By: Jonathan Costello
What do the rapper T.I. and infamous computer innovator John McAfee have in common? They’ve both been indicted in 2020 on tax charges related to cryptocurrency. If you read about John McAfee in a novel, you would think the author got lazy and borrowed the character from a knock-off James Bond story. McAfee made his fortune in the 1970s and 1980s by creating one of the first anti-virus digital security companies. His actual net worth is unknown because of his unusual income, the financial collapse, and his various legal troubles. But over the past few years, McAfee has been advertising his services as a promotional base for smaller, lesser-known cryptocurrencies.
McAfee left the United States to live in Belize, a known tax haven. While living in Belize, McAfee was raided by the Gang Suppression Unit of the Belize Police, where he was arrested for weapons and drug charges. McAfee was also the primary suspect in the very suspicious death of his neighbor, an American ex-pat, who died of a single gunshot wound. Several months later, when being sought for questioning in the murder, McAfee fled to Guatemala believing that if he were captured in Belize the police would execute him. Once in Guatemala, he pleaded for asylum. The Belize Police subsequently seized his property, and his house burned down under suspicious circumstances. Asylum talks broke down, and McAfee was subsequently deported to the United States, whereupon his arrival, he hired an escort who he went on to marry.
In 2016, McAfee ran for President of the United States under the Cyber Party and later the Libertarian Party. In 2018, he announced he was running for president again, and enthusiastically endorsed bath salts as a wonder drug. As of 2019, McAfee had declared that he believed the IRS’ authority to be invalid and that taxes are illegal, subsequently going on the run from the United States and living somewhere in international waters on a boat. Later in 2019, he was arrested in the Dominican Republic under suspicion of smuggling high-caliber weapons and ammunition. It was not until 2020, after McAfee claimed to have been assaulted by police during an arrest in Norway for using a thong as a mask during the COVID-19 pandemic, that the United States Justice Department, in conjunction with the Securities and Exchange Commission, indicted McAfee on charges of fraud and failure to report taxable income on over $20 million dollars in digital cryptocurrency that had been paid to him in exchange for online promotions. McAfee was arrested in Spain and faces extradition to face charges of tax evasion and tax fraud.
The key to the story is that the IRS expects citizens to report all taxable transactions, whether the IRS knows about it or not. Cryptocurrency falls squarely in the latter category, where the IRS may not have detailed records of the transaction but expects earnings to be reported.
The IRS guidance for how cryptocurrency is taxed has changed slightly over the last year. At the start of the year, right before tax season, cryptocurrency was generally accepted to be taxed as property. However, under a recent memo from the IRS, cryptocurrencies are to be taxed as “convertible currency” because they hold value and act as a substitute for real fiat currency.
Starting in 2020, on Schedule 1, every taxpayer has to answer whether at any time in the past year if they sent, received, sold, exchanged, or otherwise acquired any interest in virtual currency. This leaves little wiggle room for misunderstanding. The reasoning behind the IRS’s stance on cryptocurrency taxation was because of how the IRS views cryptocurrency. Unlike the U.S. Dollar, or E.U. Euro, the IRS viewed cryptocurrency as property, not currency, and as result tax rules that apply to property transactions also apply to cryptocurrency. An example of one such rule is appreciation in value; much like art or classic cars, cryptocurrency can change in value over time and through that ascension to wealth, the individual owner can face tax consequences.
However, the June 29, 2020 memo from the IRS clarifies that cryptocurrency should be treated more similarly to a fiat currency than a classic car when it comes to federal income tax. Because it can be treated as a currency, the IRS also stated that cryptocurrency provided in exchange for any task or microtask can be taxed. What is a microtask? A microtask can be any simple activity such as viewing images, downloading apps and leaving a positive review, playing games, or completing online quizzes, often times the compensation for the tasks are a dollar or less.
If a cryptocurrency trader or miner receives a form 1099-K or a 1099-B, then the IRS knows that the recipient of the form has reportable transactions thanks to the IRS Information Reporting System. Cryptocurrency exchanges are required to create 1099-K forms and report the accounts to the IRS for any individual who makes more than $20,000 in a month.
What does this all mean for John McAfee? Over a couple of years, McAfee had been paid in cryptocurrency to promote the initial public offerings of several smaller profile cryptocurrencies. Each count of tax evasion carries a maximum charge of five years in federal prison while each charge of failure to file taxes carries a maximum charge of one year in federal prison. According to the SEC filings, McAfee and his bodyguard were paid $23 million in digital assets to make promotional claims, inflating the value of the cryptocurrency long enough for McAfee and his associates to cash-out and leave the investors holding “digital assets that are now essentially worthless.” If found guilty, McAfee could not only face five years of prison for each of the five counts of tax evasion but could also be obligated to pay a fine of $250,000 on each count. In addition to the year of prison for each of the five charges of willful failure to file tax returns, McAfee could be fined $100,000 on each count. The SEC also seeks injunctive relief, banning McAfee from trading cryptocurrency, as well as the “return of allegedly ill-gotten gains,” meaning that McAfee may be facing $1.65 million in fines, plus 30 years in federal prison, and will need to return the profits from the “pump-and-dump” promotional scheme.
Blockchain, the technology that cryptocurrency is built on, has clear potential for a safer, more secure future of the world wide web. However, as a currency, cryptocurrencies should be taxed and regulated. Per the IRS’s June 2020 memo, an individual ascends to wealth by exchanging services for cryptocurrency, thus it should be taxed as a currency. As a long-term solution, cryptocurrency will likely require new legislation or SEC regulations since traditionally taxed fiat currency does not typically fluctuate in value in a manner that resembles a penny-stock. Cryptocurrency accounts for a cumulative market capitalization, over $200 billion, for reference, the cryptocurrency market is approximately the same as the entire GDP of Greece. The IRS has shown that it wants cryptocurrency to be taxed similarly to a fiat currency, and ultimately cryptocurrency needs to be regulated and taxed as a traditional currency if it is ever to obtain legitimacy and shake the reputation as the currency of criminals.
Student Bio: Jonathan T. Costello is a second-year law student at Suffolk University Law School and a contributor for the Journal of High Technology Law. He is also the Treasurer of the Suffolk Law Business Law Association, and in Spring 2021, Jonathan is interning for the Massachusetts Supreme Judicial Court. Jonathan earned a Bachelor of Arts degree in History from Trinity College where he completed a junior thesis on recidivism in the United States. Between undergraduate and law school, Jonathan worked in real estate and insurance while coaching rowing in the Boston area.
Disclaimer: The views expressed in this blog are the views of the author alone and do not represent the views of JHTL or Suffolk University Law School.
