Bitcoin Investment Trust (GBTC) Tax Structure (CTB Off Topic)
Did you know there is more than meets the eye to the U.S. tax situation of GBTC and its shareholders? Let’s discuss!
Recently Viral Stock – GBTC
Bitcoin Investment Trust (GBTC), sponsored by Grayscale Investments, LLC, is a publicly traded investment vehicle, the first of its kind that allows trading the Bitcoin price movement.
GBTC closed at $927 per share on Tuesday, August 30, 2017. As of July 31, 2017, each share of GBTC is equivalent to 0.09258535 BTC (see https://grayscale.co/bitcoin-investment-trust/), meaning each share is trading as if the true value of BTC on August 30, 2017 is approximately $10,012.38 ($927 / 0.09258535). As of the time of this article, BTC can be purchased on Coinbase for approximately $4,600, so clearly GBTC trades at a premium to the value of Bitcoin. The reason for the premium could be the ease of acquiring shares for those with a taxable broker account or IRA; and the comfort/security of purchasing Bitcoin through a broker account, or other reasons.
How do we learn about the Company’s Tax Structure (Hint: “S-1”)?
When companies register certain securities with the Securities & Exchange Commission (SEC) to be publically traded, they file a Form S-1 (http://www.investopedia.com/terms/s/sec-form-1-a.asp ). When companies file Form S-1, they often provide invaluable information about their operations, objectives of their offering, uncertainties/risks and – the Tax Structure! GBTC has filed Form S-1 (with two amendments); the latest amendment is below (tax discussions around page 32 and 99):
https://www.sec.gov/Archives/edgar/data/1588489/000119312517158456/d157414ds1a.htm
Is the Company's Tax Structure plan 100% solidified?
In the S-1 filing, the company stated the following (page 32):
“The treatment of the Trust for U.S. federal income tax purposes is uncertain” (S-1 page 32”).
In addition, following statement was provided in the S-1 filing (partial redaction in the middle):
“The Sponsor intends to take the position that the Trust will be treated as a grantor trust for U.S. federal income tax purposes. Assuming that the Trust is a grantor trust, the Trust will not be subject to U.S. federal income tax. Rather, a pro rata portion of the Trust’s income, gain, losses and deductions will “flow through” to each beneficial owner of Shares.
….[redacted a sentences from quotation]…
… and the IRS or a court might not agree that, the Trust is properly treated as a grantor trust for U.S. federal income tax purposes. The Trust is seeking a ruling from the IRS that the Trust is a grantor trust for U.S. federal income tax purposes, but there can be no assurance that the Trust will be successful in obtaining such a ruling.” (page 99)
Ok, if GBTC was later determined not to be a Grantor Trust, so what?
According to the S-1 filing (and general U.S. tax rules for entity classification), if GBTC is not a trust, it is either a Partnership or a Corporation.
What is the difference between taxation of a Grantor Trust and a Partnership?
For a Grantor Trust, there is no U.S. income tax at the level of the entity (GBTC); rather, each shareholder in the entity will be “passed through” the income/loss to report on their tax returns, based on their share in the gain/losses of the Trust each calendar year; as the shareholder is treated as owning a share of the undivided interest in the Trust’s Bitcoins.
Partnership tax structures operate similarly in that earnings are passed through to partners, and information statements are provided to partners to report income/loss on a pass-through basis. Note, there are still many fundamental differences in Trusts vs. Partnerships.
There are also differences in trust implications based on the type of trust that is set up, so when investing in or setting up a trust, consult an advisor.
What is the difference between taxation of a Grantor Trust/Partnership (“pass-through” type entity) and a Corporation?
A U.S. C corporation is taxed on its net taxable income for the year at a maximum 35% tax rate in the United States; then, the net remaining earning are taxed again at the shareholders level when eventually passed through to shareholders as a dividend (to the extent of earnings/profits). If GBTC was treated as C Corporation, this would result in double taxation to shareholders on the appreciation in the price of Bitcoin; as GBTC’s buying/selling activities would be taxed first at the corporate level, and then a second time when the earnings were passed through as a dividend to shareholders. And distributing the Bitcoin directly would not get around the two layers of tax.
A Corporation, why is this significant, I buy stock in corporations all the time through the stock market?
As noted above, GBTC is trading a significant premium to the price of Bitcoin. One could argue GBTC’s underlying Bitcoin is trading on a “pre-tax” valuation, as the tax liability is expected to be passed through to shareholders and thus not be reflected at the entity level (similar as if a U.S. person buys/sells BTC directly). It is possible that if GBTC were re-characterized as a C Corporation, there would be a negative adjustment to the valuation of GBTC (U.S. corporate tax rate); and going forward every $1 USD of appreciation in Bitcoin would only yield $0.65 increase in the market’s perceived value of GBTC (the “Yahoo-Alibaba conundrum”).
I am not an investment/valuation expert, rather just commenting on the information in the S-1 filing. To be fair, the corporate taxation is only an issue if the IRS re-classified GBTC as a Corporation. See below from the S-1, GBTC is looking to obtain an official IRS ruling, which is commonplace for large companies when contemplating significant transactions/structures (page 99):
“The Trust is seeking a ruling from the IRS that the Trust is a grantor trust for U.S. federal income tax purposes, but there can be no assurance that the Trust will be successful in obtaining such a ruling.”
Have there been any updates on the ruling?
I have checked the SEC website, Grayscale website and Bing.com but have been unable to find anything. It is totally possible the ruling was filed/passed, but I have no idea (I could be looking in the wrong place); which is why I am writing about it as the uncertainty was outlined in the S-1 filing and that is the latest information I can find online. I did note that in the company's 2016 tax information statement, they assert the company "is" a grantor trust (first page):
In addition, in the investor FAQ, the Company continues with explaining the tax situation, which I believe to be consistent with a trust tax situation:
Do you have an example of any companies with unsuccessful ruling attempts?
For an example in recent history, which is more complicated, I recommend to review valuation reports on Altaba (formerly Yahoo) which holds an investment in Alibaba, a Chinese internet company. Altaba (formerly Yahoo) is an early investor in Alibaba with an approximate 15% stake, and has a significant unrealized gain. When the IRS announced in 2015 it would not rule on a spin-off transaction (which would allow Yahoo to re-structure the company to avoid US tax on the unrealized appreciation in Alibaba), it caused significant uncertainty in the valuation of Yahoo. Link below from Forbes:
Since we will move forward assuming Grantor Trust treatment applies, I am a U.S. citizen/resident, will I receive an Information Statement such as a 1099 if I hold GBTC Shares?
Based on the S-1, a U.S. citizen/resident shareholder should receive an information statement from GBTC. Below is a quote from the S-1 (page 102):
“The Trust or the appropriate broker will file certain information returns with the IRS and provide holders of Shares with information regarding their shares of the Trust’s annual income (if any) and expenses in accordance with applicable Treasury regulations.”
GBTC provided a general tax information statement in 2016, which can be found below with examples on how to calculate gains:
Even If a U.S. shareholder does not sell their shares, each year the buying/selling of the Bitcoin within the trust in order to pay the management fee / trust expenses will result in a taxable pass-through of income/loss to the shareholders of GBTC, meaning a supplementary form is expected every year.
In addition to a U.S. person’s share of the gain/losses of the Trust, he/she can expect to receive a share of the management fee and trust expenses to claim as a deduction on the personal return subject to many hurdles/limitations (consult a tax advisor).
When as a U.S. person sells the shares in the trust, they are treated as selling the underlying Bitcoin and will have a gain/loss. Basis calculations are complicated. More information is provided in the S-1, I have kept it short.
What is the name of the information statement I will receive?
The forms required to be filed by a trust (or broker) can vary based on the structure of the trust, reach out to GBTC directly for this information; or wait and see. At the end of the day, whatever form is sent (or custom letter) will hopefully be the information necessary to report the gain/loss on your tax return.
When will I receive Supplemental Information?
Hopefully by the due date of your tax return, April 15th (earlier depending on the expected Form to be received). At the end of the day it depends on the information returns GBTC or brokers plan to file with respect to the GBTC holding.
How do I handle this if I am not a U.S. citizen/resident:
Information can be found further in the S-1 filing (page 102):
https://www.sec.gov/Archives/edgar/data/1588489/000119312517158456/d157414ds1a.htm#tx157414_24
Will owning GBTC mean I have to pay more for my tax return preparation due to more work?
Consult your tax advisor/software for pricing. Additional forms like this create additional work.
Can I purchase GBTC through and IRA, ROTH IRA and other investment vehicles?
Yes you should be able to per the Trust sponsor, Grayscale (https://grayscale.co/bitcoin-investment-trust/); consult your personal tax/investment advisors.
Takeaway
The author recommends a current or potential GBTC investor read the S-1 filing, as well as any press releases issued after the date of the S-1 filing, to know what to expect for 2017 taxes. Also, for current GBTC investors, look out in the mail next winter!
Disclaimer
This is not investment advice regarding any decision to invest (or to not invest) in GBTC or BTC, and does not constitute personal tax advice to any person; and cannot be relied on under Circ. 230 to avoid taxes or penalties. For taxes related to GBTC, consulting your tax advisor or GBTC; and for investment advice consult your broker.
Photo Credits
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I want nothing to do with the US tax code, unless it is 100% clear. We need to simplify it , I have been a YAHOO share holder for a long time, and the mess with them and BABA was a nightmare.
Thank you, for me personally just buying bitcoin is less of a tax compliance nightmare than buying a grantor trust investment. because at least holding BtC directly, I will know what I am buying and selling. However, in the case of buying a grantor trust, I would own so little in the trust that can't really control it (other than entering/exiting the investment).
Sounds like the old tax shelter days of the 1980's when assets got artificially inflated to allow large tax deductions with little capital investment.
Thanks @bobreedo, I think you are on to something. New entrants are currently buying in GBTC at a premium to underlying Bitcoin. Are you saying, if Bitcoin is transferred to settle the management fee (or sold for USD to settle the fee in USD), it seems like there could be a loss recognized; if the fair value of BTC is less than new entrants' price to acquire the equivalent portion of their stock which could be deemed their underlying BTC basis? Plus, do you think there would be a potential itemized deduction w/ 2% AGI haircut for the fair value of the management fee (prorata share)? And do we expect these would occur due to the trust rules, even if the price of the stock keeps going up (with basis adjusted for the person's final stock sale)?
These trust rules are complex, so I might not have it 100% correct from all angles; either way, at the end of the day, if folks on this platform are buying GBTC, I am expecting to see a flurry of posts when tax season comes around.
I feel like this is an issue that needs to be a more talked about issue. In general, it just seems like people are not aware of the potential underlying penalties with GBTC. Also, a $10,000 valuation of Bitcoin would be crazy. Could it be possible that it is slightly overvalued or am I just being bearish?
Guess, what, just 10 hours later the implied value is approximately $11,503 ($1,064 / 0.09258535)!!!!
Excellent work and worth reading!
That 2016 tax information statement they filed could definitely be understood to mean they did get Grantor Trust status, especially when it is backed up in the investor FAQ, as you stated.
Thanks and agree, wish I could find a press release though. I will look again.