Memorandum
To: Trusts Unlimited, Jim George, Steve D____________
From: Robert M. Bly
Re: Taxation of Dinars at revaluation
There has been considerable discussion as to whether the dinars are taxable upon revaluation, or when they are cashed in. The following attempts to address this issue as well as set forth my reasons for the conclusions reached.
There are really two questions which must be addressed.
- Does the mere holding of dinars without cashing out after revaluation impose a tax liability upon the holder? No. Until any kind of disposition, there is no taxable event, therefore, if an individual owns dinars and there is a revaluation, the holder will not face any tax until he/she disposes of them such as a cash out. At this point all amounts over $200.00 would be treated as capital gain. The rate would depend upon whether the time held was more than one (1) year.
- Does the creation and transfer of dinars to an irrevocable trust, corporation, or LLC and the issuance of a beneficial interest, shares, member interest in favor of the owner of the dinars without cashing in the dinars create a taxable event? Yes.
The question arises in context with waiting until after revaluation of the Iraqi Dinar to create an irrevocable trust, and this conclusion is addressed to that issue only and nothing more; since that is where the issue has arisen. The issue is really one with limited application as most currency transactions do not involve the holding of large amounts of non-traded currencies waiting for some revaluation at some future date, rather than day to day movement on international currency exchanges. All questions of taxation resulting from international currency transactions are governed by §§985-989 of the Internal Revenue code.[1] The section dealing specifically with the situation faced by most dinar holders is §988.[2] Most of §988 deals with treatment of foreign currency and profits therein. §988 is primarily for corporations operating in foreign markets and professional investors dealing in futures, pooled funds, derivatives and other financial instruments. §988 treats profits received from these types of transactions as ordinary income; that is all of §988 except §988(e) which reads as follows:
Application to individuals
(1) In general . The preceding provisions of this section shall not apply to any section 988 transaction entered into by an individual which is a personal transaction.
(2) Exclusion for certain personal transactions. If nonfunctional currency is disposed of by an individual in any transaction, and such transaction is a personal transaction, no gain shall be recognized for purposes of this subtitle by reason of changes in exchange rates after such currency was acquired by such individual and before such disposition. The preceding sentence shall not apply if the gain which would otherwise be recognized on the transaction exceeds $200.
(3) Personal transactions. For purposes of this subsection, the term “personal transaction” means any transaction entered into by an individual, except that such term shall not include any transaction to the extent that expenses properly allocable to such transaction meet the requirements of—(A)section 162 (other than traveling expenses described in subsection (a)(2) thereof),or,(B)section 212 (other than that part of section 212 dealing with expenses incurred in connection with taxes). [Emphasis added]
§988(e)(1) takes the transaction out of all of the preceding §§ of 988 (those treating profit as ordinary income) so long as the transaction is a personal transaction as defined in subparagraph 3 of the above section, into which people holding dinars for revaluation fall. Thus, we must look to subparagraph 2 as this is where the resolution of the issue is to be found.
The second sentence of subparagraph 2 limits the provisions of the first sentence inasmuch as it provides that if there is any increase in value of foreign currency due to increase in exchange rates, and that increase is more than $200.00, gain is recognized and presumably taxed. Most people currently holding dinars would see gain even with a small revaluation to, say, $1.00 to 1 Dinar.
In the Internal Revenue Code words have very powerful meanings. The words underlined above have very distinct meanings within the Internal Revenue Code and in taxation in general. “Disposition” means any kind of transfer or exchange, see IRS Pub. 334 (2012) which defines “disposition” as any transfer where there is some kind of exchange of one thing for something else. Note that §988(2) provides “disposed of…in any transaction”.
Another word that has significant meaning in this section is “gain”. As used herein, the word means that any increase in value is treated as gain as opposed to ordinary income, thus, to the extent there is any tax it is at the capital gains rate rather than ordinary income rates, unless it is for gain on property held for less than one year, in which case it is taxed at the ordinary income tax rate.
The final word which needs to be closely followed is “recognized”. Under the Code and prevailing tax positions there is a significant difference between recognition and realization. “Realization” means actual receipt of profit, whereas, “recognition” means the point at which the thing is taxed. It is critical that §988(e) uses this word twice, thus clearly setting forth when the taxable event, if any, occurs.
Using the following example let me illustrate how this works.
A buys 1M dinars for $1,000.00. At some future point, (more than a year) the dinar revalues to 1 IQD: $1.00. This means that the value of the dinars in A’s possession are now worth $1,000,000.00. As long as A does nothing with the dinars there is no taxable event. Suppose A wants a trust for the reasons of reduction of IRS scrutiny and asset protection, which are the primary reasons the trusts are marketed. He cashes out sufficient Dinars to purchase a trust, and take care of some other matters, say $20,000.00. Since the dinars that A cashes out cost him $20.00 ($.001 x 20,000), A will have a gain of $19,980 less $200.00 for a net taxable gain of $19,780.00.
This is not the end of A’s potential tax problem. He creates the irrevocable trust and takes back a beneficial interest and then transfers the rest of the appreciated dinars to the trust. Because the trust is an irrevocable trust A has made a disposition of his appreciated dinars. Even though he has not cashed them in he has recognized gain of the appreciated value of the dinars. Steve should be familiar with this concept since this was precisely what occurred prior to 1997 when people transferred appreciated property to offshore trusts. At that time the transfer was taxed as gain and a Form 926 had to be filed. As I recall, people were advised at that time to cash out their appreciated property, pay the tax and then transfer the cash to the trust, which could be directed to purchase the very same property (if stock or other negotiable instruments) which were sold, or better yet, transfer cash or cash like assets. This was changed in 1997 by the enactment of The Small Business Jobs Protection Act of 1996 to the present law requiring the filing and reporting by the offshore trustee of income earned by the trust and imputed to the beneficiary.
Since A is the transferor, any tax liability and responsibility for reporting would fall on him, not the trust, totally frustrating one of the purposes for having the trust, i.e. IRS scrutiny. At the time the transfer, A has “disposed” as defined by the Code and illustrated by IRS Pub 334 of an asset that has appreciated in value by “increase in exchange rates after such currency was acquired by such individual and before such disposition”, and therefore has recognized gain. This is a taxable event and because it is capital gain, the tax would have to be reported in the quarter in which it was received.
[1] 26 USC 985 et seq.
[2] 26 USC 988 et seq.