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CORPORATE TAX & ACCOUNTING
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October 2014
 
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Bitcoin Transactions in Practice
Bitcoin Transactions in Practice Introduction

Bitcoin is an experimental, decentralized digital currency that enables instant payments to anyone, anywhere in the world. Bitcoin uses peer-to-peer technology to operate with no central authority. In other words, managing transactions and issuing money are carried out collectively by the network. Bitcoin is one of the first successful implementations of a distributed crypto-currency. Building upon the notion that money is any object, or any sort of record, accepted as payment for goods and services and repayment of debts in a given country or socio-economic context, Bitcoin is designed around the idea of using cryptography to control the creation and transfer of money, rather than relying on central authorities.

Creation of Coins

The creation of coins must be limited for the currency to have any value. New coins are slowly mined into existence by following a mutually agreed-upon set of rules. A user mining bitcoins is running a software program that searches for a solution to a very difficult math problem whose difficulty is precisely known. The difficulty is automatically adjusted regularly so that the number of solutions found globally, by everyone, for a given unit of time is constant (an average of six per hour). When a solution is found, the user may tell everyone of the existence of this newly found solution, along with other information, packaged together in what is called a “block.”
 
Currently, blocks create 25 new bitcoins. This amount, known as the block reward, is an incentive for people to perform the computation work required for generating blocks. Roughly every four years, the number of bitcoins that can be mined in a block reduces by 50 percent. Originally, the block reward was 50 bitcoins; it halved in November 2012. Any block that is created by a malicious user that does not follow this rule, or any other rules, will be rejected by everyone else. In the end, no more than 21 million bitcoins will ever exist.
 
Because the block reward will decrease over the long term, eventually miners will pay for their hardware and electricity costs by collecting transaction fees. The sender of money may voluntarily pay a small transaction fee which will be kept by whoever finds the next block. Paying this fee will encourage miners to include the transaction in a block more quickly.

Sending Payments

To guarantee that a third-party cannot spend other people’s bitcoins by creating transactions in their names, Bitcoin uses public key cryptography to make and verify digital signatures. In this system, each person has one or more addresses each with an associated pair of public and private keys that they may hold in a wallet. Only the user with the private key can sign a transaction to give some of their bitcoins to somebody else, but anyone can validate the signature using that user’s public key.
 
For example, assume Debi wants to send a bitcoin to Russ. Only the first two steps require human action. The rest is done by the Bitcoin client software.
  • First, Russ sends his address to Debi.
  • Next, Debi adds Russ’ address and the amount of bitcoins to transfer to a message (a transaction message).
  • Then, Debi signs the transaction with her private key, and announces her public key for signature verification.
  • And last, Debi broadcasts the transaction on the Bitcoin network for all to see.
Looking at this transaction from the outside, anyone who knows that these addresses belong to Debi and Russ can see that Debi has agreed to transfer the amount to Russ, because nobody else has Debi’s private key.

Preventing Double-Spending

The process described does not prevent Debi from using the same bitcoins in more than one transaction. However, the following process does; this is the primary innovation behind Bitcoin:
  • Details about the transaction are sent and forwarded to all or as many other computers as possible.
  • A constantly growing chain of blocks that contains a record of all transactions is collectively maintained by all computers, and each has a full copy.
  • To be accepted in the chain, transaction blocks must be valid and must include proof of work. One block is generated by the network every 10 minutes.
  • Blocks are chained in a way so that, if any block is modified, all following blocks will have to be recomputed.
  • When multiple valid continuations to this chain appear, only the longest such branch is accepted and it is then extended further.
When Russ sees that his transaction has been included in a block, which has been made part of the single longest and fastest-growing block chain, extended with significant computational effort, he can be confident that the transaction by Debi has been accepted by the computers in the network and is permanently recorded, preventing Debi from creating a second transaction with the same coin. In order for Debi to thwart this system and double-spend her coins, she would need to muster more computing power than all other Bitcoin users combined.

Anonymity

When it comes to the Bitcoin network itself, there are no accounts to set up, and no e-mail addresses, user-names or passwords are required to hold or spend bitcoins. Each balance is simply associated with an address and its public-private key pair. The money belongs to anyone who has the private key and can sign transactions with it. Moreover, those keys do not have to be registered anywhere in advance, as they are only used when required for a transaction. Transacting parties do not need to know each other’s identity in the same way that a store owner does not know a cash-paying customer’s name. Each person can have many such addresses, each with its own balance, which makes it very difficult to know which person owns what amount.

Accounting for Bitcoin Transactions

With a growing number of companies accepting bitcoins, such as Amazon, Target, Overstock.com, CVS, Subway, Home Depot, and K-Mart, questions arise as to the proper accounting for these transactions. If a company accepts bitcoins as a method of payment, what should the accounting look like? What is the firm receiving? Note that, since bitcoins are not legal tender, they cannot be considered cash. To simplify the accounting for these transactions, many companies outsource this function. For example, Coinbase is a firm that operates independently of the seller firm, similar to PayPal. In either case, a customer clicks on a button on the selling company’s website and enters his or her banking, credit card, or, in the case of bitcoins, Bitcoin wallet information, so that the payment can be deducted from the customer’s account.
 
When PayPal processes a sale, the customer’s payment is received in U.S. dollars by PayPal and deposited into the seller’s merchant account with PayPal. The payment can be withdrawn by the seller from the PayPal merchant account in U.S. dollars directly into the seller’s traditional bank account, less a percentage that is withheld as a transaction fee by PayPal.
 
The primary difference in the case of Bitcoin transactions through a processor like Coinbase is that the customer’s payment is received in bitcoins and deposited into the seller’s account with Coinbase in bitcoins. The payment can be withdrawn by the seller from the Coinbase merchant account in U.S. dollars directly into the seller’s traditional bank account, less a fee for exchanging the bitcoins for U.S. dollars. However, the rate of exchange doesn’t affect the seller. For example, if Overstock.com sold a piece of furniture for $1,000, and the customer chose to pay in bitcoins, the exchange rate becomes the customer’s burden, not a risk assumed by the seller. The sales price is $1,000, so the buyer has to pay the current equivalent of one thousand U.S. dollars out of his or her bitcoin wallet to Coinbase. The bitcoins are instantly converted to $1,000 and transmitted to the seller. If the buyer had originally paid $1,200 for those same bitcoins, that is irrelevant to the seller.
 
Conversely, if a seller accepts bitcoins directly as a form of payment, there is virtually no authoritative accounting guidance. No official statement has been made regarding Bitcoin accounting methods, other than a comment from the FASB that financial reporting for Bitcoins falls under special purpose framework (formerly known as OCBOA, an other comprehensive basis of accounting) since there is no U.S. GAAP for digital currencies. In addition, the FASB has no plans to add Bitcoin accounting to its research agenda. Some accountants who have examined the issue have decided to treat the Bitcoin transactions like barter transactions.

Tax Implications

According to Internal Revenue Service (IRS) Notice 2014–21, the IRS will treat bitcoins as property for tax purposes, applying rules it uses to govern stocks and barter transactions. In other words, purchasing a $2 cup of coffee with bitcoins bought for $1 would trigger $1 in capital gains for the coffee drinker and $2 of gross income for the coffee shop.
 
Bitcoins held for more than one year and then sold would face the lower tax rates applicable to capital gains—a maximum of 23.8 percent compared with the 43.4 percent top rate on property sold within a year of purchase. Further, Bitcoin miners will have to report their earnings as taxable income with a value equal to the worth on the day it was mined. If they mine as part of a business, they would have to pay payroll taxes as well. The IRS will require information reporting similar to how the tax agency receives notification of stock transactions and payments to independent contractors.
Fast Growth of Sharing Economy Impacts Tax Reporting

Fast Growth of Sharing Economy Impacts Tax Reporting Charles R. Goulding, Raymond Kumar and Jacob Goldman discuss the tax implications of sharing economy services and what hosts should anticipate from a tax planning standpoint.
 
The incredible, almost overnight growth of the 'sharing economy' is now confronting tax reporting. Among the largest shared economy service providers are Airbnb for apartment and other space rentals, and Uber, Lyft and Sidecar for car services.
 
In the U.S., the providers of these services are generally required to issue Form 1099s reporting the gross income received by the host providing the shared services. Many of the hosts, particularly individual apartment renter hosts, may not be familiar with business income and other tax reporting requirements.

Apartments and Short Term Rentals

By definition, most Airbnb and other sharing economy real estate hosts are apartment renters, since most condo and coop bylaws prohibit owners from providing short-term rentals. Not only are many renters not familiar with business tax reporting, but they typically don't have a large amount of tax deductible costs related to the rental. Although the hosts' rental expense may be partially deductible, it will be limited to the allocable space used by the guest. The typical host as a result will not have the usual real estate owner tax deductible expenses such as deprecation, mortgage interest, and repairs and maintenance. This means that a large portion of the hosts rental income will likely be considered taxable income. Hosts in rent-controlled apartments will have even smaller amounts of tax-deductible expenses. Hosts with large amounts of short term rental income (particularly if their other sources of taxable income are small) may find themselves with first-time Federal and state quarterly estimated income tax reporting obligations.
 
In addition to income taxes, many jurisdictions (particularly major cities) impose hotel and occupancy taxes and other short-term occupancy transit taxes. Since the federal government has tax information sharing agreements with the state and local government jurisdictions, the gross income amounts may be readily accessible by the local taxing authorities.

Automobile Sharing

With today's mobile phone applications, travelers to and from many states and even countries can simply call a car sharing service when they travel to almost any destination. Again, the revenue earned by the vehicle host will presumably be readily accessible to all taxing authorities. The vehicle host may already depreciate the vehicle if used in another business entity. This means that most of the gross revenue less ride-specific costs such as tolls and perhaps gasoline will become taxable income.
 
For independent contractor professional drivers, the added income may result in both meaningful amounts of increased income and self-employment taxes. Accordingly, independent drivers may need to plan for large tax increases and larger quarterly estimated tax payments. In the deregulated car sharing industry, mobile phone applications in many instances enable variable pricing for high demand events, which can further augment the independent drivers’ income.

Conclusion

The greatly expanding sharing economy participants need to consider and understand the taxable implications of their provided services. Tax advisers serving the shared host community need to help their clients prepare for this new economy.
The HVAC Business and Tax Aspects of the Dotcom Retail Conversion

The HVAC Business and Tax Aspects of the Dotcom Retail ConversionCharles R. Goulding, Lynn Bertrand and Andrea Albanese discuss the special consideration that should be given to HVAC when converting dry goods retail spaces to businesses that are HVAC intensive.
 
As many retailers wholly or partially move from brick-and-mortar shops to internet sales, large amounts of retail space is becoming vacant and gradually being converted to more HVAC (heating ventilation and air conditioning) intensive businesses. HVAC requirements for certain service businesses are much different than dry goods retail space due to the increase in air conditioning, refrigeration, and ventilation.
 
In order to successfully make this conversion, shopping center and retail property owners should be aware of the utility rebates and tax benefits that may be available. Energy efficient capital improvements of HVAC equipment may be eligible for Section 179D EPAct tax benefits while replacement programs for equipment may be able to be expensed for tax purposes under new repair regulations effective January 1, 2014.

HVAC Business Aspects

It is important for accountants and tax advisors involved with retailers to understand the business aspects of HVAC purchases. HVAC is very expensive and the same category of HVAC components can vary widely in the amount of operating costs related to energy use.
 
The more frequently purchased core component of an air-conditioned retail store is called a rooftop package unit. Package units are rated in terms of Energy Efficiency Ratio (EER). These ratios range from an EER of 9 to 13. Although higher rated equipment tends to be more expensive, they use measurably less electricity. Additionally, utility rebates may be available for higher performing units. Before settling for lower cost package units, property owners and advisers should analyze life cycle costs from higher initial cost equipment that may be entitled to a utility rebate price reduction. Simply stated, a cheaper HVAC sticker price typically isn't the better alternative.
 
Growing categories of HVAC-dependent retail space include health clubs and gyms, restaurants, and medical clinics.

Health Clubs and Gyms

Health clubs and gyms are a fast growing facilities category, as the International Health, Racquet and Sportsclub Association estimates approximately 30,000 clubs nationwide. These facilities obviously have a need for higher HVAC capacity than a dry goods retail store.

Restaurants

The National Restaurant Association has predicted that restaurant sales will reach a record high in 2014 and continue the growth trend seen in the past 5 years. Restaurant HVAC must be carefully planned due to the presence of the heat generating kitchen equipment and high volume of people during popular meal times. Many utilities offer cash rebates for more energy efficient cooking and kitchen equipment.

Medical Clinics

As health care costs skyrocket and the population ages, consumers and insurance companies alike are looking for ways to reduce costs accordingly. The number of hospital substitutes, including urgent care facilities and pharmacy-based medical clinics, is projected to continue increasing and these facilities have unique HVAC needs.

Repair Regulations Finalized in 2014

If HVAC work is carefully planned and documented, then replacement work may be expensed for tax purposes (as opposed to capitalized) under new one-for-one replacement tax regulations effective January 1, 2014. These regulations address the concept of building systems and whether or not the work was a betterment, adaptation or restoration of the system. In the case where there was not an improvement to the building system, repair tax expense treatment may be available.

Conclusion

Whether capital improvement or replacement work, HVAC modifications may be eligible for tax benefits. Building managers and business owners should be aware of this when planning conversion from dry good retail space to HVAC intensive businesses.
Information Reporting for Employers and Insurers Under the Affordable Care Act (ACA)

Information Reporting for Employers and Insurers Under the Affordable Care Act (ACA) The U.S. Department of the Treasury and the IRS released final rules to implement the information reporting provisions for insurers and certain employers under the ACA, which take effect in 2015.
 
Mark J. Mazur Assistant Secretary for Tax Policy said, “Treasury’s final rules significantly streamline and simplify information reporting while making it easier for employers and insurers of all sizes to provide the quality, affordable health coverage that every American deserves.”
 
While 96 percent of employers are not subject to ACA reporting requirements or the employer responsibility provision because they have fewer than 50 employees, in 2015 requirements begin to phase-in for the remaining 4 percent of employers that are required to offer quality, affordable coverage to employees or make a payment. The final regulations include the following key provisions.

Single, Combined Form for Information Reporting

Employers that “self-insure” will have a streamlined way to report under both the employer and insurer reporting provisions. Responding to widespread requests, the final rules provide for a single, consolidated form that employers will use to report to the IRS and employees under both IRC §§6055 and 6056, thereby simplifying the process and avoiding duplicative reporting. The combined form will have two sections: the top half includes the information needed for IRC §6056 reporting, while the bottom half includes the information needed for IRC §6055.
  • Employers that have fewer than 50 full-time employees are exempt from the ACA employer shared responsibility provisions and, therefore, from the employer reporting requirements.
  • Employers that are large enough to be subject to the employer responsibility provisions and that self-insure will complete both parts of the combined form for information reporting.
  • Employers that are subject to employer responsibility but do not self-insure will complete only the top section of the combined form (reporting for IRC §6056). Insurers and other providers of health coverage will report only under IRC §6055, using a separate form for that purpose. Insurers do not have to report on enrollees in the Health Insurance Marketplace, since the Marketplace will already be providing information on individuals’ coverage there.
Simplified Option for Employer Reporting

For employers that provide a “qualifying offer” to any of their full-time employees, the final rules provide a simplified alternative to reporting monthly, employee-specific information on those employees.
  • A qualifying offer is an offer of minimum value coverage that provides employee-only coverage at a cost to the employee of no more than about $1,100 in 2015 (9.5 percent of the Federal Poverty Level), combined with an offer of coverage for the employee’s family.
  • For employees who receive qualifying offers for all 12 months of the year, employers will need to report only the names, addresses, and taxpayer identification numbers (TINs) of those employees and the fact that they received a full-year qualifying offer. Employers will also give the employees a copy of that simplified report or a standard statement indicating that the employee received a full-year qualifying offer.
  • For employees who receive a qualifying offer for fewer than all 12 months of the year, employers will be able to simplify reporting to the IRS and to employees for each of those months by simply entering a code indicating that the qualifying offer was made.
  • To provide for a phase-in of the simplified option, employers certifying that they have made a qualifying offer to at least 95 percent of their full-time employees (plus an offer to their families) will be able to use an even simpler alternative reporting method for 2015. Those employers will be able to use the simplified, streamlined reporting method for their entire workforce, including for any employees who do not receive a qualifying offer for the full year. Those employers will provide employees with standard statements relating to their possible eligibility for premium tax credits.
The final regulations also give employers the option to avoid identifying in the report which of its employees are full-time, and instead to just include in the report those employees who may be full-time. To take advantage of this option, the employer must certify that it offered affordable, minimum value coverage to at least 98 percent of the employees on whom it is reporting.

What Information Is Reported

The statute calls for employers, insurers, and other reporting entities to report information including:
 
For IRC §6055:
  • Information about the entity providing coverage, including contact information.
  • Which individuals are enrolled in coverage, with identifying information and the months for which they were covered.
For IRC §6056:
  • Information about the employer offering coverage, including contact information and the number of full-time employees.
  • For each full-time employee, information about the coverage (if any) offered to the employee, by month, including the lowest employee cost of self-only coverage offered.
Streamlined Information

The final rules omit data elements in the statute that are not necessary to understanding coverage offered and provided, in the interest of streamlining. These include (but are not limited to):
  • The length of any waiting period,
  • The employer’s share of the total allowed costs of benefits provided under the plan,
  • The amount of advance payments of the premium tax credit and cost-sharing reductions.
For more information, see the final regulations under IRC §§6055 and 6056.
 
On July 24, 2014, the IRS released the draft forms that taxpayers will need to comply with the Affordable Care Act’s information reporting requirements. The forms are necessary for satisfying reporting obligations under IRC §§6055 and 6056. IRC §6055 reporting is required to comply with the IRC §5000A minimum essential coverage requirements, while IRC §6056 reporting is required to administer the IRC §4980H employer shared responsibility provisions and the IRC §36B premium tax credit.
 
Applicable Large Employers (ALEs) will use Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, and Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, to satisfy reporting requirements under IRC §§6055 and 6056. Employers that are not ALEs, as well as health insurance issuers and sponsors of self-insured plans, will complete IRC §6055 reporting using Form 1094-B, Transmittal of Health Coverage Information Returns, and Form 1095-B, Health Coverage.
 
Form 1094-C includes a column asking ALEs to report the total number of employees, not just the number of employees that are considered full-time employees under IRC §4980H(c).
 
Finalizing the forms and providing instructions will be essential if the IRS hopes to have employers voluntarily comply with the reporting requirements for the 2014 tax year, which was encouraged in the final regulations issued in Treasury Decisions 9660 and 9661. A statement on the IRS website says the agency anticipates releasing the final forms and instructions by year-end.
 
The IRS also released the following draft ACA-related forms:
  • Form 1095-A, Health Insurance Marketplace Statement;
  • Form 8941, Credit for Small Employer Health Insurance Premiums;
  • Form 8962, Premium Tax Credit (PTC); and
  • Form 8965, Health Coverage Exemptions.
Why Service Providers Need to Understand Clients’ Financial Metrics

Why Service Providers Need to Understand Clients' Financial MetricsThe importance of understanding the financial metrics crucial to a client’s environment to avoid making tax decisions that may not be the most optimal for the firm’s success is presented by Charles R. Goulding, Raymond Kumar and Jacob Goldman from R&D Tax Services.
 
Accountants and tax advisers are all familiar with the terms ‘pretax earnings’ and ‘after-tax earnings.’ However, advisers sometimes fail to perceive which measure is more relevant for business decision making for a particular client.
 
Understanding the differences in companies is crucial for advisers who want to provide relevant advice and get important projects approved.

Publicly Traded Companies

Publicly traded companies are primarily valued in the marketplace based on price-earnings multiples, which are based on pretax earnings. However, one exception lies with companies that can materially reduce income taxes compared to the other companies in the market place by techniques such as inversion to a low tax jurisdiction or achieving REIT status. These companies will be typically assigned a higher earnings multiple in the stock market.
 
Many publicly traded companies (particularly those that are pretax earnings sensitive) will not authorize tax savings projects where the costs of implementation are meaningful in relation to the cash tax savings.
 
For example, suppose that a company trading at a multiple of 15-times pretax earnings can reduce its income taxes one time by $800,000 by spending $100,000 pretax. Although that result may strike many as a excellent cash-on-cash return, the publicly traded company may not want to experience a $1.5 million reduction in stock market value to save $800,000 in cash taxes.
 
Public companies that are less sensitive to pretax earnings multiples due to their long standing reputations or supportive concentrated owners are more willing to consider and implement routine tax planning (such as the above example) that not only reduces pretax earnings, but also meaningfully increases after-tax cash flow. 
 
Note however that a publicly-traded company will typically be very open to a cost reduction project that net of project costs will enhance pretax earnings. To illustrate, using the same numbers from the above example, a project that increases pretax earnings by $100,000 adds $1.5M in firm stock market value when using a 15-times earnings multiple.

Private Companies

A goal of most private companies is to increase enterprise after-tax cash flow. A company with higher overall cash flow has more capital available for all business opportunities, which may include capital expenditures, marketing, acquisitions and owner distributions. 
 
Sticking with the figures in our example, most private companies would jump at the chance to save $800,000 in taxes for a cost of $100,000 and would most likely immediately authorize the tax project that enables them to do take advantage of this savings.
 
One important exception to the above scenario lies with private companies that are preparing for a business sale, particularly if the expected acquirer is a publicly-traded company. With a public company acquirer fact pattern, the purchaser tends to be willing to pay a higher multiple purchase price for a seller with higher pretax earnings that will in turn increase the purchaser's total enterprise value after the purchase.

Conclusion

In conclusion, before accountants and tax advisers attempt to have any tax and non-tax projects authorized, they need to understand the financial metrics important to their clients. The "money-saving" or "cash-flow increasing" solution isn't always the ideal one, depending on each company's financial goals.
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Heard about the latest tax developments? Managing Director Joe Harpaz is a regular contributor on Forbes. Explore his timely discussion around policy proposals and changes, breaking down complex issues. Find the blog hosted on Forbes at forbes.com/sites/joeharpaz.
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