Main Street Business

#536 The Crypto Tax Loopholes The IRS Don't Know About

• Mark J Kohler and Mat Sorensen

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In this episode of the Main Street Business Podcast, host Mark J. Kohler unpacks the intersection of traditional tax strategies and the world of cryptocurrency. Learn how the "Trifecta Concept" can streamline your estate planning and operational income, while also addressing the unique tax challenges of crypto mining, NFTs, and gaming revenue.

Here are some of the highlights:

  • Mark begins by mapping out the Trifecta Structure for client asset organization.
  • Mark breaks down the S corporation strategy: Split income into reasonable comp and K-1.
  • Operational crypto income: Mining, certain staking, gaming revenue, NFT creation.
  • Importance of organizing client's crypto activities within the trifecta framework.
  • Tax strategies: Using IRAs or solo 401(k)s for gaming income.
  • Gaming tokens are taxable income subject to self-employment tax.
  • How to use software to track cryptocurrency basis for reporting purposes.
Speaker 1:

Welcome to the Main Street Business Podcast with your distinguished hosts, mark J Kohler and Matt Sorenson. Both are best-selling authors and have over 25 years of industry experience, with 10,000 client consultations, making them the leading tax and legal experts in the nation. Together, they'll unpack the most complex tax, legal and financial strategies crucial for saving more, stressing less and building generational wealth. Today they're your personal advisors, ready to break it down for you and make the tax and legal game easier than ever. Here is Mark and Matt.

Speaker 2:

Oh well, Mark, they're not going to see that I got paid in tokens because it's going into my phantom wallet. Oh, you mean, the blockchain is private, it's not public and the IRS has no clue how to track cryptocurrency transactions. Wrong, the IRS can come back to these kids 10 years from now and say we want the tax and the penalty and the interest. This is the conversation we've got to start having with our clients Now. Is there a tax strategy here? Yeah, we might take that income and pop it into an IRA and take a write-off. And now your kid's building tax-free income somewhere else. I've got kids that have created solo 401ks with their gaming income. This is for real, it's right now. And then, when they don't understand it, you lay out the trifecta.

Speaker 2:

Before we talk crypto, let's talk regular small business, regular investing. When we're investing over the years and we're starting small business and we have our assets and our legacy, what does that look like? And then I want to overlay crypto on top of it, because we all have lives with a lot of moving parts day jobs, small business, rental property, home, our retirement accounts. How does crypto fit into all that? And it's a lot easier to sometimes understand cryptocurrency and NFTs and digital assets. When we first step back and go, what's my portfolio or my asset mix or my asset classes look like right now? So this is where, over the years, I developed this concept called the trifecta. You don't learn this in law school. You don't learn this in a master's program. You don't learn it in the bar exam or the CPA exam or enrolled agent. You don't learn this. You got to learn it on the streets. You got to hopefully learn it from some old white guy in the corner of the law firm that's going to pass on some kernel of wisdom which they normally don't.

Speaker 2:

I came up with this trifecta concept and this is what it looks like. So the foundation of our trifecta is our estate plan, and I'm going to use several little phrases here estate plan or revocable living trust, and if we overlay the tax concept on this, it's really our 1040, because all of our ownership, our money, our wealth, should flow downhill into this foundation, and I'm going to call it our legacy. This is our, yeah, our legacy, what we want to leave for our family, and I'm going to call it our legacy. This is our, yeah, our legacy, what we want to leave for our family and I'm going to have to report my taxes at the end of every year. But the revocable living trust is that formal document that's going to hold everything, and I don't care if you're young or old, rich or poor, kids or no kids, married or single. You have got to have a revocable living trust. This is the trust that's going to prevent, probate, keep you organized and help you feel like you've got a vision for what you're trying to build. The trust is absolutely critical. May create some privacy, but definitely some structure for the assets you're building Now.

Speaker 2:

With that foundation, then on the left side, we are going to put our operations and on the right side, we're going to put our assets. Assets generally create passive income and operations are going to create ordinary income. Now this, by the way, again this plays right into cryptocurrency. This is why you've got to see this. So operations are typically going to be a side hustle. 50 million Americans now have a side hustle and millions of Americans have a main hustle, which we convert to an S corporation when the time is right, and it could be an LLC or an Inc, but we make that S selection. If I have a day job, it's over here on the side bink and my spouse may have a W-2, bink. What we're trying to track here is our business operations. What am I doing that might be creating ordinary income operations? What am I doing that might be creating ordinary income?

Speaker 2:

Now, the problem with this ordinary income is we pay a tax that's pretty crappy and it's called self-employment tax. So if I now this is going to play into crypto in a big way and again, Bobby alluded to this and even explained some of this and we're just going to dive in a little deeper now If I bring in a hundred grand, I spend 25 grand in expenses. Think of a realtor. Realtor brings in a hundred thousand 1099, 25 grand in expenses, net 75. Self-employment tax is going to be 15.3%. Let's put that in red 15.3% or $10,000. Then I'm going to pay my Fed and state tax if I'm in a state with tax. So boom, boom, boom. This is pretty hard hitting and this can apply to crypto as well.

Speaker 2:

Now, if I do it right and I catch the vision, I do quality planning with an advisor. I'm going to take that same income and actually funnel it through an S-corp with the same expenses, with the same net profit, but I'm going to split it into reasonable comp and K-1. And I've been teaching reasonable comp for 25 years. I have never had a client audited for taking too low of payroll. So be ready to embrace yourself. You advisors out there that may think I'm a little aggressive. Again, let me repeat I have never, ever, ever had a client audited for too low of reasonable comp. I teach CE on it myself. I read every case on reasonable comp, I teach it, I write about it and I stand behind my principles. I teach it, I write about it and I stand behind my principles In this example all day long.

Speaker 2:

I would probably take $25,000 to $35,000 in payroll. I'll go $25,000 in payroll, $50,000 in K-1, and I would save FICA of 15.3% approximately $7,500 in tax savings. Holy crap, that's a big deal. All right, Now this conversation I talk about all the time, and this is the operation side. Now the asset side. Let's get over to there.

Speaker 2:

This is going to be stuff like and I'm going to split this in half I might have an LLC that owns rental property. So think of this as a. If we go back to that realtor example, I have a realtor with a 1099 and that realtor picks up a little rental property every couple of years. They're building wealth with rental real estate. I'm going to have passive income in this. Llc could be a single member, LLC would be reported on a schedule E and it flows down to my 1040. Well, I may also be building a 401k with my day job. Okay, I may also have a solo 401k with my S corporation. I should hopefully be building a Roth IRA my spouse and kids so I could have multiple Roth IRAs and I may have a health savings account in the mix.

Speaker 2:

This is my I'm going to call this my tax deferred or tax free section. Anything I can build up in this section is hopefully going to be zero tax in the long run, if I do it right, because I'm going to be converting traditional dollars to Roth Over here. This is kind of my personal income and I'll pay tax on it or not, and I may have depreciation and write-offs that come through real estate. All of this flows down to my 1040 and the trifecta is born the estate plan or my trust owns this LLC. It's the beneficiary of my retirement accounts, it's the owner of my S-corp, it's the owner of my side hustle and, to simplify it, my trust is the owner of my LLC, my S-corp and the river runs through it. This is my trifecta. So if we look at a slide here, just to bring it together, so right here would be a common digital representation of this that we do for clients. My tax advisors build these for clients and we see a trifecta normally. So this is kind of the normal average American.

Speaker 2:

Before we put crypto on top of it. You ready, Bam. Now we cryptoize the trifecta. We've cryptoized I don't know if cryptoized is a word, but I just created it. So, Urban Dictionary, you're on notice. So this cryptoized trifecta, we now see that certain types of income are actually operational. Bobby alluded to this Mining meta ventures, certain types of staking, gaming revenue. Being an NFT creator, this is going to be subject to that crappy tax I just talked about Not good. So over here, investments are going to be that other type of staking income trading NFTs or digital assets and trading crypto. Those are going to be more passive. So we can take our trifecta and now overlay it with our crypto operations.

Speaker 2:

Now, why this is so important? Because as an advisor, you want to be able to have conversations with your clients and not confuse them. So when your client walks in and you've got to break them the bad news that their crypto transactions have to not only be tracked and basis has to be tracked, and you've got to talk about LIFO and HIFO and FIFO and all this stuff and, oh my gosh, and their brains start to explode. And then you're like, oh, and, by the way, you got a 1099 for gaming, oh, and you got a 1099 over here, or you did some mining and all, and your client just wants to crawl in a hole. That's not the feeling you want to generate with your client. You want to generate a feeling of strength, comfort, safety, confidence, and you do that by saying to your client slow down, let's put this on the whiteboard.

Speaker 2:

Let me show you the trifecta and what we're going to do is put your and you draw this on the board or get on Zoom with them and you go hey, if you're buying Bitcoin, if you're buying Sol, if you're buying ETH Bobby was talking about, you need to help your client understand oh, that's a bucket. Do I need an LLC for that? Probably not. Llcs. Don't save taxes. I might have that in a personal wallet. I might have it on a platform like a custodian, like Coinbase, Gemini, some of the and, as Bobby points out. You have an IOU. They're holding your Bitcoin, or really not you. So you might have hard wallets and custodial wallets and you start to learn about those strategies.

Speaker 2:

But the point is this is your personal holdings on your asset side? And your client's like, okay, okay, I get that, Okay, it's not overwhelming. And then say, yeah, we're going to put some software on top of that to track your basis so that when it's time to report, we kind of know what the hell happened last year. And so they're like, okay, okay. And then you come over here and go, oh, are you creating some cryptocurrency? Are you taking crypto in your business as a form of payment? Mandy's going to talk about that tomorrow. How do you take crypto in your business? Are you also doing mining? Are you gaming and I want to use some examples here in a moment and, uh, even certain types of staking, and we're going to talk about that after.

Speaker 2:

So this brings up the topic of self-employment tax and a topic of maybe an LLC, maybe an S corporation, and so your client's like, okay, you got a plan for me, Mark. Yeah, we got a plan. Don't stress, this is your trifecta, this is your world, and we're going to help build that and look at your retirement accounts. Maybe we do our cryptocurrency trading in a Roth IRA and pay no tax at all. Tomorrow, Terry and I are going to talk about that, so you're going to be able to give them options that, most importantly, make sense of all this, because you don't want them confused and you don't want them frustrated. You want them feeling safe with you. When your client feels safe with you, they want to pay you for advisory services and they never leave you. And when you say this is how we operate and if you don't like it, go somewhere else, they say all right, I'll get in line.

Speaker 2:

How does this work? Because you're in control of your practice, not the client. Their stress is not your stress. You are the one captaining the relationship. And when you start to own that and value your real service and put a price tag on it and create a structure for that, you get better clients, you make more money, you have better job satisfaction and your clients are happier too, your family's happier. Your relationships are better because you're taking ownership.

Speaker 2:

And it all starts with this conversation. So I know when Bobby was talking, it was like what the crap Information overload out. When Bobby was talking. It was like crap information overload. You take a breath, you bring it back and say you know what? I can be the leader here. I can lead my clients through this maze and I can help them feel safe and confident. And then the client's like sign me up. We want to be able to divide crypto transactions into two types, so let me give you a couple reveals. You may have seen me on social media lately.

Speaker 2:

Gaming industry has completely changed. It's fascinating. Kids are now playing video games to make money. They're not paying to play video games. They're getting paid to play. Advertisers are putting ads in video games are putting ads in video games. Video game industry is now a billion dollar venture and they want kids to play their games and so they're paying them in tokens. Sometimes those tokens are very they're specific to the game, but when they leave the game, they can take that token and trade it for, ultimately, a Bitcoin. And if you can get a Bitcoin, you can get a US dollar.

Speaker 2:

And the IRS has said if you earn tokens playing a video game, that is taxable income and it's not just staking. You earned it playing a game. When LeBron James plays basketball, he gets paid. He has to pay tax on that. That's his job. And whether a kid is playing Axie Infinity and they're playing a video game and they're getting paid, they're getting paid just like LeBron James. It's just on a video game and they have to pay tax on it as if it's business income subject to self-employment tax. And that's going to blindside these kids, these clients that are earning tokens.

Speaker 2:

Now I know what they're going to say Mark, I didn't get a 1099. I don't have to claim the income. Oh, you're right, they didn't send you a 1099. That's right. There's this exception in the tax code that if you don't get a 1099, you don't have to claim the income you earned. Yeah, that's right. Wrong, oh well, Mark, they're not going to see that I got paid in tokens because it's going into my phantom wallet ultimately. Oh, you mean, the blockchain is private, it's not public and the IRS has no clue how to track cryptocurrency transactions. Wrong, you see the train coming down the track. On this one, there's no statute of limitations. The IRS can come back to these kids 10 years from now and say we want the tax and the penalty and the interest. This is the conversation we've got to start having with our clients.

Speaker 2:

On your questionnaire for tax prep. You're going to say did any of your kids play video games and earn tokens? Oh, yeah, they have a MetaMask wallet or they have a whatever wallet. Yeah, they. Okay, let's drop it into some software and see what we got going on. And we got to claim that income. Now is there a tax strategy here? Yeah, we might take that income and pop it into an IRA and take a write-off. And now your kid's building tax-free income somewhere else getting a write-off.

Speaker 2:

I've got kids that have created solo 401ks with their gaming income. A kid can be sitting on a couch earning gaming income as an influencer playing games. Kirby, remember that we got a kid that was making a hundred grand a month as an influencer video showing him playing video games and doing pranks and playing on the YouTube making a hundred grand a month, and we're getting getting him into a solo 401k. That's another client we're trying. I just want to bring him. This is for real, it's right now. And then, when they don't understand it, you lay out the trifecta oh, this is like a landscaping business. Yes,

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