Should Your Organization Accept In-Kind Cryptocurrency Donations?

Date May 16, 2022
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Article Authors

Increasingly, investors are incorporating cryptocurrencies into their portfolios. Cryptocurrency
has graduated from the fringes of the dark web, where it resided for most of the last decade, to gain acceptance by mainstream institutions and investors. In February, Superbowl LVI featured three advertisements for cryptocurrency companies, one of which generated so much traffic that it crashed the company’s website. Considering the widespread adoption of cryptocurrency and the tax benefits of in-kind charitable contributions of appreciated property, charitable organizations should expect to see an increased number of donors seeking to make in-kind donations of cryptocurrency.

Donors of property are entitled to a charitable deduction equal to the appreciated fair market
value of such property at the time of the transfer —so long as the property has been held for more than one year1. At the same time, it is well established that unrealized gains are generally not recognized when a donor makes an in-kind transfer for no consideration2. The meteoric rise in the use of cryptocurrency in the last year presents an opportunity for charitably inclined taxpayers to maximize this double tax benefit. In some cases, donors have almost no basis in their cryptocurrency holdings, putting the after-tax value of nonrecognition on equal footing with the charitable deduction.

While current economic conditions present a unique fundraising opportunity for charitable organizations to solicit cryptocurrency donations, the opportunity carries compliance risk requiring careful consideration and planning.

The Uniform Prudent Management of
Institutional Funds Act

The Uniform Prudent Management of Institutional Funds Act (the “Act”) has been enacted in 49 states, the District of Columbia, and the U.S. Virgin Islands. The only state that has not adopted the Act is Pennsylvania, which imposes substantially similar requirements through its own law. In making
investment decisions for endowment funds, the Act requires the charitable organization to (1) act in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances (the “prudence standard”),3 and (2) consider its charitable purposes and the purposes of the endowment4.

The Act sets forth eight factors to guide investment decisions, which require the charitable organization to consider:

• general economic conditions

• the possible effect of inflation or deflation

• the expected tax consequences, if any, of investment decisions or strategies

• the role each investment or course of action plays within the overall investment portfolio of the fund

• the expected total return from income and the appreciation of investments other resources of the organization

• the needs of the organization and the fund to make distributions and to preserve capital, and

• an asset’s special relationship or special value, if any, to the organization’s charitable purposes5.

The Act specifically permits charitable organizations to invest in any kind of property or type of investment consistent with its terms.6 There is no reason to believe that this blanket permission excludes cryptocurrency, but the prudence standard—guided by the factors listed above—will likely preclude a charitable organization from allocating sizable portions of its endowed funds to
most cryptocurrencies due to their inherent volatility.7 Investment decisions about individual assets are not made in isolation but rather in the context of the portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the endowment and the charitable organization.8 Additionally, a charitable organization is required to diversify its
portfolio unless special circumstances dictate otherwise.9 Accordingly, cryptocurrency may find a home as a small allocation within a diversified portfolio.

The big caveat to the requirements above is that they are all subject to the donor’s expression of contrary intent.10 While the emphasis on donor intent does not mean that the donor can or should control the management of the charitable organization, the drafters’ comments to the Act provide that a charitable organization has an overarching duty to comply with donor intent, which is primary to the charitable purposes of the organization or endowment.11 Accordingly, if the donor of a gift instructs the charitable organization to invest the gift in cryptocurrency by the gift instrument, the organization will not fall out of compliance with the Act by abiding by the donor’s instructions.

As mentioned previously, charitable organizations are likely to see an increased prevalence of in-kind donations of cryptocurrency by tax-motivated donors. An organization that accepts such a donation must then decide whether to retain the cryptocurrency or dispose of it. The Act
requires that an organization make and carry out decisions concerning the retention or disposition of property or to rebalance a portfolio to bring it into compliance with the purposes, terms, and distribution requirements of the organization as necessary to meet other circumstances and the requirements of the Act.12

While an organization that accepts such a donation will generally prefer to liquidate cryptocurrency immediately upon receipt to raise cash for their charitable purposes or convert it to a more suitable investment, the donor may prefer the organization to retain the cryptocurrency for a period or
indefinitely. If the donor fails to express this intent in the gift instrument, the organization will have to decide whether it will retain the cryptocurrency at the expense of its organizational goals or dispose of the property and jeopardize the likelihood of receiving gifts from the donor in the future.

Notably, the Act does not require the organization to arrive at a particular outcome – the organization may consider a variety of factors in deciding whether to retain or dispose of the cryptocurrency, and a decision to retain it for a period or indefinitely may be a prudent decision.13 The drafters’ comments to the Act explain that the potential for developing additional contributions by retaining property contributed to the organization is among the “other circumstances” that the organization may consider in deciding whether to retain or dispose of the property. Accordingly, the organization might be able to justify the retention of a position in a cryptocurrency that is otherwise unsuitable for its investment portfolio on the grounds that the donor i a prospect for future donations. While the organization will likely be able to justify retention with documented discussion and analysis, this gray area is an uncomfortable place to be.

Federal tax reporting obligations

If the donor is claiming a tax deduction of more than $5,000 with respect to a charitable contribution of cryptocurrency, the donee organization is generally required to sign
the donor’s Form 8283, if requested, to substantiate the deduction. The signature of the donee organization does not represent agreement with the appraised value of the cryptocurrency but merely acknowledges its receipt and that the organization understands its own reporting obligations if the cryptocurrency is disposed of within three years of receipt.14 If the organization disposes of the donated cryptocurrency within the three-year window, it must file Form 8282 to report information about the disposition to the IRS and provide a copy of the form to the original donor.

Remaining compliant through adequate risk management

Charitable organizations must be deliberate in their compliance efforts, establishing robust risk management procedures setting forth detailed instructions for organizational personnel to follow whenever cryptocurrency comes through the door. Risk management procedures may be
different for each organization but should include common-sense measures such as requiring any
donor making an in-kind gift of cryptocurrency or establishing a fund to hold cryptocurrency to sign an approved gift instrument stating, in no uncertain terms, the donor’s intent for the gift; requiring any donation of cryptocurrency with a value exceeding $5,000 to be disposed of only with the approval of a specific individual responsible for federal tax reporting; and requiring that any purchase of cryptocurrency be accompanied by documentation of the discussion and analysis justifying the purchase.

Read the full Spring issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.

1 Treas. Reg. § 1.170A-1(c)(1).

2 The Humacid Co. v. Comm’r, 42 T.C. 894, 913 (1964).

3 UPMIFA § 3(b).

4 UPMIFA § 3(a).

5 UPMIFA § 3(e)(1).

6 UPMIFA § 3(e)(3).

7 Notwithstanding this observation, it is noted that one of the
largest charities in the country, the Silicon Valley Community
Foundation, is reported to hold $4.5B in digital assets according
to its financial statement, accounting for nearly a third of its
total investments.
https://www.siliconvalleycf.org/sites/default/files/documents/
financial/2017-independent-auditors-report.pdf

8 UPMIFA § 3(e)(2).

9 UPMIFA § 3(e)(4).

10 UPMIFA § 3(a).

11 See drafters’ comment on UPMIFA § 3 and 3(a): “In addition,
subsection (a) of Section 3 reminds the decision-maker that
the intent of a donor expressed in a gift instrument will control
decision making. Further, the decision-maker must consider the
charitable purposes of the institution and the purposes of the
institutional fund for which decisions are being made.”

12 UPMIFA § 3(e)(5).

13 See drafters’ comment on UPMIFA § 3(e)(5).

14 IRC § 6050L(a)(1)-(2). The exception for publicly traded
securities does not apply because cryptocurrency does not
qualify as a “security” for this purpose. See IRS Frequently
Asked Questions on Virtual Currency.

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Cryptocurrency and Taxes

Date February 25, 2022
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Cryptocurrency has moved from the realm of shadowy internet message boards to front stage financial news. Crypto and NFTs are just as much a part of news network discussions as the stock market is -stealing headlines, talking time and pageviews from its more traditional predecessors. However, along with the increased attention to those new financial vehicles comes updated tax considerations. Below is a primer for cryptocurrency tax considerations, and is by no means a full discussion:

I have been mining cryptocurrency and have started to receive coins from this activity – is this taxable?

Yes – IRS Notice 2014-21 states that successfully “mining” cryptocurrency will create income for the taxpayer. The amount of gross income includible to the taxpayer is the fair market value of the cryptocurrency at the time of receipt.

Where do I report this income on my tax return?

How to report this income is dependent on the purpose/nature of your activity. If you are pursuing this purely as a hobby, any income would be included on 1040 Schedule 1 Line 8 Other Income. These amounts are not subject to self-employment taxes however, you are unable to take deductions against this income as hobby-related expenses are not allowed. Alternatively, if your activity would be regarded as business activity, you likely will need to report the income on Schedule C. Additionally, you can take ordinary and necessary business expenses against this income – however, you may also be subject to self-employment taxes.

What happens if I later sell the cryptocurrency that I have mined?

The IRS views virtual currency as property, and as such general rules around property apply. The basis of your mined coins would be the fair market value as of the time of receipt – since you are required to include that as income as discussed above. If the property is a capital asset (think stocks for most taxpayers as an example), then capital gain or loss would result from a sale. Whether gains or losses are categorized as long-term or short-term will depend on how long you have held the coin for, similar to a sale of stock. Long-term treatment would apply if held for over a year, short-term if held for less than a year.

If the property is not a capital asset, ordinary income or losses would result. Common examples here would be items like inventory or items held for sale directly to customers are typical areas where this treatment would apply.

I did not mine any cryptocurrency, but I did purchase some this year. Do I have to pay tax on my purchase? Do I need to check that box about crypto transactions on the 1040?

If you only purchased crypto during the year and had no other transactions (sale, using it to purchase other goods/services, etc) then there are no further tax consequences for the year. Additionally, you are not required to check the box regarding crypto transactions.

When I sell cryptocurrency – does it matter which specific coin I sell? It can matter a lot! The IRS allows taxpayers to specifically identify units of virtual currency, granted that you meet documentation requirements. Those requirements are (1) the date and time each unit was acquired, (2) your basis and the fair market value of each unit at the time of acquisition (3) the date and time each unit was sold, exchanged, or otherwise disposed of, and (4) the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit. These requirements are met by several popular wallets, and this is a great area to utilize tax planning strategies, as selling coins that you have held for over a year with a high basis would have a different tax impact than coins recently purchased with low basis. Donating virtual currency can also be a viable tax planning strategy. Please consult with an HBK Tax professional first before using this as a tax planning strategy.

What if my wallet doesn’t provide that type of documentation and I have not kept the records either?

If you do not use specific identification related to sales and exchanges, the IRS deems that you are disposing of them in chronological order – starting with your earliest unit. This would be first-in, first-out basis, or FIFO. I didn’t receive any type of 1099 or official-looking document when I made my sales – do I still need to report this on my tax return? Yes! Any income, gain or loss from virtual currency needs to be reported on your tax return, whether you received a statement or not.

What about forks?

The taxability of a fork depends on which type – soft or hard. A soft fork is a change of the protocol of the software that can be backward compatible. This can be used to implement new features for a coin = but, importantly, it is still the same coin. It is not creating a new coin. Soft forks are not a taxable event, since you are still holding the same original coin.

Hard forks are different – these are software upgrades that are not backward compatible, and all users must upgrade to the new software to continue participating. This is a permanent divergence from the original chain, which can potentially create a new coin. It is possible to have a taxable event after a hard fork, if a user ends up possessing both the original cryptocurrency and a new cryptocurrency, via either the hard fork or airdrop. Speak to an HBK tax advisor for further information.

What about staking?

Staking is essentially lending your crypto – by lending your crypto, you are helping to secure and validate a given chain. In return, you have the potential to earn more crypto, similar to an interest payment. The more crypto that you are lending, the higher your chances of earning are. The taxability of this is still waiting for further clarification. As recently as December 21, 2021 the IRS released guidance that defined a “transaction involving currency” to include “receipt of new virtual currency as a result of mining and staking activities.” However, in the case Jarrett et al v. United States, the position is being taken that any coins gained through proof of stake should be considered new property that was created by the taxpayer. The IRS declared that it was refunding money to the Jarrets as a result of this case. IRS clarification or further court cases may provide further insight as to the taxability of these transactions.

This is by no means a full deep dive into the world of cryptocurrency taxation – new vehicles, methods and transactions are being created all the time. Hopefully, this primer has helped to understand some of the basics around taxation as it relates to cryptocurrencies. As with other areas of tax, please consult with your HBK tax advisor regarding these types of transactions.

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Cryptocurrencies & Foreign Bank Reporting: What You Must Know

Date August 9, 2019
Categories
Article Authors
HBK CPAs & Consultants

In today’s world we are seeing drastic changes in how we interact with our environment. Those interactions are becoming predominantly electronic through the use of phones, computers, watches, etc. Our currency is following suit. By now, many have heard the terms “bitcoin” or “cryptocurrency” – but do they understand the concept? The news regularly reports on how this electronic currency enables us to complete transactions in ways that we have not experienced in the past. While this technology is being embraced by some, there may be unexpected tax-reporting implications that the headlines often miss. It’s imperative for taxpayers engaging in foreign banking and potentially, in cryptocurrencies, to understand basic information related to foreign reporting requirements. The Basics of Cryptocurrency What is “Bitcoin” and how does it work? Bitcoin is a type of cryptocurrency, which is a digital virtual currency housed online. It is generally held in a virtual “wallet.” These virtual wallets operate like bank accounts in which a third party holds the currency. Cryptocurrency can be purchased using traditional analog currency, such as U.S. Dollars, Euros, British Pounds, etc. Bitcoin is the most popular form of cryptocurrency, and it is used as a functional currency by many major retailers including Amazon, Sears, Home Depot, and CVS. While some use cryptocurrency to function like traditional currency, many are using it for investment purposes in a manner similar to that of stocks being traded on an exchange. Foreign Bank Account Reporting in General The U.S. Department of the Treasury and the IRS want to be informed as to where taxpayers are keeping their bank accounts and their respective balances. Two main documents that taxpayers involved in the use of foreign banking should be aware of are the U.S. Department of the Treasury Foreign Bank and Financial Accounts Report (Form 114) and the IRS Statement of Specified Foreign Financial Assets (Form 8938). These two foreign reporting forms are applicable to U.S. citizens, residents, corporations, partnerships, and even trusts, and must be filed (along with a normal federal income tax return) if the filing requirements are met. In general, Form 114 is applicable if a taxpayer is holding a bank account outside the United States and the balance in the account exceeds $10,000 USD at any point during the tax year. Form 8938 would become applicable (in addition to or separate from Form 114) if the bank account balance exceeds $50,000 ($100,000 for married filers) for the tax year. Both forms are informational to the applicable governmental agency and no taxes are paid on the balance. However, severe penalties can and will be assessed for a failure to file these required forms. Cryptocurrencies as Foreign Bank Accounts Since cryptocurrencies are electronic currencies tied to a virtual wallet, it is possible that the wallet where the cryptocurrency is held may be located in a foreign country. While there is currently no official guidance related to foreign reporting for cryptocurrencies, it is possible that a taxpayer owning cryptocurrency could have foreign reporting requirements based solely on the location of the wallet. The IRS recently notified the public that letters are being sent to taxpayers who are cryptocurrency holders, urging them to comply with U.S. tax laws related to cryptocurrencies. We will provide details about additional reporting requirements, and other potential tax implications for cryptocurrency holders, as they become available. Please contact a member of the HBK Tax Advisory Group at 239-263-2111 if you would like to discuss potential foreign reporting requirements for cryptocurrency or any foreign banking matters. Additional Resources: https://www.irs.gov/businesses/comparison-of-form-8938-and-fbar-requirements https://www.irs.gov/businesses/small-businesses-self-employed/report-of-foreign-bank-and-financial-accounts-fbar https://www.irs.gov/pub/irs-utl/irsfbarreferenceguide.pdf https://www.irs.gov/businesses/small-businesses-self-employed/virtual-currencies https://bitcoin.org/en/how-it-works

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