ZGL wallet: achieve zero gain/loss for tax purposes with coin control

[Peter R]

When you want to make specific identification you also need to make sure the specific identification of which one you are selling is done verifiably at the time you are selling it,  and be able to prove WHEN you decided and made the record which one you were selling, in order to provide adequate identification

This is an advantage of the ZGL wallet.  It performs automatic coin control to ensure zero capital gain/loss on day-to-day purchases, while keeping private records of all transactions.  

In the US; there can also still be reporting requirement, even when there is a loss or  wash.  

We need legal confirmation on this point as applied to ZGL.  Upon my preliminary research, I believe you are required to report the events where you realized a gain, and should keep private records of the ones that were a wash.  

On reddit, it was argued that filling 3,000 (ZGL) transactions would be considered a "frivolous filing" and that you would be subject to the $5,000 Frivolous Filing Fine.  


Once again: this is not legal advice.  IANAL.  

[1714912059]

1714912059

[1714912059]

1714912059

[1714912059]

1714912059

[1714912059]

1714912059

[Anon136]

As Jonathan strode through the town he immediately noticed a
dignifi ed well-dressed man kneeling in the street, trying pain-
fully to walk. Yet, the man didn’t appear to be crippled – just short.
Jonathan offered a helping hand, but the man brushed him aside.

“No, thank you!” said the man, wincing in pain. “I can walk
okay. Using knees takes some getting used to.”

“You’re okay? But why don’t you get off your knees and walk
on your feet?”

“Ooooh!” moaned the man, squirming in discomfort. “It’s a
minor adjustment to the tax code.”

“The tax code?” repeated Jonathan. “What’s the tax code have
to do with walking?”

“Everything! Ow!” By now the man settled back on his heels,
resting from his torturous ordeal. He pulled a handkerchief from
his shirt pocket and mopped his brow. He shifted his balance to
massage one knee, then the other. Many layers of worn-out patches
had been sewn on at the knees. “The tax code,” he said, “has
recently been amended to level the fi eld for people of different
heights.”

“Level the fi eld?” asked Jonathan.

“Please stoop over so I don’t have to shout,” pleaded the man.

“That’s better. The Council of Lords decided that tall people have
too many advantages.”

“Advantages of tallness?”

“Oh, yes! Tall people are always favoured in hiring, promotion,
sports, entertainment, politics, and even marriage! Ooooh!” He
wrapped the handkerchief around the newest of many rips in his
grey pants. “So the Lords decided to level us with a stiff tallness
tax.”

“Tall people get taxed?” Jonathan glanced sideways and felt his
posture begin to droop.

“We’re taxed in direct proportion to our height.”

“Did anyone object?” asked Jonathan.

“Only those who refused to get on their knees,” the man said.

“Of course, we’ve allowed an exemption for politicians. We usually
vote tall! We like to look up to our leaders.”

Jonathan was dumbfounded. By now, he found himself slouching,
self-consciously trying to shrink. With both hands pointing down at
the man’s knees he questioned incredulously, “You’ll walk on your
knees just for a tax break?”

“Sure!” replied the man in a pained voice. “Our whole lives are
shaped to fi t the tax code. There are some who have even started to
crawl.”

“Wow! That must hurt!” Jonathan exclaimed.

“Yeah, but it hurts more not to. Ow! Only fools stand erect and
pay the higher taxes. So, if you want to act smart, get on your knees.
It’ll cost you plenty to stand tall.”

Jonathan looked around to see a handful of people walking on
their knees. One woman across the street was slowly crawling.
Many people scurried about half-crouching, their shoulders hunched
over. Only a few walked proudly erect, ignoring the sanctions
completely. Then Jonathan caught sight of three gentlemen across
the street sitting on a park bench. “Those three men,” indicated
Jonathan. “Why are they covering their eyes, ears, and mouths?”
“Oh, them? They’re practising,” replied the man as he leaned
forward on his knees to shuffl e along. “Getting ready for a new
series of tax proposals.”

[Anon136]

Only a few walked proudly erect, ignoring the sanctions completely.

That's a nice story, and I understand the point completely, but the majority of the population isn't ready to protest taxes.

Bitcoin is a nice stepping stone towards freedom, it's an asset that the private key holder has complete control over. So, maybe these taxpayers start using Bitcoin today to enjoy some of it's advantages, and then later on down the road, everyone realizes what it means to have the power of private ownership again.

Mighty oaks from little acorns grow.

it wasnt a commentary on how people should disobey. the point was to show how comical and surreal rational responses to irrational edicts can often be.

so like what i mean is, this whole proposal doesn't actually change anything, its a completely meaningless act, paying from this address or that makes no difference (in the real world, i guess it matters to government), and the effort being put in to controlling your coins properly doesnt help feed the poor or cloth the sick or w/e else. Every bit of effort one puts into controlling their coins for this purpose is productive effort that is being thrown into a black hole, never to be seen again, effort that could have been used alternatively to address number of aspects of society which are less than ideal.

When i see proposals like this, in my mind what i see is someone proposing that we should walk on our knees. thats not a criticism of people who walk on their knees, its rational for them to do so. what it is is a criticism of anyone who intellectually supports the conditions which lead to such zany and wasteful behavior. This sort of wasted potential energy is precisely why some societies are so much wealthier than others, think hong kong and cuba, singapore and hati. This is the sort of crap that is exactly why these societies are so materially different from one another and here it is, right here at home.

[allenove]

I American IRS behavior was very dissatisfied, they do not admit that BTC is the official currency but also to collect his property tax.

[Peter R]

When i see proposals like this, in my mind what i see is someone proposing that we should walk on our knees.

I see it as walking on our knees and standing tall at the same time.  

Work on the ZGL wallet is productive in terms of changing perceptions: for example, the proposed use of the mixer to recognize capital gains events legitimizes such devices as a tool to ensure US tax compliance.  This has the advantage of diffusing coin particles more quickly throughout the economy, weakening arguments against bitcoin's fungibility.  This also further reinforces the concept of bitcoin as token money (http://en.wikipedia.org/wiki/Token_money) with strong privacy properties and the notion that ownership belongs to he who controls the private key.  

To get from A to B, we have a lot of myths to shatter.  We will do this one step at a time by jumping through certain hoops and walking around others.  

[acoindr]

Disclaimer: I am not a lawyer and this is not tax advice.

I don't see why ZGL support couldn't be added as a feature for Armory, or any other wallet for that matter.  It requires detailed coin control, but from the user perspective the complexity can remain entirely hidden.  

Not entirely. The way I see it working a user would need to jot a note of every transaction with the software, and probably keep a physical receipt too. The wallet would keep its own ledger of coin identifications, which coins were received when, for how much, and which were spent when and for how much.

The wallet would need to have real-time BTC price data from a source that the IRS would deem reliable, ...

Not really. According to the Wall Street Journal's Q&A the fair market value of coins can be determined by a listed exchange rate based on supply and demand, which is consistently applied. Choosing any large Bitcoin exchange as a data source should be fine.

... and it would need a way to occasionally realize capital gains on "low cost basis" coins.

I don't see why. You wouldn't realize a capital gain or loss on coins until some transaction. The wallet IMO should have an informative interface showing how much in total capital gains or losses a user had at any given time, given the current exchange rate. There would be actual capital gains and potential capital gains (or loss), the actual ones being records of noted transactions which took place.

By checking the Capital Gain Tracker a user could make informed decisions about when to purchase or sell coins (or market goods and services) for tax benefit. For anyone thinking this is an unfair tax loophole scheme I'd argue it's not. Sales tax on purchases would still apply, and probably not be under reported since customers would prefer a receipt for their own tax records. From the property owner (Bitcoin holder) perspective it's simply smart asset management, with diligent record keeping. There is no law against that.

I think the most effective way to realize a capital gain for tax purposes is to use a coin mixer.  You would send 1 BTC + fee into the mixer and receive a new 1 BTC coin sharing 0 taint with the original coin.  Since this is a new piece of property exchanged at arm's length, you are required to recognize the capital gain on this "low cost basis" coin you sent into the mixer at the moment of the exchange.

If you wanted to force a realized capital gain (or loss) I agree this should work. The new property received would enter the wallet system at the current fair market exchange rate.

When you want to make specific identification you also need to make sure the specific identification of which one you are selling is done verifiably at the time you are selling it,  and be able to prove WHEN you decided and made the record which one you were selling, in order to provide adequate identification ---- typically, this would be done in writing with the broker you use to sell the capital asset.    For example:  to sell a specific lot of stock,  you must identify which basis lot(s) you are selling  before the settlement date of the trade.

It is fine, if you make the decision on the fly, and can prove you did.

That's the whole point of the wallet, to keep track of and intentionally use certain pieces of property (coins) at different times. Making notes of the transaction with the wallet software along with keeping physical receipt records should suffice.

In the US; there can also still be reporting requirement, even when there is a loss or  wash.  

We need legal confirmation on this point as applied to ZGL.  Upon my preliminary research, I believe you are required to report the events where you realized a gain, and should keep records of the ones that were a wash.

I believe that's correct. The U.S. tax system is sold as "voluntary compliance", meaning tax payers self report what they owe and how they concluded that. The catch is you have to be correct in the event of an audit or possibly face back penalties and interest. This is where keeping good records comes in. A person who can produce detailed records has a good basis for an argument, even if they made a mistake, although tax could still be due.

On reddit, it was argued that filling 3,000 (ZGL) transactions would be considered a "frivolous filing" and that you would be subject to the $5,000 Frivolous Filing Fine.

I don't believe that applies. Definition of the word frivolous: not having any serious purpose or value. That's the opposite of the detailed transaction records the ZGL wallet creates.

http://www.law.cornell.edu/uscode/text/26/6702

26 U.S. Code § 6702 - Frivolous tax submissions

(a) Civil penalty for frivolous tax returns
A person shall pay a penalty of $5,000 if—
(1) such person files what purports to be a return of a tax imposed by this title but which—
(A) does not contain information on which the substantial correctness of the self-assessment may be judged, or
(B) contains information that on its face indicates that the self-assessment is substantially incorrect, and ...

[Peter R]

Disclaimer: I am not a lawyer and this is not tax advice.

I'm not sure you are following the idea behind the ZGL wallet.  It's purpose is to recognize larger "taxable gain" events on a weekly, monthly or as needed basis, such that all day-to-day spending is provably zero gain/loss.  This helps to ensure compliance with US tax laws.   

Sending the IRS filings that contain frivolous information is a frivolous filing.

[Anon136]

When i see proposals like this, in my mind what i see is someone proposing that we should walk on our knees.

I see it as walking on our knees and standing tall at the same time.  

Work on the ZGL wallet is productive in terms of changing perceptions: for example, the proposed use of the mixer to recognize capital gains events legitimizes such devices as a tool to ensure US tax compliance.  This has the advantage of diffusing coin particles more quickly throughout the economy, weakening arguments against bitcoin's fungibility.  This also further reinforces the concept of bitcoin as token money (http://en.wikipedia.org/wiki/Token_money) with strong privacy properties and the notion that ownership belongs to he who controls the private key.  

To get from A to B, we have a lot of myths to shatter.  We will do this one step at a time by jumping through certain hoops and walking around others.  

Don't get me wrong. The purpose of my post is not to marginalize your contribution. This is great work you are doing. As stated previously, I don't fault people for walking on their knees, it's perfectly rational.

[Peter R]

Don't get me wrong. The purpose of my post is not to marginalize your contribution. This is great work you are doing. As stated previously, I don't fault people for walking on their knees, it's perfectly rational.

No offense taken.  I quite enjoyed your story and agree that it shows the irrationality of current tax law.  

[acoindr]

Disclaimer: I am not a lawyer and this is not tax advice.

I'm not sure you are following the idea behind the ZGL wallet.  It's purpose is to recognize larger "taxable gain" events on a weekly, monthly or as needed basis, such that all day-to-day spending is provably zero gain/loss.  This helps to ensure compliance with US tax laws.   

I'm not sure I understand what you're saying here. According to the Wall Street Journal's Q&A on the IRS guidance any transaction with the coins would (or I should say could) be a taxable gain (or loss) event.

Q-6:  Does a taxpayer have gain or loss upon an exchange of virtual currency for other property?

A-6:  Yes.  If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain.  The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency. ...

We might be saying the same thing, but to clarify, what I'm saying is I see the ZGL wallet as recording all relevant tax activity surrounding coins. For example, it starts at 0, but when it receives coins they are marked with the current exchange rate for tax basis. Depending on what the exchange rate does, a user could decide whether to make a real world purchase or delay it for tax benefit. If the exchange rate rose they would have a capital gain if the fair market value of what they were "purchasing" (exchanging for their coins) was commensurate, or in other words had a value which exceeded the original lower cost basis. That's a complicated way of saying the bitcoin sale was pegged to U.S. dollars.

In order to offset that capital gain the wallet could also hold coins purchased at a higher rate reflecting a capital loss relative to the exchange rate at the time of the purchase. By using a calculated portion of each of these higher and lower cost basis coins the final trade would result in a capital gain and loss of exactly zero.

Since shopping habits and coin purchases can be haphazard, I see the wallet as maintaining some amount of capital gain or loss at any given time, which could prompt users to adjust their behavior accordingly for beneficial tax effect.

Again, we might be saying the same thing. The part where you lose me is when you talk about calculating events on a weekly, monthly, etc. time frame, because that's not a way I see it working unless users spending habits followed that structure. Every single trade is potentially a capital gain or loss event no matter when it occurs. However, the wallet could track all that info and behave such that over time against a backdrop of volatile exchange rates a user could end up with marginal capital gain or loss, with fairly little effort.

Sending the IRS filings that contain frivolous information is a frivolous filing.

I agree. We are saying the same thing here.

[Peter R]

Again, we might be saying the same thing. The part where you lose me is when you talk about calculating events on a weekly, monthly, etc. time frame, because that's not a way I see it working unless users spending habits followed that structure. Every single trade is potentially a capital gain or loss event no matter when it occurs. However, the wallet could track all that info and behave such that over time against a backdrop of volatile exchange rates a user could end up with marginal capital gain or loss, with fairly little effort.

I think we are beginning to see things similarly.  

What I mean is that eventually you will run out of coins purchased at a "high cost basis".  You will only have "low cost basis" coins in your ZGL wallet.  If you spend a "low cost basis coin" to purchase a coffee you would recognize a taxable gain.  It may be difficult to ensure compliance with US tax laws under such circumstances as you could be making over 10 such purchases per day.  

Instead, when your wallet runs out of "high cost basis" coins, your wallet would automatically recognize a "lump sum" capital gain by swapping "low cost basis" coins for new coins using a mixing service.  You would report these transactions since they resulted in a capital gain.  

But now your wallet can continue forging ZGL coins which are "current" in the sense that the moment you spend them, your cost basis is exactly equal to their current market price.  

The ZGL method is advantageous to both the filer and to the IRS.  It reduces your paper work without affecting the accuracy of your private records (in fact you now keep better records than ever!), and it reduces the paper work that the IRS has to process.  

In my opinion, if you sent a report to the IRS that documented 3,000 tiny transactions, where each one has a gain of exactly zero, I think they may view this as "an attempt to protest" and fine you $5,000.  

It may appear you are launching a DoS attack, for lack of a better term.  

[bitcoiner49er]

Assuming you have enough coins to spread your spending such that it would zero in regards to taxes, would you actually be better off doing so?

Example: Purchasing a $1000 item when BTC value is $1000 will require 1 BTC. If you wait until the event becomes a negative gain (again in regards to taxation), you obviously save USD in terms of taxes, but end up paying more in BTC.

At the end of each tax year, you may have saved paying taxes in USD, but robbed yourself of BTC that may or may not equal the value saved in taxes. Obviously this depends on the value of BTC, but if you subscribe to an ever increasing value for BTC over the long term, you may actually benefit from paying taxes, vs spending more BTC to create negative gain events.

[Anon136]

Don't get me wrong. The purpose of my post is not to marginalize your contribution. This is great work you are doing. As stated previously, I don't fault people for walking on their knees, it's perfectly rational.

No offense taken.  I quite enjoyed your story and agree that it shows the irrationality of current tax law.  

It was a chapter from "The Adventures of Jonathan Gullible" by Ken Schoolland.

[Peter R]

Assuming you have enough coins to spread your spending such that it would zero in regards to taxes, would you actually be better off doing so?

Example: Purchasing a $1000 item when BTC value is $1000 will require 1 BTC. If you wait until the event becomes a negative gain (again in regards to taxation), you obviously save USD in terms of taxes, but end up paying more in BTC.

At the end of each tax year, you may have saved paying taxes in USD, but robbed yourself of BTC that may or may not equal the value saved in taxes. Obviously this depends on the value of BTC, but if you subscribe to an ever increasing value for BTC over the long term, you may actually benefit from paying taxes, vs spending more BTC to create negative gain events.

If you trade your bitcoins and realized a gain as measured in USD on the trade, then you have a taxable gain.  The ZGL wallet doesn't change this fact.  ZGL is simply a tool to ensure compliance with US tax law.  Also, there is never a need to "wait until the event becomes a negative gain" with ZGL. 

If you want to keep more bitcoin, then keep more bitcoin!

[acoindr]

What I mean is that eventually you will run out of coins purchased at a "high cost basis".  You will only have "low cost basis" coins in your ZGL wallet.  If you spend a "low cost basis coin" to purchase a coffee you would recognize a taxable gain.  It may be difficult to ensure compliance with US tax laws under such circumstances as you could be making over 10 such purchases per day.  

Instead, when your wallet runs out of "high cost basis" coins, your wallet would automatically recognize a "lump sum" capital gain by swapping "low cost basis" coins for new coins using a mixing service.  You would report these transactions since they resulted in a capital gain.  

Okay, now I understand what you're talking about. That won't work. You're saying the wallet is set up where the coins you spend are always spent at a time when their value with respect to U.S. dollars has declined, so that there is no capital gain on the trade and nothing to report. There are two problems with that. First, it's possible for the exchange rate, overall, to keep increasing during your spending period. Second, the IRS won't take your word for it there was no capital gain, like teachers in school they want you to "show your work".

But now your wallet can continue forging ZGL coins which are "current" in the sense that the moment you spend them, your cost basis is exactly equal to their current market price.  

There is no way you could do that, because nobody and no software can predict what the market price will be at any time in the future.

The ZGL method is advantageous to both the filer and to the IRS.  It reduces your paper work without affecting the accuracy of your private records (in fact you now keep better records than ever!), and it reduces the paper work that the IRS has to process.  

The way I envision it that's quite possible. Software can produce extremely precise and organized reporting.

In my opinion, if you sent a report to the IRS that documented 3,000 tiny transactions, where each one has a gain of exactly zero, I think they may view this as "an attempt to protest" and fine you $5,000.  

It may appear you are launching a DoS attack, for lack of a better term.  

That's not how it works. I think you said you were not from the US? In fact this is the problem you quoted from that Georgetown Law professor, Levitin:

http://www.theatlantic.com/technology/archive/2014/03/why-bitcoin-can-no-longer-work-as-a-virtual-currency-in-1-paragraph/359648/

It's the fact that every single bitcoin trade can be viewed as a taxable gain or loss event, with them classified as property, which causes Levitin to argue they are now unworkable as currency. That's why Bitcoin Foundation's legal counsel says the classification results in unrealistic and cumbersome reporting requirements.

Average people are generally not meticulous enough to keep up with every property trade they perform, especially when that property behaves more like a currency. Add to that potential capital gains to report and you end up with a potential financial accounting nightmare for Bitcoin currency users. The idea you have about offsetting gains with losses though using smart software decisions counters that. What I'm saying is in addition the software, if designed intuitively, can also make the accounting and documentation effortless. It's a double win.

Regardless of any ZGL wallet Bitcoin users would be expected to show capital gains (or losses) on every bitcoin transaction. Even if those were all at a loss transaction documentation should still be made and records kept in case of audit. That's how it works in the U.S.

[tacotime]

I don't think this would work. This tax attorney advises using the FIFO method and nothing else for bitcoins.

The biggest issue for most bitcoin users is determining their basis. Because bitcoins are fungible, you run into the problem of tracing the cost of each bitcoin you hold. You cannot just arbitrarily choose your basis. The IRS will permit you to use the FIFO method (First in, First out). Any other method such as LIFO or Average Cost Basis is not advisable, particularly now that we know foreign currency rules do not apply

I doubt you're bound to FIFO, as no other US industries are.  They're trying to eliminate LIFO in general by law, but as long as a mining company for precious metals is allowed to make use of it, it seems appropriate for Bitcoins so long as it's used consistently.

[Bit_Happy]

It is possible to design a wallet that automatically organizes your transactions...

I read the OP, but not the whole thread.
Is anyone working on this yet?

[smooth]

Okay, now I understand what you're talking about. That won't work. You're saying the wallet is set up where the coins you spend are always spent at a time when their value with respect to U.S. dollars has declined, so that there is no capital gain on the trade and nothing to report.

He's not proposing that. You need to go back and reread the OP. There will still be capital gains, just not on every single little transaction. There would be a smaller number of transactions with larger gains, not altogether different from cashing in shares of an appreciated mutual fund once per month and then spending that money out of your checking account, as opposed to using a debit card and charging lots of little transactions directly to the mutual fund (each of which would be a taxable event).

The ZGL wallet function is like the checking account here. There might be a small amount of tax avoidance (in some cases, though in other cases taxes might increase), but that is minimal compared to the reduction in taxable events.

[Peter R]

@ acoindr

I think you are still misunderstanding how ZGL works.  You said that each purchase cannot be guaranteed to be zero gain/loss but it can.  Just check out my example in the OP.  As long as the wallet knows the bitcoin price at the time of purchase, and as long as the wallet controls a sufficient number of coins purchased above and below the current price, it is always possible to create a ZGL coin that has a cost basis exactly equal to the current market price at the time of purchase.  

I discussed Levitin's comments earlier in this thread.  What he says gives further credence to the idea of ZGL coins.  Each bitcoin is a unique piece of property with a different cost basis.  This is what allows you to forge ZGL coins that are "current" at the time of purchase such that they result in exactly zero gain or loss.  

The wallet is keeping the most meticulous records possible, BTW.  It is aware of every detail and can prove every tax-related fact.  

[smooth]

Is it every transaction, or just those $600 or more?

The 600-or-more rule refers to reporting of payments in trade or business (1099s). It has nothing to do with capital gains.