Wednesday, October 1, 2014

Pentaho Data Integration with XERO makes it really easy to extend the reach of your current world of data. In this case, we can now build dashboards and analytics, perhaps run some predictives over Xero

Stuart Guthrie for  BizCubed writes: One of the things I love about Pentaho is its great data management tool PDI, or 'Kettle' as it's known. Pentaho can load in and write out over 100 different data sources. It's the ultimate tool for data munging – I've never seen anything in its league for diversity and capability.
Recently at BizCubed, we've had a lot of requests for integration to xero.com, that's an effective software-as-a-service (SAAS) accounting system from New Zealand.  Screen Shot 2014-02-22 at 10.40.26 am
Xero has a nice webservice / REST based API set that exposes securely lots of data for reading and writing. This makes it a perfect target for PDI (did I mention it's a great data munging tool?).
The obstacle to all of this is the need to play nicely with Oauth- an open standard for securing webservices. Oauth is used at some of the major Web assets like Google and Facebook.
Since there was no example we could call on currently in PDI, we went to the Java-defined class level as examples were provided on the xero developer site.
Atul, our newest engineer at BizCubed, developed the java class and tested the capability in fast order. We can now load Bank Transactions out of Xero for a given user / certification and get it into the PDI for further fun.
This is our simple example:
 NewImage
What we are doing here is loading Bank Transactions from a specific Xero account out to a database. The practical application of this is to set a loop around this transformation and access all accounts for a specific bookkeeper, helping them to keep their various clients bank accounts reconciled on a daily basis.
We would do this by loading this data back to a dashboard or report viewable by the book keeper(s). Currently, to achieve this, the bookkeepers need to log into each and every Xero account and check the bank reconciliation page manually.
Since this is a User Defined Java class, our next port-of-call is to turn it into a true PDI plugin which makes the first two steps a lot simpler and provides translations to all of the various Xero web services, allowing Pentaho Data mungers to load and extract data from this neat accounting tool any time they want.

A DEEPER DIVE

The two steps that matter in this transform are Step 3 and Step 5.
NewImage
Step 3 uses Java from the examples at Xero to access the web service with the Oauth certificates and extract the relevant XML for the relevant account. We've got the code if you want it, just fill out the form on this page and we can send it to you.
Step 5 is neat, you can use the PDI XML Path reader to extract the pieces of the Xml data returned from Xero.
NewImage
I arrived at this screen by copy/pasting the Xero XML into the 'content' tab as an 'example of content'. PDI then asked me at what 'level' of the Xpath to loop around. In this case, it was '/Response/BankTransactions' Choosing that, returned the fields as above.
Putting this step together took about 1 minute in Pentaho. It would have been 2 hours at least for a skilled experienced Java Software Engineer believe me – I was one!
Pentaho Data Integration makes it really easy to extend the reach of your current world of data. In this case, we can now build dashboards and analytics, perhaps run some predictives over Xero. A great extension to a great product.
Now.. to talk to those bookkeepers…
About BizCubed: BizCubed introduced the Open Source BI platform Pentaho to the Australian marketplace at CeBit in May 2006.  Our clients have since ranged from local to federal government, manufacturing to financial services, and from small two-person companies to large billion dollar organisations. With a quality ecosystem of partners, contributors and customers, BizCubed is changing how data is consumed and delivered in Australia and New Zealand.
 All of our services are geared towards making businesses smarter. We enable the rapid implementation of robust business analytics capabilities through knowledge sharing and systems integration. We guide decision-makers on the critical path to developing a technology enabled organisation. We help customers showcase the potency of good business information through compelling data visualisations. Visit BizCubed Here.
Posted on 10:40 AM | Categories:

The Self Employment Tax Trap

Tax Defense Network writes: Unlike wage earners that work for employers and have their taxes withheld from their wages and deposited with the IRS, the self-employed have to calculate and pay their taxes themselves. Tax rules for the self-employed are different from those for businesses, individual taxpayers and those working for employers. Generally, self employed individuals are required to file a tax return if they earn $400 or more from self-employment.
Many times, misunderstanding IRS requirements or a lack of information causes the self-employed to underreport income and incur a tax debt. The tax rules that the self-employed must consider when calculating and paying their taxes are discussed below.
Self-Employment Tax
Self employed individuals are required to pay the self-employment tax in addition to federal income tax. Self Employment tax includes the self-employed individual’s Social Security and Medicare taxes. From 2013, an additional Medicare Tax of 0.9 percent was required to be paid by the self-employed. This additional Medicare Tax applies to wages, compensation, and self-employment income that is above a certain threshold.
Estimated Taxes
Self employed individuals may also be required to pay Estimated Quarterly Taxes. Estimated taxes include self-employment, income and any other tax a self employed individual may be required to pay and are paid at specific intervals throughout the year. Generally, if you expect to owe more than $1,000 in taxes by the end of the year, you should be filing estimated taxes.
Many times, self-employed individuals do not pay estimated taxes quarterly and wait for the traditional filing deadline of April 15th. This leads to tax debt, as correctly paying estimated taxes every quarter is essential to remain compliant with the tax laws. The IRS even charges a penalty for underpayment of estimated tax.
Tax Credit and Deductions
There are many deductions that the self-employed can claim. Certain qualifying business expenses can be deducted from income to reduce taxes. The Home Office Deduction is often used by self-employed individuals who work from home.
Self-employed individuals can claim the Earned Income Tax Credit if they file Form 1040 Schedule C. This tax credit reduces the tax liability of those employed by an employer or work independently.
In order to avoid mistakes in calculating taxes and running the risk of a debt, it’s recommended to either seek the help of a tax professional or keep yourself up-to-date about the tax laws that impact you.
Posted on 9:46 AM | Categories:

The impact on XERO of the NZ currency fall, a 10% increase in revenue

Lance Wiggs for The National Business Review writes: The currency fall has a wonderful effect for exporters, especially those who have most of their costs back here in New Zealand.
As I write this, the NZD versus the USD has fallen about 10% since earlier this year. As an exampled of what this means I’ve made a simple spreadsheet estimating the impact on Xero [NZX: XRO].



My take is that the fall from the end of May to today would increase their estimated monthly revenue by about 4.3%.




Obviously this is only for revenue received after the exchange rate changes, so don’t expect any surprises when Xero announces their September revenue, although their Annualised Run Rate might have a boost.
But we’ve also heard talk of a desired optimum level of a rate of $.65 US dollars per NZD. If that happened tomorrow (and I am never a fan of fast movements), and if the AUDNZD cross rate stayed the same, then the Xero table would look like this:



That’s would show almost 10% increase in revenue, a lovely bonus for Xero and Xero’s shareholders. Xero does have a lot of staff offshore, but the bulk of their costs would be in NZD, so overall they should see a net increase in profitability, which in their case means little, as they are very well funded and constrained by things other than monthly profitability.
Every other exporter will be facing a similar scenario, but SaaS providers are luckiest because their costs are often largely in NZD, and so they will maximise the benefit.
Posted on 7:12 AM | Categories:

Tuesday, September 30, 2014

American Express Serve® and Intuit Team Up this Tax Season To Deliver Fast and Convenient IRS Refunds

 American Express Serve and Intuit Inc. INTU, +0.09% announced today that eligible tax preparers using the Intuit ProSeries and Lacerte Software will be able to offer their clients the ability to receive eligible IRS tax refunds on a new American Express Serve Card, a full-service reloadable prepaid account1. This new integrated disbursement option with American Express Serve allows tax preparers to seamlessly register clients for a Serve Account during the tax return preparation process.  Clients can receive their eligible IRS refund onto their new American Express Serve Card as soon as the funds are transferred from the IRS.
"This is truly a win-win experience for both our small business tax professionals and their clients.  Tax preparers can grow their practices – offering more convenience and flexibility - while helping their clients keep more of their hard earned money by securing their refunds without incurring costly check cashing fees," said CeCe Morken, Senior Vice President and General Manager of Intuit's Professional Tax Division. 
"By teaming with Intuit, we're very excited to bring to market a solution for tax preparers to offer their clients a fast and convenient way to receive their IRS refunds because they no longer have to wait on a paper check," said Stefan Happ, General Manager, U.S. Payment Options, Enterprise Growth at American Express. "With Serve, clients will also be able to access a number of features including the ability to set money from their IRS refund aside for future purchases in a linked Reserve account, spend using their permanent Serve Card virtually anywhere American Express® Cards are accepted and withdraw funds using the MoneyPass ATM network."
When tax preparers renew or purchase ProSeries and Lacerte they can enroll to offer their clients the ability to apply for an American Express Serve Card and to have their federal refund directed to that Card. The process is easy and automated and eligible clients will receive a permanent Serve Card in the mail as soon as they are registered by the tax preparer and their application is approved. Their refund will be directly added to their new Account once the funds are transferred from the IRS.  This convenient solution will be announced today at Intuit's Investor Day.
American Express Serve is a full-service reloadable prepaid account that does not require a credit check, includes free ATM withdrawals at over 24,000 ATMs nationwide2, free Direct Deposit, free online bill pay, and free Mobile Check Deposit3 for a monthly fee of $1 that can be waived with Direct Deposit4.
Posted on 4:16 PM | Categories:

Avalara Unveils “Five-Minute” Sales Tax Return

Avalara, Inc., a leading cloud-based sales tax and compliance automation technology provider, today unveiled a major update to its TrustFile® tax return offering that will cut the time to prepare sales tax returns to as little as five minutes. More information is available at www.trustfile.com.
Avalara has offered TrustFile as a desktop software product since acquiring the company in 2007 and continues to serve thousands of customers on that platform. TrustFile was modernized and upgraded to an online offering earlier this year and, starting this week, businesses of all sizes can get fully populated signature-ready tax return forms based on a simple upload of their sales and tax collection data. TrustFile currently supports signature ready returns in several states, with more being added every week. The company expects its signature ready return solution to be available nationwide in early 2015.
Avalara also plans to add electronic filing to TrustFile during the first half of 2015, eliminating the need for businesses to manually print sales tax returns and mail payments to the government. The company has filed more than 500,000 sales tax returns in the past 12 months for its TrustFile and Avalara Returns customers and remits billions of dollars to state departments of revenue on their behalf, making it one of the largest filing providers in the industry.
“Small businesses spend hours every month preparing forms, filing returns and remitting sales tax in every state where they operate, often without the help of an accountant,” said Joe Davy, General Manager of TrustFile. “Avalara is on a mission to provide the fastest, easiest way for these businesses to automate this process, and signature ready returns is a milestone in this effort. Ultimately, we expect most small businesses using TrustFile to be able to file in about five minutes.”
TrustFile Online currently provides detailed sales tax reporting information for thousands of customers across more than 12,000 tax jurisdictions in the United States, helping business owners know exactly where, when and how much to file – and whether or not they are collecting the right amount of tax in each state. Business owners can also use TrustFile to print completed sales tax return forms and store a record of their sales tax history in the cloud.
“This is another major advance from Avalara for businesses of all sizes,” said CEO Scott McFarlane. “Ten years ago, we disrupted the outsourced compliance market by bringing the power of the internet to bear on the problem of calculating and collecting the right amount of sales tax. We entered the returns side of the business when we bought TrustFile back in 2007 and used that technology to add automated returns preparation, filing, and remittance for our AvaTax customers. Now we are introducing a way for the rest of the world to get in on the action. I describe the new TrustFile as our ‘turbo tax for sales tax.’ It’s another example of Avalara making sales tax less taxing.”
About Avalara
Avalara helps businesses of all sizes achieve compliance with sales tax, VAT, excise tax, and other transactional tax requirements by delivering comprehensive, automated, cloud-based solutions that are fast, accurate, and easy to use. Avalara’s end-to-end suite of solutions are designed to effectively manage complicated and burdensome tax compliance obligations imposed by state, local, and other taxing authorities in the United States and internationally.
Avalara offers hundreds of pre-built connectors into leading accounting, ERP, ecommerce and other business applications. The company processes millions of tax transactions for customers and free users every day, files hundreds of thousands of transactional tax returns per year, and manages millions of exemption certificates and other compliance related documents. Founded in 2004 and privately-held, Avalara’s venture capital investors include Battery Ventures, Sageview Capital, Arthur Ventures, and other institutional and individual investors. Avalara employs more than 700 people at its headquarters on Bainbridge Island, WA and in offices across the U.S. and in London, England and Pune, India. More information at: www.avalara.com
Posted on 4:13 PM | Categories:

High Net Worth Family Tax Report / Autumn 2014

Table of Contents
  • What You Need to Know About Corporate Inversions
  • Taxpayer Avoids Penalties by Relying on Professional Advice
  • IRS Streamlines Offshore Voluntary Disclosure Program
  • IRS Issues Additional Guidance as to When Construction Begins for Production Tax Credit
  • The End of the Year Is Rapidly Approaching
  • IRS Changes Rules Regarding IRA Rollovers
  • Tax Court Addresses Income, Estate and Gift Tax Issues Related to Personal Goodwill
  • Tax Court Attributes Significant Value to Personal Goodwill in Estate Tax Valuation Case
  • California Franchise Tax Board Expands Concept of Doing Business in California for Out-of-State Corporations
  • Recent Case Emphasizes Importance of Keeping Records of the Tax Basis of Assets
  • Court Holds That Land Sold Was Inventory That Gave Rise to Ordinary Income
  • Another Taxpayer Mistake Causes Loss of Charitable Contribution Deduction
 What You Need to Know About Corporate Inversions 
It seems like every day brings news of another possible corporate inversion transaction. The news reports usually describe these transactions as another United States corporation moving or relocating outside of the country. While the management of the U.S. company tries to downplay the tax impact, most of these transactions are largely driven by tax savings – for the corporation. While they may lower taxes for the corporations that are inverting, these transactions generally result in tax bills for many shareholders.
The U.S.-based company does not actually move offshore in an inversion transaction. Instead, the company agrees to acquire a foreign corporation and structures the acquisition so that the U.S. company becomes a subsidiary of the foreign company it is acquiring. The shareholders of the U.S. company exchange their shares for shares of the foreign corporation. Since the U.S. company usually has a larger market capitalization than the foreign corporation, at the completion of the transaction the former shareholders of the U.S. company often end up owning more than 50 percent of the shares of the foreign corporation that was acquired. The foreign corporation must have sufficient market capitalization so that the U.S. shareholders do not end up owning 80 percent or more of the foreign corporation, or it will be treated as a U.S. corporation for income tax purposes and the inversion will not have accomplished anything. (Some of the proposals being discussed in Congress to stop inversions would lower this threshold to 50 percent.)
Transactions involving the exchange of stock for stock of the acquiring company are normally structured in a manner that allows the U.S. shareholders to exchange their stock without having to recognize any tax gain that may be inherent in their shares. A different rule applies, however, where the shares are exchanged for shares of a foreign corporation in which the U.S. shareholders will receive more than 50 percent of the stock. In that case, the exchange is taxable to the U.S. shareholders. The taxes may be significant if a shareholder owns a large block of stock, the shareholder has held it for a very long time and it has a low cost basis.
While the shareholders are given an opportunity to vote on the transaction, many of the outstanding shares may be owned by pension funds and other institutions that are not sensitive to tax considerations. Individual shareholders may be forced into a transaction that will result in a large tax bill. If you are charitably inclined, donating the shares of a corporation that is likely to be inverted may be a smart move. You can give the shares to a charity without recognizing your tax gain and still receive a charitable contribution deduction for the full fair market value of the shares, subject to the applicable percentage limitations.
If you want to consider a charitable contribution of shares of a company likely to invert, you must make the contribution before the transaction has received all necessary approvals and the charity is legally required to exchange the shares for shares of the foreign corporation. If you wait too long, the gift will be treated as one in which you sold the shares and then gave the resulting cash to the charity. The safest course is to donate the shares before the shareholders of the U.S. company have approved the transaction.
Concerned that Congress would not be able to act on inversion transaction in an expeditious manner, the IRS on September 22 issued Notice 2014-52. The Notice provides that regulations will be issued under five different sections of the Internal Revenue Code in order to make inversions more difficult to implement and to reduce the tax benefits of inverting. The regulations will be effective for inversion transactions completed on or after September 22, 2014.
The regulations will make it more difficult for a U.S. corporation to invert by tightening the rule that the former shareholders of the U.S. company cannot own 80 percent or more of the foreign acquirer after the inversion. The bulk of the regulations will make inversions less beneficial by making it more difficult for the new foreign parent to utilize the tax-deferred foreign earnings of the acquired U.S. company. We will continue to monitor this area and keep you apprised of any further developments.
Taxpayer Avoids Penalties by Relying on Professional Advice
In the recent Tax Court case of Vision Monitor Software LLC v. Commissioner (September 3, 2014), the Tax Court disallowed a taxpayer’s deduction for losses incurred by a partnership in which he was a partner because he did not have sufficient income tax basis in his partnership interest to deduct those losses. The taxpayer claimed that he obtained the needed basis by contributing his own promissory note to the partnership. The court denied the basis and pointed out that there is considerable previous case law that says a taxpayer does not have any tax basis in his own note.
The IRS also sought to impose the 20 percent substantial understatement penalty. One defense against the imposition of this penalty is the taxpayer’s reliance on professional advice. The partnership’s longtime attorney, who is a certified tax specialist, recommended the note contribution as a means of increasing the partners’ tax basis in the partnership. He gave this advice orally rather than in writing. In order to use reliance on professional advice as a defense against the substantial understatement penalty, the taxpayer must establish that (1) the advisor was a competent professional who had sufficient experience to justify reliance; (2) the taxpayer provided the advisor with the necessary and accurate information on which to base his advice; and (3) the taxpayer actually relied in good faith on the advisor’s judgment.
The court found all three of these conditions were satisfied and granted the taxpayer relief from the penalty. While there is no requirement that the relied-on advice be written, getting professional advice in writing is certainly the better practice. Whether the taxpayer acted reasonably in relying on this advice when several cases had already held that a taxpayer did not have any tax basis in his own note is a good question. The advisor made a weak argument that another case – one that granted the basis to the taxpayer – applied in this case, but the court held it was not applicable because the case was based on very different facts. The court nevertheless determined that the advice given by this advisor would seem reasonable to the taxpayer, who did not have deep knowledge of the tax law.
IRS Streamlines Offshore Voluntary Disclosure Program
On June 18, 2014, the IRS announced new Streamlined Filing Compliance Procedures (Streamlined Programs) and changes to the existing Offshore Voluntary Disclosure Program (OVDP). These programs are intended to help taxpayers correct any failures to report foreign financial assets and income (and to fix other tax compliance issues). The following provides a summary of the key features of the new Streamlined Programs and the changes made to the existing OVDP.
Streamlined Programs — There are two different Streamlined Programs – one for U.S. taxpayers residing outside the United States, and one for U.S. taxpayers residing in the United States. These two programs have many of the same requirements. For example, both programs require (1) either an original or an amended U.S. tax return, depending on the circumstances, for the three most recent years for which the due date for the return has passed (including extensions); (2) payment of any tax shown as due on the returns submitted under the program plus interest; (3) Foreign Bank Account Reports FBARs electronically filed for the most recent six years for which the filing deadline has passed; and (4) a written statement (on the form required by the IRS) signed under penalties of perjury that certifies, among other things, that the taxpayer’s failure to report offshore accounts and income was due to non-willful conduct. For this purpose, the IRS has defined non-willful conduct as conduct that is due to negligence, inadvertence, mistake or a good faith misunderstanding of the law. On the other hand, willfulness is generally understood to mean a voluntary, intentional violation of a known legal duty.
In addition to the requirements mentioned above, U.S. taxpayers residing in the United States generally must pay an offshore penalty equal to 5 percent of the highest aggregate balance/value of the taxpayer’s foreign financial assets during the past six years. The offshore penalty does not apply to U.S. taxpayers that (1) do not have a U.S. abode and (2) have been physically outside the U.S. for at least 330 days for any one or more of the most recent three years for which the due date for the return has passed. If a U.S. taxpayer successfully completes one of the Streamlined Programs, the IRS agrees to waive any failure-to-file and failure-to-pay penalties, accuracy-related penalties, information-return penalties, and FBAR penalties for the amounts reported under the one of the Streamlined Programs. This waiver does not apply if the taxpayer’s original noncompliance was the result of fraud or willful misconduct, however. In addition, the IRS does not provide any confirmation as to whether the taxpayer has successfully completed a Streamlined Program.
OVDP — For taxpayers who do not meet the eligibility requirements for the Streamlined Programs, the OVDP still may be an option. The change recently made by the IRS to the current OVDP was to increase the 27.5 percent offshore penalty to 50 percent in the case of taxpayers who had accounts with any bank or facilitator identified by the U.S. Department of Justice as being under investigation or as cooperating with a government investigation.
Warning — Once a taxpayer makes a submission under one of the Streamlined Programs, the taxpayer is no longer eligible for the OVDP. Similarly, a taxpayer who submits an OVDP disclosure letter after July 1, 2014, is disqualified from participating in the new Streamlined Programs. If the IRS has initiated a civil audit or criminal investigation of the taxpayer, regardless of whether the audit or investigation relates to undisclosed foreign financial assets, and regardless of whether the taxpayer knows about the audit or investigation, that taxpayer will not be eligible for any of the IRS’s disclosure programs mentioned above. Taxpayers should seek professional tax advice before entering into one of the IRS’s disclosure programs.

IRS Issues Additional Guidance as to When Construction Begins for Production Tax Credit
As described in prior newsletters, a taxpayer is entitled to a production tax credit (PTC) with respect to sales of electricity from certain qualified facilities where construction of the facility began before January 1, 2014. The IRS had previously provided two methods to determine when construction began on a qualified facility – a physical work test and a 5 percent safe harbor test.
Recognizing that uncertainty as to whether particular projects will qualify for the PTC has delayed outside investment, the IRS has issued additional guidance. The new guidance clarifies that the physical work test focuses on the nature of the work performed, not the amount or cost. Assuming the work performed is of a significant nature, there is no fixed minimum amount of work or monetary or percentage threshold requirement.
The IRS also clarified that a taxpayer may begin construction of a facility with the intent to develop it at a certain site but thereafter transfer equipment and other components of the facility to a different site, where development is completed and the facility is placed in service. The work performed or amounts paid or incurred by the taxpayer before 2014 may be taken into account for purposes of determining when construction began with respect to the facility.
The IRS also clarified rules relating to transfers of equipment between unrelated parties. If a facility is transferred by a developer to an unrelated taxpayer, the work performed or amounts paid or incurred by the developer before 2014 are taken into account if the facility consists of more than just tangible personal property but not if it consists solely of tangible personal property (including contractual rights to the property under a binding written contract).
The new guidance adds another safe harbor in the case of a single project comprising multiple facilities. In this case, if the taxpayer paid or incurred at least 3 percent of the total cost of the project before January 1, 2014, the safe harbor will be deemed satisfied with respect to any number of individual facilities as long as the aggregate cost of those individual facilities at the time the project is placed in service is not more than 20 times the amount paid or incurred by the taxpayer before 2014 and the continuous efforts test is met (or deemed met) under prior guidance. For example, assume Developer incurs $30,000 in costs prior to January 1, 2014, to construct a five-turbine wind farm that will be operated as a single project. In October 2015, Developer places the project in service. The total cost of the project is $800,000, with each turbine costing $160,000. Since Developer incurred at least 3 percent (but less than 5 percent) of the total cost before 2014 and satisfied the continuous efforts test by placing the project in service before 2016, Developer may claim the PTC on electricity produced from three of the turbines ($480,000 cost of the three turbines is less than 20 x $30,000 incurred before 2014; that would not be the case based on four turbines).
For more information, please contact Alan J. Tarr at atarr@loeb.com or 212.407.4900.
The End of the Year Is Rapidly Approaching
Now is a good time to think about year-end tax planning in multiple areas. Many people take advantage of the annual exclusion from gift tax that is available to each person to make gifts each year. For 2014, the annual exclusion amount is $14,000, and this amount can be given to an unlimited number of donees. You can also make direct payments of tuition and medical expenses for an individual without incurring any liability for gift tax. These payments are not subject to and do not count against the $14,000 annual exclusion amount.
Interest rates also remain very low, but many think increases are on the horizon. Intra-family sales of assets can be structured with loans bearing interest at the Applicable Federal Rate (AFR). For October 2014, the AFR for loans with a maturity of more than three but less than nine years is 1.85 percent for loans requiring annual payments of interest. For loans with a term of nine years or more, the rate is 2.89 percent with annual payments of interest. For very short-term loans of not more than three years, the rate is .38 percent for loans requiring annual payments of interest. Certain other wealth transfer strategies also benefit from a low interest rate environment. Included among these are grantor retained annuity trusts (GRAT). For September 2014, the discount rate used to compute the required annuity payment is 2.2 percent.
It may be advantageous to pay deductible expenses and make charitable contributions before year-end unless you have reason to believe your tax bracket will be significantly higher next year. Many itemized deductions are impacted by the alternative minimum tax, so you will have to prepare, or work with your accountant to prepare, a reasonably accurate tax projection.
Depending on your age, you may want to either make deductible contributions to retirement accounts or be required to take minimum distribution amounts out of the plan. Penalties apply where a required minimum distribution is not taken.
Finally, if you have realized capital gain income, you may wish to see if you have investments or other assets with unrealized losses you could sell to reduce your taxable gain. If you sell stock or other securities at a loss and wish to repurchase the same stock or securities, you can do so if you wait for 30 days after your sale. If the same stock or security is purchased within 30 days before or after your sale, the loss will not be deductible.
IRS Changes Rules Regarding IRA Rollovers
The IRS has issued Announcement 2014-15, which provides that the IRS will be following the decision in Borrow v. Commissioner, TC Memo 2014-21. That case holds that the one-rollover-per-year rule under Section 408(d)(3)(B) applies to all of a taxpayer’s IRAs, not to each IRA separately. This is a change in the IRS position, and the IRS has indicated that it will be rewriting Publication 590 to reflect this change. This means that the one-rollover-per-year rule (applied on a 12-month basis, not a calendar-year basis) is now going to apply on a taxpayer basis, rather than an IRA by IRA basis. Note that there is no limit on the number of direct transfers. The IRS has announced that it will not apply the new rule to any rollover that involves an IRA distribution occurring before January 1, 2015.
Tax Court Addresses Income, Estate and Gift Tax Issues Related to Personal Goodwill
In the recent case of Bross Trucking, Inc., TC Memo 2014-107, the Tax Court again considered whether the shareholder of a corporation was possessed of personal goodwill relative to the business of the corporation. The case is important because the existence of personal goodwill may enable a shareholder of a C corporation that is selling its assets to receive a significant part of the purchase price directly from the buyer, rather than through the corporation. If a C corporation sells its assets, the corporation pays tax on any gain realized, and if the after-tax proceeds are distributed to the shareholders, they may realize additional gain and pay additional tax at their level. If the shareholder can establish that he owns personal goodwill related to the corporation’s business, he can sell that goodwill directly to the buyer and avoid any corporate tax on that component of the sales price.
A sale was not at issue in the Bross case. Mr. Bross was the sole shareholder of Bross Trucking, which provided trucking services to construction companies, many of which were owned by members of his family. Bross Trucking was charged with several regulatory violations and was in danger of having its trucking operations shut down, so Mr. Bross decided that Bross Trucking should cease its trucking business. To ensure continued availability of trucking services for his construction companies, Mr. Bross’ sons formed a new trucking company. No assets were actually transferred from Bross Trucking to the new company, but about 50 percent of its employees were former employees of Bross Trucking.
On audit, the IRS took the position that Bross Trucking distributed its goodwill to its shareholder Mr. Bross, who then made a gift of that goodwill to his sons. This distribution would cause the corporation to recognize a tax gain because the goodwill had significant value but no tax basis. The Tax Court determined that Mr. Bross personally owned any goodwill that existed. There were a few keys to this conclusion. The court found that Mr. Bross developed numerous personal relationships with customers and suppliers that were important to the business of Bross Trucking. Mr. Bross had no employment agreement in place with Bross Trucking that prohibited him from competing with the corporation. In the court’s view, this meant that any goodwill attributable to those relationships was owned by Mr. Bross and not by Bross Trucking. Additionally, Bross Trucking could not really have goodwill of any significant value, given that it was on the verge of being shut down by the regulators.
Finally, the court considered whether there could have been a transfer of goodwill associated with the workforce in place at Bross Trucking by virtue of the fact that 50 percent of the new company’s employees had previously been employed by Bross Trucking. The court determined there was no transfer of a workforce in place because the new company hired its own employees and there was no plan or program for such an employee transfer. Also, the other 50 percent of the employees of the new company, including a number of key employees, did not previously work for Bross Trucking.
The IRS also contended that Mr. Bross made a gift to his sons of the goodwill assets he received from Bross Trucking. The court held he did not transfer any goodwill to his sons because he did not receive any goodwill from Bross Trucking. This does not mean that Mr. Bross could not have made a gift of his own personal goodwill in the trucking business to his sons. The court’s apparent reasoning for there being no gift by Mr. Bross of his own goodwill was its factual finding that the new company developed its own customers through the contacts the sons had and the company did not use any of Mr. Bross’ goodwill.
Tax Court Attributes Significant Value to Personal Goodwill in Estate Tax Valuation Case
Two months after the Tax Court decided the Bross Trucking case, it addressed the significance of personal goodwill in valuing the stock of a closely held corporation, STN.Com Inc. in Estate of Franklin Z. Adell, TC Memo 2014-155. The decedent, Franklin Adell, owned all of the shares of STN stock. His son Kevin was the president of STN and was instrumental in the development of its business.
STN provided cable uplinking for its only customer, the Word, which was a 24-hour, urban, religious programming station. Kevin had prior experience with religious programming and used his connections to garner the support of various religious leaders in launching the Word.
In valuing the STN shares for Franklin’s estate tax return, the estate appraiser used the discounted cash flow method, projecting future revenue for the five years subsequent to death. In determining the projected cash flow during that period, the estate’s appraiser reduced the cash flow by an economic charge for Kevin’s personal goodwill because STN’s revenue was dependent upon Kevin’s relationships. Kevin had no employment agreement with STN and was not subject to a covenant not to compete. The appraiser quantified the economic charge at between 37 and 44 percent of sales. There is no explanation in the decision as to how this very sizable charge was derived.
The Tax Court accepted this valuation, concluding that because Kevin was free to leave STN and compete against it, the large economic charge taken was warranted. This economic charge had an enormous impact on the value of STN, reducing the value by more than 70 percent from what it would have been without the economic charge.
This adjustment for personal goodwill was enormously beneficial to the estate, resulting in a final valuation which was about one-third of the IRS appraiser’s value. The reduction attributable to Kevin’s personal goodwill is conceptually similar to a loss of key person discount. However, the decisions authorizing such a discount have generally quantified that discount at 5 to 15 percent. The economic charge applied in the Adell case is tantamount to a loss of key person discount of more than 50 percent.
It remains to be seen whether this valuation approach to personal goodwill could supplant the much more modest loss of key person discount in the future. However, the taxpayer victories in Bross Trucking and Adell could also turn into a double-edged sword. The IRS asserted in Bross Trucking that the transfer of personal goodwill was a taxable gift. The court did not reject that possibility entirely, but found that the facts did not support that such a transfer was made. However, suppose Kevin Adell had used his personal relationships to help establish his children in a new cable uplinking venture. The rationale behind Bross Trucking and the quantification of personal goodwill endorsed in the Adelldecision could result in the IRS asserting that Kevin Adell’s assistance to his children amounted to a multi-million-dollar taxable gift.
California Franchise Tax Board Expands Concept of Doing Business in California for Out-of-State Corporations
In a legal ruling issued in July, the California Franchise Tax Board held that where the only contact with California an out-of-state corporation has is as a member of a limited liability company that is doing business in California, the out-of-state corporation is doing business in California for the purposes of the $800 minimum franchise tax imposed each year on corporations incorporated in, or doing business in, California. The ruling does not draw any distinction between member-managed and manager-managed limited liability companies.
The State Board of Equalization had held in a 1996 case that a limited partner of a limited partnership doing business in California is not considered to be doing business in California merely as a result of being a limited partner, if it had no other contacts with the state. The FTB apparently feels that limited liability companies are different from limited partnerships, although this distinction is murky at best in the case of a non-managing member of a manager-managed limited liability company. It remains to be seen whether this ruling will pass judicial muster for the nexus required under the United States Constitution in order for a state to be able to tax the income of a non-California-based taxpayer.
Recent Case Emphasizes Importance of Keeping Records of the Tax Basis of Assets 
A Tax Court case that was recently affirmed by the United States Court of Appeals highlights the importance of keeping good records of the income tax basis of your assets. In the case of Hoang v. Commissioner, the taxpayer did not report any gains from securities sales on his 2006 income tax return. The IRS, however, received copies of 1099s issued in the taxpayer’s name by various brokerage firms. The IRS assessed tax based on a taxable gain equal to the total proceeds reported on the 1099s. In the Tax Court, the taxpayer was given the opportunity to provide evidence of his income tax basis in the securities sold, but he declined to do so. The Tax Court determined, and the Court of Appeals agreed, that the IRS was correct in determining the gain as the full amount of the proceeds received from the sales.
The mandatory broker reporting of tax basis will greatly alleviate these issues as to investments held in brokerage accounts. As to other asset classes, however, it is up to taxpayers to keep records of the adjusted income tax basis of their assets and to prove thebasis if called upon to do so in an audit.
Court Holds That Land Sold Was Inventory That Gave Rise to Ordinary Income
We normally think that selling a parcel of land one has held for a long period of time will result in capital gain income subject to federal income tax at a lower rate than ordinary income. A recent court decision reminds us that this is not always the case. Mr. Allen purchased a parcel of real property in 1987. He admitted during pretrial discovery that he purchased the property with the intent of developing it for sale. He attempted to develop the property through 1995 but was not successful. He then spent four years looking for financial partners and developed multiple sets of plans for the development of the property. In 1999, Mr. Allen sold the property to a developer under an agreement that called for him to receive a specified amount each time the developer sold a lot from the property. Mr. Allen received the final installment payment in 2004.
Mr. Allen reported the sale on his tax return as giving rise to a long-term capital gain. Following an audit, the IRS determined that Mr. Allen always intended to sell the property and worked to do so from the date he acquired the property. Therefore, in the IRS’s view, the property was “held primarily for sale” and was not a capital asset in Mr. Allen’s hands.
As a starting point, most kinds of property are capital assets under the definition contained in the Internal Revenue Code. The Code also contains a number of exceptions, however. One exception is any property that is held by the taxpayer primarily for sale. It is well established that when somebody buys a tract of land and then subdivides it and sells individual lots, those lots are not capital assets because the taxpayer bought the land with the intention of selling it. This is a very subjective area because most of the time when somebody purchases an investment, he or she hopes to realize a gain by selling it at some point, yet sales of assets held for investment do give rise to capital gain income in most cases. The court attempts to draw distinctions between situations where a taxpayer purchases something and it appreciates over time and situations where the taxpayer attempts to add value by working to transform the nature of the asset.
The case ended up in the United States District Court for the Northern District of California. The court determined that Mr. Allen purchased the property with the intent to develop and sell it and was actively involved in attempting to develop the property for the sale of lots. While Mr. Allen claimed that he had abandoned his development efforts, the court found that he had not done anything to demonstrate when or why his intent changed with respect to the property.
An interesting aspect of the court’s analysis centers on the fact that Mr. Allen made only a single sale with respect to the property. It is a commonly held view that one cannot be viewed as holding property primarily for sale if the owner disposes of it in a single-sale transaction. The court noted that any notion of a “one-bite” rule, in the words of the court, has been rejected in other cases.
The takeaway from this case is that if you purchase property intending to develop it but later change your mind, you need to do something visible and provable that will document your changed intention regarding the property. For example, if you had applied for a subdivision map or other entitlements, withdrawing your application could be used later as evidence of your changed intention regarding the property. This case reminds us that selling the property in a single-sale transaction may not be enough to generate capital gain income, even where the property had been held for 12 years.
Another Taxpayer Mistake Causes Loss of Charitable Contribution Deduction
It has become unusual for a month to go by without the tax news reporting another case where a taxpayer has lost a charitable contribution deduction due the failure of the taxpayer to follow all of the rules relating to the particular deduction. We have written about this before but it continues to be in the news, and it is apparent that the IRS is continuing to scrutinize closely deductions for charitable contributions. In order to obtain a deduction, the taxpayer must follow a series of very particular rules. A series of court cases indicates there is virtually no margin for error.
A recent case in this area deals with conservation easements. In Seventeen Seventy Sherman Street, LLC (TC Memo 2014-124), the Tax Court disallowed the taxpayer’s charitable contribution deduction because the taxpayer failed to take into account the value of property received back in the transaction. In computing his charitable contribution deduction, the taxpayer must subtract from the gross amount of his gift the value of anything that the taxpayer receives back as a result of making the gift.
The property item that caused the taxpayer to lose his deduction was much less common than the kinds of things normally received, such as attendance at a banquet or the value of goods or services purchased at a charitable auction. In this case the taxpayer dedicated a conservation easement over property the taxpayer owned and hoped to develop. In consideration for the granting of the easement, the taxpayer received a zoning change for the property. The taxpayer did take the value of the zoning change into account in determining the value of the easement for purposes of computing his income tax deduction.
The taxpayer also received a recommendation from the local planning and development agency to the planning board that the taxpayer’s request for a variance from the view preservation ordinance be approved. The taxpayer did not put any value on this recommendation or make any corresponding reduction to the amount of his contribution deduction. The court determined that the recommendation was a bargained-for consideration that, based on the record in the case, was very important to the taxpayer. The taxpayer had not submitted any evidence as to the value of the recommendation; therefore, the court was unable to determine whether the value of the easement granted was greater than the value of the consideration received back by the taxpayer. In short, the court could not determine whether the taxpayer had given anything, so it did not allow any deduction.
Posted on 4:12 PM | Categories:

Coinbase Leads Move to Bring Bitcoin to Masses

Anthony Effinger for Bloomberg writes: Brian Armstrong and Fred Ehrsam certainly look like the kind of guys who could help bitcoin recover from its wild years.
They are tall and textbook fit, and as poised as Swiss bankers -- Vulcan Swiss bankers. Armstrong, 31 and a former software engineer at Airbnb Inc., shaves his head. Ehrsam, 26 and a former foreign-exchange trader at Goldman Sachs Group Inc. (GS), keeps his hair short and very much in place. When they discuss bitcoin, they rarely smile. Do not try to make them laugh.
Their seriousness is understandable, Bloomberg Markets magazine will report in its November 2014 issue. Armstrong and Ehrsam are the founders of a startup called Coinbase Inc., whose mission is to convince everyone that bitcoin isn’t an Internet scam or a libertarian plot against the government or a digital version of goldbuggery, as various skeptics have it. Rather, it’s the best thing to happen to money since the Lydians started minting coins sometime in the seventh century B.C.

Coinbase’s aim is to take a curio currency that exists only as bits on the Internet and turn it into a coin of the realm -- every realm, because part of the appeal of bitcoin is that it can cross borders as easily as e-mail.

Bitcoin Heists

It’s a big job. Reputation is everything when it comes to currency, and bitcoin’s has taken some hits. In 2013, the FBI busted Silk Road, an online drug market that ran on bitcoins. In February 2014, Tokyo-based Mt. Gox, once the largest bitcoin exchange in the world, collapsed, and suddenly 850,000 bitcoins, worth $500 million at the time, were just ... gone. (Two hundred thousand of the missing bitcoins later turned up.)
Before and since, there have been numerous bitcoin heists, blamed on hackers, and more than a few bitcoin losses -- people literally lose their bitcoins by misplacing the code that proves ownership. If you do that, there’s no reset, no more than if you drop a $100 bill through a sewer grate.
“Right now, it’s just about making people feel safe and secure,” Ehrsam says in an interview at Coinbase’s headquarters. Coinbase looks like a startup, with rows of industrial-sized Apple computers on Ikea tables, except that it’s on the 26th floor of a building in San Francisco’s financial district, nestled among the very banks bitcoin lovers love to hate.

Ripe for Replacement

Bitcoin is worth a makeover, Armstrong and Ehrsam say, because the currency solves so many problems that come with putting old technology, in particular credit cards, on the Internet. When consumers use bitcoins, merchants pay fees that are a fraction of what credit card companies get. Users can shop online without giving their names, never mind credit card information -- which, yes, explains Silk Road but also allows noncriminals to claw back some privacy.
As for security, the bitcoin system has thwarted every attack thus far. Recent hacks of Target Corp. (TGT) and JPMorgan Chase & Co. (JPM) show how the old forms of payment and transfer are ripe for replacement, bitcoin believers say.
Coinbase is a bitcoin blue chip. Armstrong and Ehrsam have scored money and support from Y Combinator, the hyperselective startup booster in Silicon Valley. New York–based Union Square Ventures led a $5 million investment in May 2013, and Marc Andreessen’s Menlo Park, California–based venture capital firm, Andreessen Horowitz LLC, anchored a $25 million B round in December.

Fleecing Merchants

Andreessen may be more stoked about bitcoin than anyone else in techdom. He says it fills a void in the Internet that has existed since he and his friend Eric Bina invented the first widely used Web browser in the 1990s: a protocol for payments. He always imagined that someone would figure out how to send money as easily as data.
(Bloomberg LP, the parent of Bloomberg News and Bloomberg Markets, is an investor in Andreessen Horowitz.)
Like many West Coast entrepreneurs, Armstrong and Ehrsam relish cutting out financial middlemen and have a special scorn for credit card companies. In Armstrong’s view, they entice customers with airline miles, then fleece merchants with fees. “This is the way they’re innovating, playing these games,” he says.
Such fees add up to a big opportunity for bitcoin. Credit card and debit fees in the U.S. totaled $72 billion in 2013, says Gil Luria, an analyst at Wedbush Securities Inc. in Los Angeles. Much of that could vanish if bitcoin catches on, he says.

Infinitely Divisible

Bitcoin arrived in the world on Halloween 2008 in the form of a nine-page white paper called “Bitcoin: A Peer-to-Peer Electronic Cash System,” authored by Satoshi Nakamoto, a person or group of people who remains anonymous. Nakamoto unleashed the bitcoin software, all of it public, in January 2009. The system allowed for the creation of 21 million bitcoins, total, with the last ones to be released in 2140.
Bitcoin lets commerce happen without an overarching authority, be it a bank that clears transactions or even a central bank that controls the money supply. It works because each bitcoin is really just a slot in a huge, peer-to-peer online ledger -- millions of slots, really, because each bitcoin, worth $373 as of yesterday, is infinitely divisible. The smallest unit so far, eight places beyond the decimal point, is called a Satoshi. It was worth about 0.0004 cent as of Sept. 18.

Double Spending

Electronic currencies had been proposed before, but no one could figure out the double-spending problem: You can’t spend the dollar in your friend’s pocket, but you could spend the same electronic dollar twice if you gave it to two people at the same time.
Nakamoto found a solution. No bitcoin transaction is legitimate unless it comports with all of the preceding transactions for each bitcoin involved. Every transaction for every bitcoin is available to every computer that joins the peer-to-peer network that runs the bitcoin system.
Buy a watch on Overstock.com, one of the biggest retailers to take bitcoins, and the system goes to work, checking the common ledger for past transactions that prove you have the money. The purchase isn’t done until all the computers on the network agree.

Bitcoin Miners

Why does anyone devote any time to checking transactions? Because programmers earn new bitcoins for the work -- if their computers also find, by trial and error, the solution to a complex equation that the bitcoin system automatically makes harder as more computing power goes to work on it. This hurdle is designed to prevent a rogue programmer from hijacking the system. Taken together, the checking and solving is called mining bitcoins.
In the beginning, people were able to mine bitcoins on desktop computers. Now, it takes huge rigs built on special chips and running in places, such as Iceland, where the electricity needed to power the machines is cheap.
That magical ledger is called the blockchain, and there is no word more exciting to Silicon Valley venture capitalists these days. Andreessen and others say the blockchain could be used to keep track of not just money but anything that needs third-party verification, such as real estate contracts or stock trades. It might even track voting and guarantee one ballot per person.

‘Ridiculous’

On a website called Proofofexistence.com, it’s possible to turn a document like a lease, or even a novel, into a hash -- a code generated by an algorithm -- and load it into the bitcoin blockchain, proving that it existed at a certain time.
Alec Ross, until last year the senior adviser for innovation at the U.S. State Department and now a consultant, says he loves blockchain technology, but he isn’t convinced about bitcoin. One basic problem: “The unit is ridiculous,” he says. At $373 per bitcoin, it’s too big. Just because it’s divisible into tiny pieces doesn’t mean people will be comfortable with tiny pieces. “It’s an important innovation in computer science,” Ross says. “I just don’t think it’s necessarily going to supplant the euro.”
Armstrong was an early adopter of bitcoin technology. After growing up in San Jose, California, he graduated from Rice University with bachelor’s degrees in economics and computer science and a master’s in computer science, all in 2005. He worked in information technology for Deloitte & Touche LLP and then returned full time to a company he had founded in college, calledUniversityTutor.com. He joined Airbnb, the online lodging company, in 2011, and set to work building the company’s anti-fraud system.

Crossing Borders

While there, he saw how hard it was for Airbnb to handle payments from around the world. Then he discovered the Nakamoto white paper and was dazzled. Here was a currency that could fly across borders via an e-mail. Proficient in a babel of computer languages, he built a digital wallet to hold bitcoins on Android phones. Already, the idea was to make bitcoin accessible, to mainstream it.
He thought there was a company in this. He applied to Y Combinator. The founders of Airbnb and Reddit Inc. went through Y Combinator, as did Justin Kan, founder of the gaming platform Twitch Interactive Inc., which Amazon.com Inc. (AMZN) bought in August for $970 million.

Conspiracy Theorists

Armstrong won a spot in the 12-week Y Combinator session that began in April 2012. Fred Wilson from Union Square Ventures was there doing office hours and met Armstrong. Until then, Wilson says, all the bitcoin guys seemed like ideologues: conspiracy theorists keen to escape what they see as the tyranny of institutions such as the U.S. Federal Reserve. “He didn’t have a hard-core libertarian bent,” Wilson says. “He was focused on solving pragmatic problems with bitcoin.”
Armstrong finished Y Combinator that June, formally launched Coinbase and went looking for money. He called on Adam Draper, son of venture capitalist Tim Draper. Adam was in the midst of starting Boost VC, a Y Combinator–like accelerator in San Mateo, California. He wanted to invest across categories but also to develop a specialty.
“We looked at drones,” he says. “They’re cool, but there are two use cases: One is taco delivery, and the other is national security.”
Draper had heard about bitcoin. Its promise became apparent, he says, after he met Armstrong at Red Rock Coffee in Mountain View, California, a hangout for caffeine-seeking coders. They talked amid the clicking of keyboards. After hearing Armstrong out, Draper invested his own money in Coinbase and six months later decided to have Boost focus on embryonic bitcoin companies. He wants to fund 100 of them.

Regulator Worries

The first big challenge Armstrong addressed was how to buy bitcoins easily. Back then, buyers and sellers gathered in parks or bars to trade cash for bits. Others wired money to brokers, often abroad, and hoped. It was hard to turn dollars, or any other currency, into bitcoins.
Armstrong solved that by gaining access to the Automated Clearing House, or ACH, the electronic rails on which certain financial transactions run in the U.S. Employers use ACH to deposit checks in employee accounts, for example. To get on, a company needs a bank to sponsor it. Bitcoin companies struggle, Armstrong says, because banks worry that with bitcoin, you can’t know your customer and prevent money laundering, two things regulators require.

Nakamoto’s Spell

Armstrong scored a banking relationship with Silicon Valley Bank in October 2012. A month later, customers could transfer money from a U.S. bank account to Coinbase and buy bitcoins. No muss, no fuss. Circle Internet Financial Ltd., a Boston-based bitcoin brokerage, also offers ACH transfers.
In New York, Ehrsam had fallen under Nakamoto’s spell. It happened when a friend from Duke University, where Ehrsam had studied computer science, pulled up the white paper. Ehrsam read that and then everything else he could discover about bitcoin. “You could find nobody in person who could explain how bitcoin worked,” he says.
He came across Armstrong’s work on the Internet. They corresponded, and Ehrsam started buying and selling bitcoins, sometimes on his phone from the bathroom at Goldman Sachs. “We traded it for fun and some profit,” he says.
Ehrsam flew to San Francisco and met Armstrong at The Creamery, a coffee shop popular with techies because it’s near the Caltrain station, where people arrive from Silicon Valley for meetings in the city. Both were a little guarded, Ehrsam recalls. “I could tell that the mental horsepower was there,” Armstrong says. “We decided to work on something for a week.”

Pizza Money

They hit it off, and Ehrsam joined Coinbase in November 2012, taking the title of co-founder. Back then, some 15,000 people had wallets on Coinbase, and they bought and sold about $1 million in bitcoins a month, Armstrong says. He and Ehrsam ran the thing by themselves out of a two-bedroom apartment in San Francisco.
At the time, one bitcoin sold for about $13. People still used a whole one to buy a pizza, if they could find a shop that accepted it.
The price of a bitcoin rose for most of 2013, peaking at $1,137 on Nov. 29. By year’s end, Coinbase had more than 600,000 users, and it got a further $25 million from venture capitalists, with Andreessen Horowitz putting in the biggest chunk.

‘Adversarial Environment’

The success of bitcoin, and Coinbase, will depend in part on whether big merchants start accepting it. Armstrong and Ehrsam are pitching them. So far, they’ve convinced computer maker Dell Inc., travel company Expedia Inc. (EXPE) and software maker Intuit Inc. (INTU) to take bitcoins and to open merchant accounts on Coinbase.
The system will have to prove secure, too, for the general public to get on board. Bitcoin “manages to function in a very adversarial environment,” says Paul Kocher, president and chief scientist at Cryptography Research, a part of semiconductor designer Rambus Inc. (RMBS) By that, he means that everyone wants to attack it, because it’s money.
Bitcoin uses something called public-key cryptography, which requires two keys, each a string of numbers and letters. One is public and identifies the sender or recipient in a bitcoin transaction. The other key is private and is used to verify, or sign, the transaction. Unlike a Facebook password, the private key can’t be retrieved with an e-mail if it’s lost. Once it’s gone, it’s gone.

‘Risky Proposition’

Bitcoin seems as futuristic as a light saber until it comes to keeping hold of the private key. Then it seems as ancient and clunky as gold. Fearing hackers, many people print out their private keys, delete them from their computers and put them in safes. Many a bitcoin has been lost to hard drives crashing, according to the U.S. Consumer Financial Protection Bureau.
“For the average consumer, bitcoin is a risky proposition,” says Mercedes Tunstall, a partner at law firm Ballard Spahr LLP in Washington and an expert on data security. Hackers can get private keys off a person’s computer, she says, because people don’t protect them properly.
“If you and I are walking down the street with cash in our pockets, we know how to keep it out of view,” she says. “With bitcoin, there is no way for the average consumer to protect themselves.”

Cold Storage

Coinbase addresses that by keeping everything in house. Coinbase users never even see their private keys. They just have accounts with passwords, and those passwords are backed up with ever-changing codes sent to their phones.
Coinbase, in turn, puts many of the bitcoins it holds in what the company refers to as cold storage. It splits individual private keys, writes them onto USB drives and prints them on paper, and puts everything in vaults and safety deposit boxes at various locations. No one person can retrieve the codes.
“We don’t want someone to come in here, kidnap Fred and me and get a quorum of these keys,” Armstrong says.
Many bitcoin lovers, Ehrsam and Armstrong included, make endless comparisons between e-mail and bitcoin. One sends data, the other money. People freaked out about the security of e-mail in the beginning, and today they send all manner of private information electronically because it’s proved easy to use and secure, provided basic security protocols are observed.
Armstrong and Ehrsam say the same thing will happen with bitcoin. The chance for merchants to avoid credit card fees of 2 percent to 3 percent and the ability to send money for free, anywhere, will attract more and more users, and more and more merchants, they say.
What seems strange and scary now will become familiar, and bitcoin will go from curio to currency. That’s the bet Armstrong and Ehrsam are making, with deadly seriousness.
Posted on 9:40 AM | Categories:

Blog Archive