IRS Changes Crypto Bankruptcy With $44 Billion Claims Against FTX: Considerations for Investors

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As if the FTX fallout hadn’t hurt crypto enough, the IRS seeking to prioritize billions of claims makes things even more painful.

The saga of FTX’s spectacular rise and fall has been widely covered in financial markets around the world, but the reality is that dismantling the more than 130 FTX-connected entities via bankruptcy courts is going to take years. While some investors, notably those with funds on deposit at FTX Japan, have been able to access and withdraw funds since February, US investors are stuck waiting for the bankruptcy proceedings to finally unfold. As if the Securities and Exchange Commission’s decree-regulation approach weren’t enough, the IRS further contributes to investor uncertainty, ambiguity, and anxiety.

The IRS has filed 45 claims totaling $44 billion against FTX and its affiliated entities, including a pair of claims – $20.7 billion and $7.9 billion against Alameda Research that relate specifically to partnership taxes unpaid. Worryingly for investors and depositors, the IRS has categorized these claims as administrative priorities, allowing these claims to replace those of unsecured creditors. As of April 2023, Sullivan & Cromwell’s legal team had recovered $7.3 billion in liquid assets, and FTX CEO John Ray is still considering a potential relaunch.

That’s great, and I hope it will allow investors and depositors to recover those funds, but the IRS says 1) this will be a significant challenge for the bankrupt exchange to cover, and 2) it has the potential to redefine planning and taxation. strategies that crypto organizations will need to discuss in the future. Given that the IRS, generally speaking, does not take such an active role in bankruptcy cases, there are several implications that investors and crypto developers should take note of as these actions continue to unfold. unroll.

Reaffirm regulatory leadership

It’s no secret that the US crypto regulatory landscape continues to be murky, ambiguous, and increasingly adversarial. While the SEC continues to state that most crypto should be registered as a security without providing criteria for doing so, Congress is unable to pass (let alone pass) legislative solutions, and accounting standard setters are only slowing their entry into the game, the IRS seems ready to reassert itself in the regulatory conversation.

Specific things investors and depositors should keep an eye out for are that 1) crypto exchanges and entities are not treated as single items under US tax law, which forms the basis of several claims filed by the IRS versus Alameda, 2) entrepreneurs and investors who have found and invest in foreign-headquartered businesses, but who are U.S. citizens, are still subject to full U.S. tax laws, and 3) that the IRS continues to view crypto as an opportunity to generate revenue.

All about customers

The IRS has been active in obtaining customer lists from companies such as Coinbase, Kraken, and others including Circle; this serves a dual purpose. First, it provides the IRS with an active list of exchange customers, transaction history, and helps the service create an audit trail to assess and collect taxes owed both by the individual and the institution. Building on the regulatory focus that has continued to move towards a more regulatory and aggressive approach, the IRS has not been shy about pursuing the collection of crypto liabilities. Collecting and assembling these client lists will only facilitate the IRS’ ability to track, assess, and collect taxes owed by US taxpayers.

Given the regulatory turmoil that surrounded FTX’s collapse and bankruptcy, including controversy around political contributions made on behalf of FTX and Samuel Bankman-Fried, it makes sense that the IRS would be interested in these customer lists. One of the most frequently cited concerns about crypto repeated by policymakers is that there is a lack of transparency and accountability for crypto traders and investors.

By inserting itself prominently into the bankruptcy proceedings, the IRS also puts itself in a privileged position to obtain even more information about customers of FTX and other exchanges.

More token write-offs

An added effect of this IRS scrutiny is that, combined with the SEC crackdown, the crypto market is in the midst of a massive reset. With digital frauds, as well as the financial costs of these frauds, causing billions in economic damage, it makes sense for regulators to take a closer look at the tokens themselves. As several major tokens have been delisted, including by US exchanges like Coinbase, the increased interest and scrutiny from the IRS appears to only amplify this trend further.

It makes sense from a business and reputational perspective. If the IRS investigates an exchange or issuer for compliance issues, searches for customer lists and trading information, and shares this data with other regulators, specific tokens will invariably find themselves under higher pressure levels. . Such an event is good for the space and will improve the quality and transparency of tokens going forward, but will lead to short-term dislocations and volatility. Either way, the IRS is going to have a lot more questions for every entity and individual involved in the crypto industry.

The IRS has shown unusual interest in FTX’s bankruptcy, and this will have implications for the entire crypto space going forward.

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I am a professor at City University of New York Lehman College. I sit on the advisory board of the Wall Street Blockchain Alliance, where I chair the accounting working group. I’m also the chair of the NJCPA Emerging Technologies Interest Group (#NJCPATech). I serve on the advisory board of Gilded, a TechStars 19 company and a participant in the AICPA-CPA.com startup accelerator. I was a visiting scholar at the American Institute for Economic Research in 2019.

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