How to use reconciliation system to get out of tax dispute dilemma?

1. Introduction

With the rise of cryptocurrencies and blockchain technology, crypto assets have become a non-negligible part of the financial landscape. However, the taxation of crypto assets has been the focus of attention both inside and outside the industry. As a global leader in the fintech sector, the US tax settlement system has an important impact on the healthy development of the crypto industry. This paper will deeply explore the basic content of the US tax settlement system, and combine the tax settlement cases of FTX and MicroStrategy, analyze the tax implications brought by the case, discuss the impact of the system on the US crypto industry, and make a summary.

2. Overview of the US tax settlement system

2.1 Development of the tax settlement system in the United States

The tax settlement system in the United States is rooted in the Taxpayer Bill of Rights. According to U.S. law, taxpayers are protected by the Taxpayer Bill of Rights while bearing tax obligations, and enjoy ten rights such as the right to know, the right to enjoy quality service, the right to final determination, the right to confidentiality, and the right to question the position of the IRS and appeal. One, entitled "The Right to a fair and equitable Tax system," clarifies a taxpayer's right to have the tax system consider facts and circumstances that may affect his or her potential liabilities, ability to pay, or ability to provide timely information, and if the taxpayer is experiencing financial hardship or the Internal Revenue Service (IRS) does not properly and promptly resolve the taxpayer's tax issues through its normal channels, Taxpayers are entitled to the assistance of the Taxpayer Defence Service (TAS). Under this right, in certain circumstances (for example, the taxpayer cannot repay the tax debt in full, or the full payment of the tax debt will cause financial hardship), the outstanding tax can be reduced by submitting an Offer in Compromise to ensure that the taxpayer can cover basic living expenses.

2.2 Implementation conditions of the US tax settlement system

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  The tax settlement system is a way to resolve the dispute through non-litigation when the taxpayer encounters a tax dispute with the authorities (such as the Internal Revenue Service, the state government, etc.), but it is difficult to determine the tax payable in the process of tax inspection. In the United States, alternative dispute resolution (ADR) was introduced into the field of administrative procedures in the 1990s and was later established as a permanent law by Congress, encouraging federal agencies to apply other informal procedures such as mediation and negotiation, of which reconciliation is the most commonly used means.
  
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  The IRS Offers in Compromise system is a binding agreement between a taxpayer and the IRS based on administrative and criminal liability (including penalties, interest, and other tax surcharges) and the amount of tax due if the taxpayer is unable to meet his or her tax obligations. Enables taxpayers to settle their tax problems with less than the amount owed. However, this agreement is conditional on the taxpayer completing the application and meeting certain conditions:
  

A. When the existence or amount of the debt is disputed, the IRS may accept a settlement.

b. If there is concern that the amount owed will be recovered in full, that is, the taxpayer's assets and income are less than the full amount of the tax liability, the IRS may accept the settlement.

(c) The IRS may accept a settlement when taxes are legally owed and can be recovered in full, but full payment would cause financial hardship to the taxpayer, or cause injustice in extraordinary circumstances.

In order to successfully enter into a Tax settlement (OIC) agreement with the IRS, an individual or company needs to complete an application to the IRS and receive final approval through the following specific steps:

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 Form 433-A/433-B

Step 4: Fill out Form 656, select the tax plan of the settlement, 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 first tax and the $205 filing fee

Step 6: Send your application to the IRS

Step 7: If the application is unsuccessful, the taxpayer can appeal to the IRS independent office within 30 days

In addition to OIC, the IRS offers other alternative dispute resolution (ADR) mechanisms, including Fast Track Mediation and Fast Track Settlement: When the taxpayer cannot reach an agreement with the reviewing authority on tax matters, the reviewing authority shall prepare Form 14717 and attach the statement of issues and valuation report of both parties for appeal, and after the appeals department accepts it, a mediator will be assigned to facilitate the settlement of the two parties through mediation meetings. If the parties fail to reach an agreement on appeal, they may proceed to Post-Appeals Mediation, where the case is assigned to another appeals office for a new hearing.

2.3 Characteristics of the US tax settlement system

To some extent, the United States is influenced by the trend of pragmatism and administrative democratization. Although there are certain provisions on the scope of application of reconciliation in legislation, the tax court encourages reconciliation, and in the Administrative Dispute Resolution Act (ADAR) passed by the US Congress in 1990, the tax court encourages reconciliation. Lawmakers also proposed "authorizing and encouraging federal agencies to apply mediation, negotiation, arbitration, or other informal procedures for the expeditious resolution of administrative disputes." When it comes to tax administration, about 80% of small tax litigation cases are settled out of court before trial, thus ending the proceedings.

3. Tax settlement between FTX and microstrategy

3.1 FTX tax settlement cases

FTX was once a well-known global digital asset spot and derivatives (crypto assets) trading platform, founded in 2019, and became the second largest virtual currency trading platform in the world in a short period of time.

In 2022, due to financial fraud by Sam Bankman-Fried, the former CEO of FTX, and Alameda Research, another trading company founded by FTX, FTX's capital chain was broken. FTX, Alameda Research and more than 134 other affiliates filed for bankruptcy in the United States, costing investors billions of dollars.

In the bankruptcy process, the Internal Revenue Service (IRS) filed an initial tax claim of $44 billion against FTX and its subsidiaries (including FLX Trading ltd., Alameda Research, etc.), which was later revised to $24 billion. It said it was related to income tax, employment tax and penalties owed for the period 2018-2022. However, FTX attorneys filed papers with the bankruptcy court in December 2023 contesting the claim and asking the IRS to provide corresponding documents confirming its claim against FTX and explaining how it estimated the back taxes it would pay. In the filing, FTX's lawyers said FTX "never received anything close to the amount of the IRS's $24 billion tax claim" and lost a significant amount of money, and refused to accept income tax liability for so-called "misappropriated income" resulting from Sam Bankman-Fried's misappropriation of FTX client funds and employment tax liability for compensation. Meanwhile, in a statement, FTX attorneys stressed that "the only source of IRS recovery is the money taken from victims." Based on this, FTX filed to settle, offering to pay the IRS $200 million in priority tax claims and $685 million in lower priority claims.

In June 2024, FTX and the Internal Revenue Service (IRS) finalized a settlement agreement under which the IRS will receive a priority claim of $200 million in FTX's bankruptcy case, to be paid within 60 days of the company's proposed reorganization plan becoming effective. In addition, the agency will 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 MicroStrategy founder and cryptocurrency billionaire Michael Saylor, accusing him and his company of "failing to pay income taxes while residing in the District for at least 10 years." His company, MicroStrategy, helped him avoid more than $25 million in district income taxes by filing false W-2 information. On his tax returns, Saylor claimed to live in Florida, which has no income tax, but had been living in a beachfront apartment in Washington. At the same time, Saylor reduced the risk of tax avoidance by receiving a salary of just $1 plus numerous benefit arrangements (such as private jet travel, the use of a car driver, and a security team), and transferred the company to pay federal taxes on the benefits, which were not considered taxable because Saylor lived in Florida. In August 2022, Saylor stepped down as CEO of Microstrategy and became executive chairman.

The lawsuit is the largest income tax fraud recovery ever filed in the District of Columbia and the first since the district amended the False Claims Act, which encourages whistleblowers to bring tax evasion charges against residents who allegedly hid their actual residence. Under the charge, anyone who knowingly submits or causes a false claim to be submitted to the government is liable for damages three times the government's losses as well as fines indexed to inflation, so experts had thought Saylor should be liable for at least $75 million in fines. However, in the face of the lawsuit, Saylor insisted that he moved from Virginia to Florida more than a decade ago, bought a house in Miami Beach, and that his center of life was Florida, where he lived, voted and served on jury duty. The Microstrategy clarified that the company had no authority to regulate and influence Saylor's personal tax affairs and therefore refused to accept responsibility for Saylor's "tax fraud" issues. In the event that the parties disagree, each expresses its desire to avoid the time, expense and inconvenience of any further litigation and to resolve all disputes and potential legal claims based on the covered conduct. As a result, on June 3, 2024, Saylor reached a $40 million settlement with the Washington Attorney General for tax fraud.

4. Implications of the US tax settlement system

4.1 Tax implications of the FTX case

The collapse of FTX, once the world's second-largest virtual currency exchange, has damaged confidence in crypto assets. The tax settlement of this case not only involves the dispute between the IRS and FTX over the amount of tax, but also involves the bankruptcy of FTX exchange and the compensation of victims of fraud. The settlement agreement avoids the debtor to spend a lot of time and expense in litigation, helps the institution to prioritize the repayment of customers in the bankruptcy process, and protects the interests of multiple parties. Therefore, in the face of high debt claims, enterprises in the United States have a certain opportunity to reach a settlement with the Internal Revenue Service at a relatively low claim cost through multi-angle appeals.

4.2 Tax implications brought by the microstrategy case

The United States has a dual legal system of federal law and state law, so it is necessary to always pay attention to changes in state law on the basis of understanding federal law. The policy differences between different states do provide certain benefits for taxpayers (such as the Florida government's exemption from personal income tax) and reasonable tax avoidance space. But lying about where you live is risky, especially under strict laws. Therefore, companies should assist employees with reasonable tax planning in accordance with the law to ensure that tax practices are compliant and transparent.

At the same time, it is worth noting that Saylor avoided a fine of up to $75 million under the False Claims Act through a tax settlement in this case, ending the Washington lawsuit with a fee of $40 million. It can be seen that tax settlements can avoid further litigation burdens, avoid lengthy and expensive legal procedures, and also help taxpayers minimize the burden of fines.

5. Conclusion

Due to the decentralized, anonymous, global liquidity and other characteristics of cryptocurrencies, individuals or companies holding cryptoassets have tax risks such as difficult supervision and evidence collection for the tax bureau, and are easy to become tax loopholes, while cryptocurrencies inevitably become tax avoidance channels.

In the case discussed in this article, the IRS launched a high tax debt claim against FTX, and in the face of FTX's questions about the amount of its debt, the IRS was not able to conduct a closer investigation of the crypto asset trading platform and provide rigorous evidence, but chose to accept the settlement plan of FTX's legal team. Settled with FTX for nearly 100 times less than the "$24bn" the IRS had previously demanded. And the tax evasion case of Saylor, a "cryptocurrency billionaire," did not go through the legal process to the end, but through a tax settlement to compensate the Washington, D.C. government. 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 reconciliation system has strong practicability, which is conducive to improving tax administration, effectively resolving tax disputes, reducing the pressure of tax inspection, and providing effective means for tax payers to deal with tax compliance supervision and make up for tax negligence.

APA Reference

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