Payment of Income Tax Liability – With Cryptocurrency?

Take-Away: Some taxpayers who owe back federal income taxes may be eligible to pay those back taxes over a period of up to six years. Qualifying for that privilege, however, is not automatic, as a couple of taxpayers learned in a recent Tax Court Memo decision.

Case: Strashny v Commissioner, No. 13836-19L, Tax Court Memo 2020-82 (June 11, 2020)

Facts: The taxpayers timely filed an income tax return for 2017, but they did not pay the income taxes that were indicated on that return. The IRS issued a notice of deficiency, plus interest, for that 2017 tax liability in an amount in excess of $1.1 million. The taxpayers filed a request [Form 9465] to pay that assessed income tax liability over six years in equal installments. That request was denied by the IRS because the married taxpayers showed annual wages of over $200,000 and $7.0 million in cryptocurrency. On the form that reported the taxpayers’ available resources [Form 433-A] they also indicated that they were withdrawing from their cryptocurrency account $19,000 a month (or $228,000 per year.) The taxpayers did not dispute their 2017 income tax liability. Rather, they claimed that, despite their wealth, they should nonetheless be able to pay that income tax liability pursuant to an Installment Agreement  (IA.) The taxpayers claimed the Commissioner abused his discretion in denying their request to pay their income tax liability over six years.

Law: The Tax Code requires that any proposed tax collection by the IRS must “balance the need for the efficient collection of taxes with the legitimate concerns of the taxpayer so that any collection action will be no more intrusive than necessary.” [IRC 6330(c)(3).] The Tax Code also authorizes an Installment Payment Agreement (IA) if the Commissioner determines that such an agreement will facilitate full or partial collection of the taxpayer’s unpaid tax liability. However, the availability of the IA is within the discretion of the Commissioner. Thompson v. Commissioner, 140 Tax Court 173 (2013).

The Internal Revenue Manuel (IRM) implements these Tax Code provisions. It provides that in the absence of special circumstances such as old age, ill health, or economic hardship, a taxpayer must liquidate assets in order to qualify for an IA. [IRM pt 5.14.1.1(5), September 19, 2014.] It also provides that a taxpayer may be eligible for an IA for up to six years, but only if the taxpayer is unable to fully pay immediately. [IRM pt 5.14.1.4.1(1)t January 1, 2016.] Consequently, the 6-year installment payment opportunity applies only when the taxpayer lacks the ability to pay the entire tax liability currently.

Tax Court: The Tax Court judge upheld the Commissioner’s exercise of discretion to reject the taxpayers’ request to pay their income tax liability in six annual installments. The taxpayers were deemed ineligible for an IA after the Commissioner determined that they could fully satisfy their income tax liability by liquidating a portion of, or borrowing against, their cryptocurrency assets. Apparently the taxpayers offered no evidence of any economic hardship or any other special circumstances. Nor did the taxpayers offer any evidence that they were unable to withdraw from their cryptocurrency account sufficient additional amounts to pay their income tax liability in full. In the absence of any proof of hardship or the taxpayers’ inability to fully access their cryptocurrency account, it is easy to see why the Commissioner denied their request for installment payments of their tax liability, and why the Tax Court judge did not find that the Commissioner abused his discretion in denying the installment payment request.

Observation: The Tax Court judge was fairly glib in the observation that the taxpayers could simply borrow using their cryptocurrency as collateral security for a loan. That may be much easier said than done.  The Court’s decision does not indicate if the taxpayers owned Bitcoin, or some other lesser known and used cryptocurrency. The reason for the taxpayers’ request, which is all speculative since the decision is silent on reasons given, is that liquidating $1.1 million in cryptocurrency could have impacted the remaining cryptocurrency value held by the taxpayers. Pledging a cryptocurrency account may be more problematic than the Tax Court judge was willing to concede.

The blockchain on which ownership of cryptocurrencies are recorded typically does not include any identifying information about the owner. These distributed ledgers instead list an address to which a particular token is associated. The tokens at an address are controlled by way of a cryptographic private key that is issued by the blockchain network to the owner of the address. The blockchain is deliberately designed this way; there is transparency with regard to the address to which the cryptocurrency is associated, but there is no record of the identity of the token owner. Consequently, cryptocurrencies have features that do not fit well into the existing legal framework for property ownership and transfer, and thus use as collateral for a loan. With a cryptocurrency token, it is not even clear if it is property for purposes of a security interest under the Uniform Commercial Code.

If a lender takes a security interest in cryptocurrency assets, the lender must consider the risk that the purported owner of the ‘asset’ cannot be recognized by a court as the ‘owner’ as well as the possibility that cryptocurrency ‘assets’ may be determined to not be personal property at all. How does the lender control the ‘collateral?’ How does the lender enforce its security interest in the ‘collateral?’ If the token is not personal property, is it intangible personal property? The point is that most lenders may not be all that eager to take as collateral a private key to cryptocurrency to collateralize a loan in excess of $1.1 million.

Conclusion: It is no surprise that neither the Commissioner, nor the Tax Court judge, was particularly sympathetic with the taxpayers, who represented that they had $7.0 million in their cryptocurrency account yet they wanted six years in which to pay their $1.1 million income tax liability. More interesting was the passing observation by the Tax Court judge that the taxpayers could simply use their cryptocurrency account as collateral security to borrow sufficient funds to pay the $1.1+ million in income tax liability. Obtaining such a loan may not be as easy as the judge implied.