Peter Connors

Partner

New York


Read full biography at www.orrick.com
Peter Connors, a tax partner in the New York office, focuses his practice on cross-border transactions. He also has extensive experience in related areas of tax law, including financial transactions, corporate reorganizations, renewable energy investments and controversy matters. He also leads the Orrick's Section 45Q practice relating to the tax credit for carbon capture and sequestration.

According to Chambers, his peers state that Peter "is an outstanding international tax practitioner' who is admired for the strength of his activity in the field of cross-border transactions and is "an excellent lawyer who has a diverse practice."

Peter serves as President of the American College of Tax Counsel.  He is also President of the USA Branch of the International Fiscal Association.

Before joining Orrick, Peter was a principal in the International Tax Services Group of Ernst & Young in New York.

A prolific author, Peter is a frequent lecturer for a variety of major organizations and has published more than 100 articles on tax planning subjects. He is a co-author of T.M. Portfolio 543 ("The Mark to Market Rules" of Section 475-2d) and the author of T.M. Portfolio 909-3d ("The Branch-Related Taxes" of Section 884). From 2008 to 2010, he was the Vice Chair, Committee Operations, of the American Bar Association Tax Section.

 A significant portion of his practice involves tax controversy, including representation of taxpayers before the U.S. Tax Court. In 2010, Peter also founded the NYC Calendar Program for the U.S. Tax Court.

He has been recognized by every edition of Best Lawyers in America since 2015.

Posts by: Peter Connors

The Next Step: FinCEN Proposes to Require Reporting of Cryptocurrency Positions Held in Foreign Accounts

FinCEN recently took another important step toward bringing virtual currency into the financial assets reporting scheme.

Taxpayers that have $10,000 or more in a foreign bank account have long been required to file a foreign bank account report (or “FBAR”) on FinCEN Form 114. The penalties for failing to report foreign bank accounts are significant: $10,000 for a non-willful failure and the greater of $100,000 and up to 50 percent of the unreported account balance for willful failures. While the rules requiring the reporting are issued under the authority of the Bank Secrecy Act, the IRS administers the rules—and the IRS has been aggressive in assessing penalties for failures to report such holdings.

The application of the filing requirement to cryptocurrency has been the subject of some uncertainty. The uncertainty arises because the reporting requirement only applies to a “financial account.” A financial account includes, but is not limited to, a se­curities, brokerage, savings, demand, checking, deposit, time deposit or other account maintained with a financial institution (or other person performing the services of a financial institution). A financial account (per 31 CFR 1010.350(c)) also includes a commodity futures or options account, an insurance policy with a cash value (such as a whole life insurance policy), an annuity policy with a cash value and shares in a mutual fund or similar pooled fund (i.e., a fund that is available to the general public with a regular net asset value determination and regular redemptions). The regulations reserve “other investment fund,” presumably for a definition to come. However, in response to questions raised by the AICPA Virtual Currency Task Force in 2019, FinCEN stated that virtual currency was not subject to FBAR reporting. This was confirmed by FinCEN in 2020 as well.

Whether or not cryptocurrencies are subject to FBAR filing, such holdings may have to be included on the IRS’s Form 8938, Statement of Specified Foreign Financial Assets. Form 8938 is the counterpart to FinCEN 114.

Recent FinCEN Proposed Rule

On December 31, 2020, FinCEN issued Notice 2020-2 that announced a proposed rule that would amend the regulations implementing the Bank Secrecy Act regarding reports of foreign financial accounts (FBAR) to include virtual currency as a type of reportable account under 31 CFR 1010.350. The proposed rule does not specify an effective date.

The decision to treat cryptocurrency as subject to FBAR reporting significantly increases the potential penalties against those who fail to properly identify these accounts. Holders of virtual currency in foreign accounts should review this rule and prepare to report such holdings once the rule becomes effective.

Word on the Street Is That Virtual Currency Is the “New Gold,” and it’s Swiftly Moving Up the IRS Watchlist

The IRS has been increasingly active in its effort to ensure that virtual currency does not become a tool for tax evasion. This is not surprising, given that—as we started the last month of 2020—the value of Bitcoin, by far the most well-known cryptocurrency in the world, reached its highest level since 2017. Between June 2019 and July 2020, about 3.1 million active accounts were estimated to use bitcoin in the U.S.

Guidance

The IRS first started publishing guidance and notices on the federal income tax treatment of virtual currency in 2014. The first one among many was Notice 2014-21, which concluded that convertible virtual currency (virtual currencies that can be used to make purchases in the real economy and can be converted into government-issued currencies) should be treated as property for tax purposes. The next Notice, Rev. Rul. 2019-24, addressed the tax treatment of more specific types of virtual currency transactions, “hard fork” and “airdrop.” The IRS has also posted answers to frequently asked questions about virtual-currency transactions on its website. Starting with taxable year 2019, the IRS revised Schedule 1 to Form 1040 to require taxpayers to identify whether they engaged in any transaction involving virtual currency. The IRS plans on going even further as shown in a released draft of the revised Form 1040 for 2020, where it proposed placing the question about cryptocurrencies in a very prominent location—immediately below the taxpayer’s name and address.

More guidance might be forthcoming. One issue is whether the rules for broker reporting should apply to cryptocurrency transactions in the same way that they apply to trades in stocks and securities. The IRS believes that increased reporting leads to greater compliance. Earlier this year, the Chamber of Digital Commerce (the “Chamber”) submitted a comment letter to the IRS and the Department of Treasury to provide its views on potential forthcoming guidance on the reporting issue. The letter pointed out there is still some lack of clarity on the tax information reporting requirement for digital asset transactions, and that further instruction is needed for taxpayers to accurately interpret existing tax rules in the digital currency context. Some of the key areas on which the Chamber had requested clarification are: how “broker” is defined in the virtual currency context—which is critical for analyzing basis reporting requirements and certain information return filing obligations—and what factors are relevant for determining the location transactions take place, which can be a critical factor for cross-border transactions.

Enforcement Efforts

At the same time that it has been providing such guidance, the IRS has begun efforts to investigate possible tax evasion using virtual currency. The agency started its enforcement efforts in as early as 2016 when it served a “John Doe” Summons on one of the largest cryptocurrency exchanges in the country. The IRS demanded that the exchange produce a wide range of taxpayer identifying information and historical transaction records, and when the exchange refused to comply, the U.S. District Court for the Northern District of California ordered the exchange to turn over taxpayer information for those who conducted transactions worth more than $20,000 on its platform for the 2013 – 2015 period.

As part of its virtual currency compliance campaign announced in 2018 to address tax noncompliance related to virtual currency, in 2019 and again in 2020, the IRS sent thousands of warning letters to cryptocurrency holders whose tax returns did not match their virtual currency transaction records. While the IRS has not made it clear where it obtained the information about taxpayers’ transactions, one possible source of data could be Form 1099 reports from virtual currency exchanges. The IRS sent three different types of letters, varying in severity. The first type, Letter 6173, raised the possibility of an examination or enforcement activity if the taxpayer didn’t respond by a specific date and noncompliance persists. The other two, Letters 6174 and 6174-A, reminded taxpayers of their obligation to report.

According to the Internal Revenue Manual (IRM 5.1.18.20.3 (7-17-19)), the IRS uses normal investigative techniques to identify virtual currency including interviews, bank or credit card analysis, summonses of exchanges and financial institutions, review of Forms 1099-K, review of FinCEN Query reports, tracking and internet searches. While this set of instructions may appear relatively old-fashioned, the IRS’ latest moves demonstrate that it is upgrading its crypto-investigation toolbox. According to published reports, in September 2020, the IRS spent approximately $250,000 on a contract with Blockchain Analytics and Tax Services LLC, which will give the IRS access to blockchain analysis tools to track cryptocurrency transactions. Earlier in the summer, the IRS also signed a deal to purchase access to certain blockchain-tracing software for a year.

Despite the industrywide complaint that the IRS’s expectations with regards to holders of virtual currency are vague and unclear, this year, the IRS and the Department of Justice have started taking more proactive actions to prosecute taxpayers who allegedly committed a greater scale of tax evasion related to the use and trade of virtual currency. In October 2020, the Department of Justice charged software pioneer John McAfee with alleged evasion of tax by using cryptocurrency. In addition, on December 9, 2020, the SEC charged Amir Bruno Elmaani, founder of cryptocurrency called Oyster Pearl, with tax evasion. Elmaani allegedly evaded tax on millions of dollars of profits from cryptocurrency transactions and using shell companies and pseudonyms to conceal his income.

Increasing Regulation and Enforcement

All indications are that regulation and enforcement of the law with respect to virtual currency is increasing. On the regulatory side, earlier this month, a new U.S. congressional bill called the “Stablecoin Tethering and Bank Licensing Enforcement Act” was introduced that aims to regulate digital currencies by requiring certain digital currency issuers to obtain a banking charter and obtain approval from the Federal Reserve. Different government agencies are working in parallel to clarify tax payment and reporting obligations with respect to cryptocurrency, and the latest movements indicate that the enforcement actions are continuing.

We expect to see more enforcement actions in the upcoming administration. In November, the president-elect Joe Biden appointed Gary Gensler, a former Commodity Futures Trading Commission Chair under the Obama administration, to its presidential transition team. Gensler has testified before Congress about virtual currency and blockchain on several occasions, and while little information is known about Biden’s stance on cryptocurrency, Gensler called blockchain technology a “change catalyst” in a 2019 CoinDesk opinion and is generally considered to be “Bitcoin-friendly.” While it is generally unclear what Gensler’s long-term official position under the Biden administration will be, he is also on top of a list of potential picks for the SEC chair. Another clue that may provide some insight with regards to Gensler’s attitude towards cryptocurrency is his 2019 statement that Facebook’s proposed digital token, Libra, should be treated as a “security,” which establishes the basis for increasing regulatory oversight. (Cryptocurrency’s uncertain status as a security for tax purposes raises other tax issues.) The general industry consensus is that, while there is a growing acceptance of the legitimacy of cryptocurrency, it is likely that more regulatory and enforcement actions will continue by the SEC against issuers and intermediaries, and by the IRS against taxpayers. More regulation is not necessarily negative—it can create clearer guidelines and landscape for exchanges and virtual currency holders and enable them to better understand the regulatory and tax authorities’ expectations. That being said, it will be important for exchanges and taxpayers to closely follow the latest government guidelines with respect to virtual currency and ensure they comply with reporting and tax payment obligations.

IRS Hints at Form 8938 Requirements for Reporting Crypto Assets Held at a Foreign Exchange

With the emergence of digital assets, the question has arisen whether digital assets held in “wallets” in foreign exchanges need to be reported on Internal Revenue Service (IRS) Form 8938, Statement of Specified Foreign Financial Assets. Form 8938 is the IRS counterpart for the FBAR, or Foreign Bank Report, which certain holders of foreign bank accounts must file with FinCEN. Form 8938 was added as part of the HIRE Act at the same time the Foreign Account Tax Compliance Act (commonly known as FATCA) was adopted in 2010. The penalty for a failure to file Form 8938 is $10,000. However, it is not clear that Form 8938 applies to digital assets.

The answer requires one to dig through the underlying statutes and the instructions to Form 8938. We start with Internal Revenue Code Section 6038D, which requires reporting of “specified foreign financial assets.” Under Code Section 6038D, a “specified foreign financial asset” is (1) a financial account maintained by a foreign financial institution and (2) one of the following foreign financial assets if they are held for investment and not held in an account maintained by a financial institution: (a) any stock or security issued by a person other than a United States person; (b) any financial instrument or contract held for investment that has an issuer or counterparty other than a United States person, and (c) any interest in a foreign entity. The term “financial account” means, with respect to any financial institution, (a) any depository account, (b) any custodial account and (c) any equity or debt interest in such financial institution (other than interests regularly traded on an established securities market).

One issue for digital asset holders is whether a person who holds such assets in a wallet maintained at a foreign exchange is holding an asset in a “foreign financial institution.” What is a financial institution? This is defined in Code Section 1471(d)(5) as an entity that (a) accepts deposits in the ordinary course of a banking or a similar business, (b) as a substantial portion of its business, holds “financial assets” for the account of the others, or (c) is engaged (or holds itself out as being engaged) primarily in the business of investing, reinvesting or trading in securities, partnership interests, commodities or any interests in such securities, partnership interests or commodities. A foreign financial institution includes investment vehicles such as foreign mutual funds, foreign hedge funds and foreign private equity funds. Very generally, financial assets are securities, commodities, notional principal contracts, insurance contracts, or annuity contracts or interests in any of the foregoing. Both the terms “security” and “commodity” are defined by reference to Code Section 475, a section of the Code that was adopted in 1993, preceding the emergence of digital assets. For example, gold is a commodity under this provision, and anyone holding gold in an offshore account would need to report the account. Should the same rules apply to bitcoin or bitcoin gold held in a wallet in an offshore exchange? The IRS has not yet taken a position on whether cryptocurrency is a security or a commodity, which it could do by a regulation or a notice. This is key to the analysis of whether or not the crypto exchange is a foreign financial institution.

At least one recent, unofficial statement provides insight into the IRS’s thinking on the reporting obligation on Form 8938. Recently, according to Tax Notes, an IRS official was asked if the IRS will assess penalties against taxpayers who haven’t been disclosing digital assets on Form 8938, and the official responded that, if taxpayers had been reporting taxable cryptocurrency transactions on their returns during prior years and properly filed Form 8938 going forward, the IRS probably would not pursue them for prior tax years. Of course, this is merely an unofficial statement, and the IRS could formally decide otherwise or examiners could take different positions during the course of an exam. Either way, taxpayers that have not been reporting their cryptocurrency transactions should file Form 8938 as soon as possible and consider filing amended returns.

Information reporting is certainly a key issue for the IRS that will drive the tax compliance process. In a sign of the attention that the IRS is giving to the reporting, the draft version of IRS Form 1040, Schedule 1, now includes a question regarding financial interests in “virtual currencies,” much like the question relating to ownership of foreign bank accounts presently on Schedule B.

HMRC’s New Approach to Cryptoassets – Tax First, Define Later

The UK tax authority, Her Majesty’s Revenue & Customs (HMRC), has taken a further step towards tackling perceived tax avoidance in transactions involving cryptoassets. Specifically, according to press reports, exchanges such as eToro, Coinbase and CEX.IO have received letters from HMRC requesting customer and transaction data.

The move follows HMRC’s most recent policy paper, “Cryptoassets for Individuals,” published in December 2018, which in turn built on the brief general guidance published by HMRC four years earlier in 2014. The 2018 policy contains the statement that HMRC will apply the relevant income or capital gains tax provisions by looking at the factual details of each circumstance rather than by reference to terminology.

While the policy paper does distinguish between exchange tokens, utility tokens and security tokens, in practice we expect HMRC to focus on a transaction’s factual elements, rather than the description of the cryptoassets.

In contrast to HMRC’s approach, the UK financial regulator, the FCA, has recently revamped its classification of cryptoassets, clearly defining which ones among them would not fall within the scope of its regulatory regime, the Financial Services and Markets Act 2000. HMRC is yet to comment publicly on this development, but it is hoped that HMRC will follow suit and provide taxpayers with more certainty in determining their tax obligations in relation to cryptoassets.

Interestingly, on the other side of the Atlantic, the U.S. Internal Revenue Service (IRS) was also reported to have sent compliance letters to holders of cryptocurrency, warning them of the consequences of their potential non-compliance with relevant tax obligations. It is not clear whether the letters are limited to those taxpayers identified in the Coinbase Summons in 2016. The IRS believes that in 2017 up to $90 billon in cryptocurrency gains went unreported. On the Chain authors have written on the topic previously here, here and here.

While the IRS confirmed in 2014 that virtual currency ought to be treated as property for tax purposes, HMRC has, so far, used the word “property” only to describe cryptoassets for inheritance tax (IHT) purposes. Whether a similar approach will be taken for other UK taxes is yet to be confirmed and cannot be assumed.

The Financial Committee of the City of London Law Society published a paper that provided a potential framework for legal classification of cryptoassets. According to the Committee, exchange tokens could constitute a new category of personal property that is neither a “chose in possession” nor a “chose in action,” subject to the Supreme Court extending the notion of personal property to such assets.

In order to tap into the value generated by cryptoassets, HMRC’s approach has been to treat cryptoassets as property in relation to IHT and as “assets” in relation to other taxes. This approach is potentially quite unclear for taxpayers if we consider that, at the time of writing, there is no legislative basis (judicial or statutory) for the classification of cryptoassets as property. The fact that HMRC has recognized cryptoassets as property only in relation to IHT, and not for other UK taxes, adds to the uncertainty.

This uncertainty, coupled with the fact that most taxing legislation was drafted before digital assets even existed, means there is an urgent need for clarification on their legal status.

This is relevant to all value-generating actions involving cryptocurrencies, including the UK tax treatment of:

  1. options on tokens – will this mirror the taxation of options over shares?
  2. ICOs – will these be taxed in the same way as IPOs? and
  3. the transfer of tokenized shares – will these fall within the scope of stamp duty?

At the moment, there is no clear answer.

One thing does seem certain, however – blockchain is a harbinger of a new way of generating value and its potential will be fully leveraged only when the tax and legal frameworks around it have reached a serviceable level of cohesion. How and when this will be achieved is difficult to say.

IRS Advisory Committee Identifies the Need to Enforce Compliance on Cryptocurrency Transactions

A recent report (the “Report”) of the IRS Commissioner’s Information Reporting Advisory Committee (“IRPAC”) has identified the need for additional guidance on cryptocurrency transactions to enforce compliance on cryptocurrency transactions. The Report heavily relies on the recent experience the IRS had in enforcing the Coinbase summons, as recently reported in On the Chain. The IRS explained the problem earlier this year: because transactions in virtual currencies can be difficult to trace and have an inherently “pseudo-anonymous” aspect, some taxpayers may be tempted to hide taxable income from the IRS. IRS News Release, IR-2018-71, March 23, 2018. Taxpayers in this situation are at risk, given that, as recently reported in On the Chain, there is no voluntary disclosure program for taxpayers that have failed to report crypto related income.

In the Report, the IRS estimates that potentially unreported cryptocurrency tax liabilities represent approximately 2.5% of the estimated $458 billion tax gap. The calculation relies upon a recent article by Fundstrat Global Advisers, which sets cryptocurrency-related labilities at $25 billion, based on taxable gains of approximately $92 billon and a noncompliance rate of 50%. The Fundstrat Report estimates that approximately 30% of the investors in cryptocurrency are in the U.S., which is more than $500 billion at the end of December 2017 (up from about $19 billion at the start of January 2017!), according to data from CoinMarketCap.

While the IRS previously addressed certain issues in Notice 2014-21, there remain significant open issues that will need additional analysis and further guidance to refine the reporting of these transactions.  For example, the reports cites the following:

  1. whether virtual currency held for investment is a capital asset;
  2. whether the virtual currency ought to be treated as a security, subject or not subject to the wash sale rules, or affected by mark-to-market implications under section 475 of the Code;
  3. whether a taxpayer may use LIFO or FIFO to determine the basis of virtual currency sold;
  4. how to track basis through activities in the blockchain;
  5. whether broker reporting is required under section 6045 of the Code for transactions using virtual currency;
  6. whether a taxpayer may contribute virtual currency to an IRA; and
  7. whether virtual currency is a commodity.

Also, while an initial reading would suggest that virtual currency would not be considered a financial account for FATCA purposes, various guidance notes issued by foreign jurisdictions for purposes of implementing the Common Reporting Standard (CRS) have indicated virtual currency does represent a financial account.  This inconsistency, the Report notes, between regimes that purportedly try to maintain a high level of consistency will be confusing to withholding agents and subject to inherent error.

Citing the recent Coinbase summons and the failures to report income identified in that case, the Report opines that many, if not most, taxpayers will report their virtual currency activities correctly if they are able to determine their tax implications.  Some taxpayers will be tempted to do otherwise, however, because anonymity is inherent in the structure of the block chain activities.  In light of Coinbase, these taxpayers are likely to use exchanges outside the jurisdiction of the U.S.  The Report notes that it is unclear at present whether the U.S. may obtain information from foreign exchange activities (determining the exact nature of residence of the virtual activities of an exchange is itself vexing under existing source and jurisdiction rules, and leads to issues of whether the activities are sourced to any jurisdiction or are stateless income).

The Report concludes with IRPAC stating that it would be very interested in helping develop information reporting and withholding guidance on these important issues.

https://www.irs.gov/pub/irs-pdf/p5315.pdf

The IRS is Closing in on Cases Regarding Bitcoin Income Reporting

Following a several-year court fight, the Internal Revenue Service (the IRS) appears to have obtained a substantial amount of information regarding individuals’ transactions in cryptocurrency, and the agency might be in a position to make criminal referrals of failures to report income from such transactions. In December 2016, the IRS, believing that virtual currency gains have been widely underreported, issued a summons demanding that Coinbase, the largest U.S. cryptocurrency exchange, produce a wide range of records relating to approximately 500,000 Coinbase customers who transferred Bitcoin, a virtual currency, from 2013 to 2015. Formed in 2012, Coinbase has served at least 5.9 million customers and handled $6 billion in transactions. Coinbase did not comply with the summons.

In seeking to enforce the summons in the Northern District of California, the IRS cited the fact that while approximately 83 percent or 84 percent of taxpayers filed returns electronically, only between 800 and 900 persons electronically filed a Form 8949, Sales and Other Dispositions of Capital Assets, that included a property description that was “likely related to bitcoin” in each of the years 2013 through 2015. Presumably, the IRS believes that more than 900 people made gains on bitcoin trading during that period.

On November 28, 2017, the court enforced but modified the summons by requiring Coinbase to provide documents for accounts with at least the equivalent of $20,000 in any one transaction type (buy, sell, send or receive) in any one year from 2013 to 2015. The order required Coinbase to provide: (1) the taxpayer’s ID number, name, birth date and address; (2) records of account activity, including transaction logs or other records identifying the date, amount and type of transaction, i.e., purchase/sale/exchange, the post-transaction balance and the names of counterparties to the transaction; and (3) all periodic statements of account or invoices (or the equivalent).

The IRS appears to be getting closer to the prospect of criminal cases:

  • In March 2018, Coinbase informed 13,000 of its customers that it would be giving information on their accounts to the IRS.
  • At the recent Tax Controversy Institute in Beverly Hills, Darren Guillot, Director (Field Collection), IRS Small Business/Self-Employed Division, said that “[he] has had access to the response to the John Doe summons served on Coinbase, Inc. for two months and has shared that information with revenue officers across the country.”
  • Bryant Jackson, Assistant Special Agent in Charge (Los Angeles), IRS Criminal Investigation Division, recently said that CI has been expecting fraud referrals from the Coinbase summons response.
  • CI and the Justice Department Tax Division have been discussing those anticipated cases and issues that may arise in them, such as proof of willfulness.

It is noteworthy that in Notice 2014-21, the IRS answered a series of questions related to the taxation of cryptocurrency (which it refers to as “virtual currency”). In the Notice, the IRS indicated that penalties would apply for failures related to the reporting of gains under section 6662 and failure to file information returns under sections 6721 and 6722. While the Notice specifically provided that penalty relief may be available to taxpayers and persons required to file an information return who are able to establish reasonable cause, it did not provide any indication as to whether reasonable cause relief would be available for taxpayers who failed to report cryptocurrency-related gains. More recently, on July 14, the Large Business and International division of the IRS initiated a Virtual Currency Compliance Campaign to address noncompliance issues.

While there may be valid reasons for failure to report cryptocurrency-related gains, taxpayers who are among the 13,000 Coinbase customers should be particularly concerned about the penalties that might apply due to the failure to report their gains.