expert] are causally connected to Auto-Owners’ actions.

In Nebula Glass International, Inc. v. Reichold, Inc. (U.S. District Court 454 F3d 1203 (2006)), Plaintiff’s expert went to great lengths to establish causation, which the Defendant challenged and argued that Plaintiff’s expert failed to link any losses to specific customers. The Court ruled that “evidence of each individual customer’s motivation is not required because [Plaintiff’s] evidence, taken as a whole, sufficiently proved causation.”

These cases, however, can be contrasted with a number of other Florida cases in which the Plaintiff’s expert was excluded or a jury award was overturned. For example, in the AlphaMed Pharmaceuticals Corp. v. Arriva Pharmaceuticals, et al case (432 F. Supp. 2d 1319(2006)), a $78 million jury award was overturned because the Court found that the Plaintiff’s expert was unable to sufficiently show that, even though the Defendant was found liable for the alleged bad acts, its damages expert was unable to establish that these bad acts caused the Plaintiff’s damages:

For [Plaintiff’s expert’s] opinions to be of any use, AlphaMed was required to offer sufficient proof of the assumptions that [Plaintiff’s expert] accepted’ as the foundation for his opinion, most importantly—that AlphaMed’s injury was caused by Arriva’s conduct. Only upon such a showing could AlphaMed proceed to the next prong of its lost profit analysis and offer [Plaintiff’s expert’s] opinion to provide the jury with a non-speculative estimation of the amount of AlphaMed’s injury.

In Winn-Dixie Stores, Inc. v. Dolgencorp, LLC (822 F. Supp. 2d 1322 (2012)), a case in which Winn Dixie alleged that Dolgencorp sold competing products in shopping centers where it had category exclusivity, Plaintiff’s expert was excluded on causation related issues, which prevented the Plaintiff from presenting its damages case. The Court ruled:

The issue is what damages, if any, Defendants caused Plaintiffs by selling more groceries than allowed in the respective stores’ grocery exclusives… Accordingly, I find that [Plaintiff’s expert’s] underlying causal theory of competition does not prove causation in this case….I also find that since [Plaintiff’s expert] does not establish causation, the probative value of her evidence is substantially outweighed by the danger of misleading the jury under FED.R.EVID. 403.

In the Nebula Glass and Winn Dixie cases, the experts’ opinions were excluded because they failed to establish causal links between the Plaintiffs’ liability and the Defendants’ damages. Yet, in the Whitby v. Infinity Radio, Inc. case (951 So. 2s 890 (2007)), the damages expert’s testimony was excluded because he failed to differentiate between factors that caused the damages (i.e. the departure and wrongful competition of a morning disc jockey at a competing radio station) from those that had nothing to do with the purported losses.

… without considering the impact of these external variables on Infinity’s profits during the period in question, [the damages expert’s] testimony failed to establish that the lost profits were the direct result of Whitby’s actions in leaving the station.

Whether a company is pursuing or defending against a case involving a claim for lost profits or other economic damages, it is important to realize that the plaintiff retains the burden of proof to establish the causal link between the alleged breach and the purported damages. A trained expert may be able to assist in establishing or challenging this link.

The Forensic Accounting practice of Berkowitz Pollack Brant has experience working with commercial litigators and providing expert testimony in a variety of lost profits cases across a range of business industries.

About the Author: Scott Bouchner, CMA, AVA, CFE, CIRA, is a director in Berkowitz Pollack Brant’s Business Valuation and Forensic Services practice. For more information, call (305) 379-7000 or e-mail info@bpbcpa.com.

Is Your Business Missing Out on Tax Breaks for Overseas Sales? By James W. Spencer

Posted on April 11, 2014 by James Spencer

According to Enterprise Florida, exporting is big business in Florida. With more than 58,000 Florida-based companies exporting products and services that account for 20 percent of all U.S. exports, the state is home to the second highest number of exporters in the country. In 2012, the Miami-Fort Lauderdale region ranked sixth among the country’s export leaders, with record reports of merchandise shipments totaling $47.9 billion to more than 200 countries.

Despite the region’s thriving export industry, many manufacturers and distributors of domestically produced products are missing out on permanent tax incentives and deferral opportunities that could result in significant savings. For example, to realize a tax rate reduction of approximately 16 percentage points, an export business may opt to form a separate Interest Charge-Domestic International Sales Corporation (IC-DISC) that merely acts as the exporter’s foreign sales agent and is the recipient of commissions of the exporter’s sales to non-U.S. customers. Doing so enables the export businesses to convert regular income, which is taxed at a top rate of 39.6 percent, to dividend income, which taxed at a top rate of 23.8 percent.

What Businesses Qualify for IC-DISC Incentives?

Businesses that benefit from IC-DISC structures include pass-through enterprises, such as S-Corps, LLCs and partnerships, as well as closely held C-corps that provide services or sell or lease products manufactured, grown or produced domestically for use or disposition outside the United States. Contrary to common belief, exporters qualifying for IC-DISC elections are not limited to those that are the sole manufacturers of domestically produced products. Rather, the IC-DISC structure may also be applied to distributors of exported products, companies that manufacture component parts of these products and even certain professionals who provide their services outside of the United States, including contractors or architects and engineers working on an offshore construction project.

How is an IC-DISC Structured?

An exporter forms and incorporates a separate entity IC-DISC, for which it elects tax-exempt status under the Internal Revenue Code. The exporter enters into an intercompany commission agreement with the IC-DISC and pays to the related entity a commission on sales, which may be the greater of 50 percent of export net income or 4 percent of gross export sales (limited to 100 percent of export net income). The exporting company deducts from its ordinary income the commission it pays to the IC-DISC followed by a payment from the IC-DISC in the form of dividends to shareholders. As a result, the shareholders are taxed on the dividend payments at a rate of no more than 23.8 percent, rather than the top income tax rate of 39.6 percent.

What Rules Must the IC-DISC Follow?

While there is no requirement that an IC-DISC hire employees or lease office space, it must maintain a separate set of books and records, meet a $2,500 capitalization requirement and pass a series of gross receipts and assets tests outlined by the IRS.

Additionally, the exporter must pass destination and use tests to demonstrate that the products it sold or leased were shipped and delivered for use, consumption or disposition outside the U.S. It must also comply with the foreign content test, which ensures that more than 50 percent of the exported product is made in the U.S. These tests represent merely a small sample of the many conditions exporters must satisfy to qualify for IC-DISC tax benefits. Complicating qualification standards are the many caveats that come with each conditional test. For example, products manufactured in the U.S. that sustains further manufacturing outside the country prior to sale are specifically excluded from the definition of export property. Yet, property sold to customers within the U.S. that does not undergo further manufacturing prior to export and is shipped to a foreign destination within one year satisfies the IC-DISC tests.

While the IRS has set forth very specific rules regarding how export companies establish intercompany pricing with their IC-DISC, exporters may face additional challenges relating to transaction grouping, transaction-by-transaction methodology, expense allocation and the no-loss rule.

Are there Other Tax Advantages to IC-DISCs?

Exporters may choose to defer distributions by using the cash to loan the commission payments back to the exporter and earn a deduction on the loan interest while treating the interest income as a shareholder dividend.

The IC-DISC is an often-overlooked tax-savings tool for export businesses. Structuring the IC-DISC to IRS standards and optimizing its benefits to meet desired goals requires careful planning with the assistance of experienced legal and accounting counsel.

The International Tax Services practices of Berkowitz Pollack Brant has deep experience helping businesses navigate through international tax planning and compliance waters.

About the Author: James W. Spencer, CPA, is a director in Berkowitz Pollack Brant’s Tax Services practice. For more information, call 305-379-7000 or email info@bpbcpa.com.

Keeping Up with Evolving Estate Tax Planning Regulations by Jeffrey M. Mutnik

Posted on April 09, 2014 by Jeffrey Mutnik

We live in a complicated world where modifications to rules and regulations occur frequently. For example, Americans went from a year without estate or generation-skipping transfer taxes to the edge of a fiscal cliff that allowed the federal lifetime exemptions of gift, estate and generation-skipping transfer taxes to fall from $5 million $1 million (with inflation adjustments). Just two days later, the government reinstated the $5 million exemption and issued a flat, 40 percent tax rate. While this was initially heralded as a “permanent” solution, weeks later the President’s budget called for a future reduction in the exemption and increase in the tax rate.

As a result of this ever-changing environment, estate planning cannot be done in a vacuum. Rather, it must be done in a continuum of time with the realization that a plan enacted yesterday may not work tomorrow. This, in turn, requires a careful focus on plan flexibility.

The IRS recently issued guidance that provides a potentially huge benefit to surviving spouses when decedent spouses died in 2011, 2012 or 2013 and did not use all of the federal lifetime exemptions available to them. In situations where the decedent’s estate was not large enough to require the filing of a tax return, there still existed a need for the survivor to file a return to elect portability of the unused exclusion. Unfortunately, many families that expected the unused exclusion to pass on to surviving spouse did not file a timely Estate Tax Return (Form 706). These families now have an option to make a late portability election for those years, only when Form 706 was not required originally and they file the form by December 31, 2014.

There are several estate-planning techniques that enable the movement of assets from owners to family members and/or friends with no tax costs. Some of these planning tools, which can include gifts, sales and establishing entities to receive assets for future generations, are facing limits to their benefits.

For example, the White House is currently seeking to modify a “loophole” in Grantor Retained Annuity Trusts (GRATs), when the terms are less than 10 years. Additionally, there is a looming threat to Crummey powers, a trust provision that currently allows beneficiaries to withdraw contributions to a trust and treat it as a present interest gift that qualifies for the annual gift tax exclusion. Under President Obama’s FY 2015 budget proposal, these provisions would be replaced with a flat $50,000 total annual exclusion, regardless of the number of trust beneficiaries. While this could eliminate paperwork, confusion and possible confrontation with the IRS, it may also require the use of lifetime exemptions for transfers to trusts that exceed $50,000 annually.

The rules and regulations of estate planning are not set in stone. Time and circumstances may result in modifications to laws that will affect families and the ways in which they preserve and pass wealth onto future generations. The best way to respond is to meet with an accountant and estate-planning advisor to develop flexible strategies that meet goals and adapt easily to changing environments.

About the author: Jeffrey M. Mutnik, CPA/PFS, is a director in Berkowitz Pollack Brant’s Taxation and Financial Services practice. For more information, call (954) 712-7000 or email info@bpbcpa.com.

Your Child, Your Tax Benefit by Joanie B. Stein

Posted on April 07, 2014 by Joanie Stein

The joys of parenthood include several benefits that can reduce a family’s taxable income, including:

Dependent Deduction. For 2013, taxpayers may claim a standard deduction of up to $3,900 for each of their qualifying dependent children under the age of 19, or 24 when the child is a full-time student. Dependent exemptions phase out once adjusted gross income exceeds $254,200 for single taxpayers, $279,600 for head of household or $305,050 for married couples filing jointly. Additionally, special rules apply to divorced couples seeking to claim the dependent exemption.

Child Tax Credit. Taxpayers whose income falls below $75,000 for single head of household or $110,000 for married couples filing jointly may claim a maximum $1,000 tax credit per dependent child under the age of 17.

Child and Dependent Care Credit. Parents who pay for someone else to care for their dependent children under the age of 13 while the parents work or look for work, could yield a child care credit of up to $3,000 for one dependent, or $6,000 for two or more qualifying dependents.

Adoption Credit. Certain expenses associated with adopting a child qualifies as a tax credit.

Higher education credits. The American Opportunity Credit, which provides a maximum annual credit of $2,500 per student, applies to individuals paying college expenses whose modified adjusted gross income is $80,000 or less, or $160,000 or less for married couples filing a jointly. Additionally, the Lifetime Learning Credit of up to $2,000 applies to qualified education expenses paid for students enrolled in eligible educational institutions, which include non-degree programs. Parents who pay the costs of post-secondary school for their dependent children may claim only one these higher-education tax credits.

Student loan interest. Taxpayers may deduct up to $2,500 in interest they paid on qualified student loans.

Self-employed health insurance deduction. Self-employed parents may be able to deduct the premiums they paid to provide health insurance for their dependent children under the age of 27.

Bitcoin Enthusiasts Prepare to Pay Taxes as IRS Addresses Virtual Currency by Rick Bazzani

Posted on April 03, 2014 by Rick Bazzani

On March 24, the IRS effectively took bitcoin out of the shadows and announced that it will treat the computer-generated currency as property for U.S. tax purposes. While many currently consider and use bitcoin as a currency, whether to purchase products and services or exchange them for legitimate forms of money, the IRS points out that it will not consider such convertible virtual currency to have any legal tender status in any jurisdiction. As a result, bitcoin users will need to consider and understand the tax implications associated with their use of the digital currency or risk penalties for failure to comply with the applicable tax and reporting requirements.

Investing in Bitcoin

As a property, bitcoin is subject to capital gains tax in the same manner that the IRS taxes gains on property transactions involving stocks and other investments. When users buy and sell bitcoin on an exchange and realize a profit, they will have to pay taxes on the capital gain. The holding period of the virtual currency will dictate whether this is short- or long-term gain. Likewise, when users sell bitcoin for less than the acquisition cost (determined by the exchange rate in U.S. dollars on the date of purchase), they may deduct the resulting capital loss.

Mining Bitcoin as a Trade or Business

The IRS considers “mining” bitcoins (by solving complex algorithms to unlock new coins) as a trade or business for which users must include in their taxable gross income the fair market value of the digital currency on the date of receipt. Moreover, individuals in the business of “mining” must recognize that income earned from this trade is subject to self-employment tax.

Buying and Selling Goods or Services with Bitcoin

Businesses, such as retailers Overstock.com and TigerDirect.com, that accept bitcoin as payment for the sale of goods or services must recognize as income the fair market value of the digital currency they receive, at the exchange rate to the U.S. dollar at the time of receipt.

Shoppers using bitcoin to purchase goods or services must calculate the gain or loss on the bitcoin based on the fair market value of the goods and services purchased against the adjusted basis of the bitcoin used in the transaction.

Tax-Reporting Considerations for Businesses Using Bitcoin

Self-employed individuals and/or independent contractors who receive bitcoin as income must include this income in the calculation of self-employment tax. Moreover, individuals who pay independent contractors using bitcoin must take into consideration the use of digital currency when determining whether they must issue and report to the IRS a 1099-MISC. More specifically, these individuals must add the value of the bitcoin payment to the cash or other payments they make in return for services to determine if they meet the threshold required to file the 1099-MISC.

Similarly, businesses and individuals that use virtual currency for all or partial payment of salaries and wages, interest, rents and other similar items must report such payments on Form W-2, Form 1099-INT, Form 1099-MISC, respectively.

About the Author: Rick D. Bazzani, CPA, is a senior manager in Berkowitz Pollack Brant’s Tax Services practice. For more information, call 305-379-7000 or email info@bpbcpa.com.

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