The Wall Street Journal reported recently that the IRS sent letters to over ten thousand taxpayers who own cryptocurrency for failing to declare income from trading cryptocurrencies. Basically, the IRS said, “We know who you are and where you live”. My observation of the “lay of the land” is that cryptocurrency ownership and use will continue to proliferate. The “days of wine and roses” when a bitcoin owner could buy and sell coins for large gains believing that he could stay of the IRS’ radar is over. Now that only there a sheriff in town, he has real bullets in his tax compliance guns.
No need to despair! While the tax treatment of cryptocurrency is not as obscure and unknown as it seems. The problem for most cryptocurrency owners that have a low-cost basis in their cryptocurrency portfolio with large unrealized gains, is how to realize these gains with minimal or no tax impact. Can a taxpayer owning large unrealized gains in Bitcoin and transfer ownership and sell the unrealized gains with no tax impact while maintaining control over the reinvestment of the proceeds and reinvest on a tax-deferred basis? Can the same taxpayer receive distributions of the deferred and reinvested gains in the future with minimal taxation? Yes, and yes! Does anybody go to jail? No!
This article outlines how Malta Pension Plans can and should be used by owners of cryptocurrency to manage their cryptocurrency investment portfolio on a tax efficient basis. At this point I have written a decent amount about these Plans. For some readers the information may be boring and repetitious, but if own cryptocurrency and proper response might be, “why didn’t someone tell me about this?” The Malta Pension is a way to thrown sand metaphorically speaking into the face of the IRS as they begin their compliance chase of traders.
Taxation of Cryptocurrency
Before its amendment by the 2017 tax act, IRC §1031 provided that personal property could be transferred in a non-taxable exchange. The 2017 tax act amended IRC §1031 to exclude personal property from qualifying for non-recognition in an exchange. Virtual or cryptocurrency as defined in IRS Notice 2014-21 is treated as “property” under IRC §1221 for income tax purposes and not currency.
As a result, trades of virtual currency will qualify as short-term capital gain or long-term capital gain income. Depending on the level of income, the long-term capital gains rate may be 0%, 15% or 20 percent. In addition, the 3.8 percent net investment income tax may apply. Short term gains continue to be taxed as ordinary income.
Overview of Malta Pension Plans (Plan)
The Malta Pension Scheme is a surrogate to the Roth IRA. The taxpayer is able to make an unlimited contribution to the Malta Pension Plan. Unlike the Roth IRA, the taxpayer may make in kind contributions to the Plan through the contribution of the asset or an interest in an entity holding the asset.
All of the income within the Malta Pension Plan is tax-deferred. The Plan is not subject to unrelated business taxable income (UBTI). The Plan is treated as a grantor trust from a federal income tax perspective. As a result, the contribution of an appreciated asset will not trigger any tax consequences on the transfer of an asset.
Malta law permits distributions to be made from such Plans as early as age 50. The rules allow an initial lump sum payment of up to 30% of the value of the member’s pension fund to be made free of Maltese tax. Based on treaty provisions, distributions that are non-taxable for Malta tax purposes are also non-taxable in the United States. Under Malta law, three years must pass after the initial lump sum distribution before additional lump sum distributions could be made to a resident of Malta tax-free. In Year 4, the PLAN may distribute additional funds to the participant. Lump sum distributions in excess of a minimum annuity amount may be made every year. Fifty percent of the distribution in excess of the annuity amount is tax-exempt, and fifty percent is taxable.
U.S. Tax Compliance Requirements
Participation in the PLAN requires compliance with the FinCEN reporting requirements for foreign bank and financial accounts. FinCEN Form 114 (Report of Foreign Bank and Financial Accounts) must be filed annually with the Financial Crimes Enforcement Network (FinCEN), a bureau of the Department of the Treasury.
Code Section 6038D, also enacted as part of FATCA, requires that any individual who holds any interest in a “specified foreign financial asset” must disclose such asset if the aggregate value of all such assets exceeds $50,000 (or such higher dollar amounts as may be prescribed).
IRS Form 8938 is used to report specified foreign financial assets if the total value of all the specified foreign financial assets in which you have an interest is more than the appropriate reporting threshold. As a foreign grantor trust, the taxpayer will most likely be required to file Form 3520.
Bob Smith, age 50, began buying Bitcoin in 2010. He is a resident of California and would be subject to a combined federal and marginal tax on the capital income in the sale of his cryptocurrency portfolio. He purchased 10,000 coins in 2010 for $1,000. The current valuation of the coins is $101.1 million. As the stability and price has begun to stabilize, Bob has concluded that it might prudent to realize some of the gains within his portfolio.
Bob creates a Malta Pension Plan administered by Acme Trust in Malta. The plan is a single participant plan. Bob transfers his entire portfolio to the Plan on a tax-free basis. The portfolio is held within a Delaware LLC that is wholly owned within the Plan. The Manager of the LLC is Bob’s best friend and CPA. The LLC’s “wallet” is the same “wallet” that he has had for the last nine years.
The entire portfolio is sold, and Bob recognizes a gain of approximately $101 million. Due to the tax treaty benefits, Bob is able to claim treaty benefits for the entire gain on IRS Form 8833. The proceeds are reinvested without taxation. The investment income and gains will remain tax deferred. Bob is able to take an initial lump sum distribution of $30 million at age 50 which is non-taxable for both Malta and U.S. purposes.
The Malta Pension Plan is a powerful vehicle designed to provide for substantial tax deferral in a manner similar to the Roth IRA. The Plan has no contribution limits. The taxpayer may contribute appreciated cryptocurrency assets without gain. At distribution a substantial portion of the deferred income may be distributed without taxation in Malta or the United States. Sounds easy! It is! The tax treatment of the Plan is clearly delineated in the U.S.-Malta Income Tax Treaty and not some “twisted” interpretation of revenue rulings or Tax Court cases.