FTX Crypto Exchange Bankruptcy Prompts Tax Questions
In the wake of the Nov. 11 bankruptcy filing of offshore cryptocurrency exchange FTX Trading Ltd., questions remain regarding tax consequences for customers.
The exchange, collectively the FTX Group, consists of West Realm Shire Services Inc (FTX US), Alameda Research Ltd. and approximately 130 affiliates. On Nov. 11, FTX filed for Chapter 11 bankruptcy in the District of Delaware. FTX’s CEO Sam Bankman-Fried stepped down and was succeeded by attorney John J. Ray III, who is known for his work liquidating Enron in the early 2000s. Bankman-Fried, who was set to testify virtually at a House Financial Services Committee hearing on Dec. 13, was arrested in the Bahamas on Dec. 12 after U.S. prosecutors filed criminal charges against him.
Reportedly, around $10 billion in FTX customer funds were loaned to Alameda to fund its trading activities and was not disclosed to FTX customers. Once customers made this discovery and began attempting to withdraw their funds, FTX paused withdrawals full-stop. The exchange, which had been operating on fractional reserves, was left with an $8 billion shortfall.
Since FTX’s bankruptcy declaration, tax professionals have been speculating on what comes next for customers tax-wise, but given the lack of precedent for a bankruptcy of this magnitude in the crypto industry and the classification of crypto technologies as property, the tax consequences are uncertain. There are many current unknowns, such as whether the assets will be considered worthless, the type of currency that will be used for any payouts, and the timing of the valuation of the assets, among other things.
The court will establish whether FTX’s estate consists of consumer accounts as part of the bankruptcy proceedings. In an interview with Checkpoint, Ledgible’s Vice President of Tax and Accounting Gabriel Brin said that consumers, who are expected to be named as unsecured creditors, “are likely to incur deductible losses.”
Writing for CoinDesk, Creighton University School of Law Frank J. Kellegher Professor of Trusts and Estates Victoria J. Haneman said that for those who “successfully cashed out and/or withdrew funds, any resulting capital loss may be used to offset their capital gains (plus $3,000 of ordinary income). Any excess capital loss is not wasted. The investor can continue to offset capital gains taxes accrued from trading or investment activities and take a deduction of $3,000 every year until the loss is exhausted, according to tax precedent.”
For customers who have been unable to access their assets due to the fact that FTX filed for bankruptcy and paused withdrawals, they will not be able to calculate a loss until bankruptcy proceedings have been completed, as they would not incur a loss until then. As Brin said, “these losses will likely not be recognizable on their tax returns until [at least] 2023 once fully ruled on by the court.”
If FTX ends up falling within the definition of a Ponzi scheme, Haneman wrote that “investors may deduct their losses as an ‘investment theft loss’ instead of a capital loss. And while capital losses are subject to loss limitation rules ($3,000 per year against ordinary income), investment theft losses are deductible immediately.”
FTX has until early March 2023 to submit a proposed plan for reorganization. The plan is subject to an approval vote by creditors and a subsequent court ruling. It is unclear how many creditors will be participating in the approval process, as there may be up to one million creditors. Developments in other major crypto bankruptcies, such as Celsius and Voyager, may also impact the timing of the FTX ruling.
In a Nov. 16 statement, U.S. Treasury Secretary Janet Yellen said FTX demonstrates “the need for more effective oversight of cryptocurrency markets” and that the “federal government, including Congress, also needs to move quickly to fill the regulatory gaps the Biden Administration has identified.”