HB 2173 and “Legal Tender”

HB 2173 and “Legal Tender”

HB 2173 has passed from the Arizona House of Representatives and to the Senate and quickly made its way through the Banking and Rules Committees. I’ve been asked by several constituents to explain why we need this piece of legislation, and what does it mean.

I may seem odd to hear a REALTOR say there is no such thing as “appreciation”, but think about it this way. If you bought a home in 1985 for $150,000 and sold it in 2015 for $300,000 did it really increase in value? Most people would say yes, of course it did. But what of inflation? When you subtract the roughly $150,000 from inflation from the $300,000 of 2015 value, all you have is equity (assuming you have paid off the principal).

Purchasing Power of U.S. DollarHerein lies the story of the loss of purchasing power, not to be confused with “value”. If the purchasing power of the Federal Reserve Bank “Note” (evidence of a slice of Federal government debt) is constantly declining in purchasing power, then by definition you cannot have an increase in value. So at best, owning a home gives you equity and the real property draws a line in the sand for preservation of purchasing power that keeps relative pace with inflation. We now trade “notes” that are evidence of debt as though they had redeemable value for some real thing.  The Arizona Legal Tender Act takes a step to restoring the concept of purchasing power preservation through precious metals that people may choose to exchange.

With help from Mr. Larry Hilton, Esq., an expert on the subject and content contributor to the Arizona bill I’ll endeavor to explain.

For all practical purposes, there exists in the United States today four distinct monetary standards: paper (including base metal coin, collectively “fiat legal tender”), together with silver, gold and platinum (collectively “specie legal tender”). 31 United States Code (U.S.C) §§ 5103 and 5112, see also, Utah Code Annotated (U.C.A.) § 59-1-1501-1. In light of this, citizens would do well not only to understand, but also to claim the benefits of exercising true choice in currency for themselves, their families and communities, as well as the country at large. An overview of the principles governing this important topic follows:

1. Equal Purchasing Power? The Secretary of the Treasury is “to maintain the equal purchasing power of each kind of United States currency.” 31 U.S.C. 5119(a). Significantly, this statutory mandate invokes the market test of “purchasing power”, not merely parity of nominal face value. To this end, Congress has provided the secretary with a variety of statutory tools. These include the directive to buy and sell precious metals from the country’s reserves (Id.) as well as the requirement that all proceeds from the sale of gold be used “for the sole purpose of reducing the national debt.” 31 U.S.C. § 5116(2) (Reagan’s Golden Rule).

Nevertheless, as a result of the secretary’s failure to make effective use of these statutory prerogatives, the purchasing power of the various U.S. currencies currently in circulation, particularly that of specie legal tender in contrast to that of the fiat paper currency, has increasingly diverged over the past several decades, which creates hazards as well as opportunities for individuals, businesses, and governmental entities alike.

2. Legal Distinction Between Dollar Standards? Notwithstanding the growing disparity in the purchasing power of the various kinds of dollars in circulation today, federal law continues to draw no legal distinction between specie and paper dollars. As the 5th Circuit recently observed, “a dollar is a dollar regardless of the physical embodiment of the currency.” Crummey v. Klien, 295 Fed.Appx. 625, 627 (5th Cir. 2008). Notably, the Crummey Court simply followed long-standing Supreme Court precedent: A coin dollar is worth no more for the purposes of tender in payment of an ordinary debt than a note dollar. The law has not made the note a standard of value any more than coin… The law knows no difference between them. Thompson v. Butler, 95 U.S. 694 (1877)

The anomaly created by the general government’s failure to maintain the equal purchasing power of each kind of currency, coupled with the absence of any legal distinction between them, provides a powerful incentive for transacting parties to tender the dollar type best suited to their respective economic interests, e.g., taking in specie legal tender for goods and services, and then paying taxes on the same in paper dollars.

3. State Legal Tender Laws? Of course, a transact-in-gold/pay-tax-in-paper strategy would severely impact tax receipts. For example, at the current 25 to 1 gold/paper dollar ratio, taxing authorities would lose in excess of 95% of the purchasing power of their collections.

From the federal government’s perspective, the lure of unfettered paper money creation may well more than compensate for this loss, but such cavalier indifference clearly imperils state and municipal tax revenues. Fortunately, states can take action to close this federally countenanced tax loophole. The U.S. Supreme Court recognized in Lane County v. Oregon, 74 U. S. 71 (1868) that in the performance of its “essential functions” a State possesses broad powers to specify acceptable tender for the payment of taxes:

If, therefore, the condition of any State, in the judgment of its legislature, requires the collection of taxes in kind, that is to say, by the delivery to the proper officers of a certain proportion of products, or in gold and silver bullion, or in gold and silver coin, it is not easy to see upon what principle the national legislature can interfere with the exercise, to that end, of this power, original in the States, and never as yet surrendered. 

Thus, a state may declare tax liability arising out of transactions in specie legal tender be paid in like tender. Indeed, Utah has done just that and Arizona appears poised to follow suit. At present four states have legal tender laws on the books. See, Colorado Revised Statutes Annotated § 11-61-101; Vernon’s Annotated Missouri Statutes § 408.010; Oklahoma Statutes § 62-4500; and UCA § 59-1-1501, et seq.

4. Gold Clause Contracts? While the general government has expressly withdrawn its consent to obligations requiring tender of a particular type of dollar (31 U.S.C. § 5118(b)), states appear to be under no such disability. Moreover, since October 27, 1977, private parties within the United States have been legally authorized to require that contractual obligations between them be paid in “a particular United States coin or currency”, including specie legal tender. 31 U.S.C. § 5118(c)(2). Thus, taxpayers appear to be free to incur tax liability using one form of legal tender and pay their taxes in another, unless a state taxing authority has required otherwise, as is the case with respect to Utah sales taxes. UCA § 59-12-107(3)(h).

5. Circulating vs. Non-Circulating? Ever since the Coinage Act of 1965, by which President Johnson dispensed with the Constitutional silver dollar standard that had served the country’s economy so well for 173 years (with rare exceptions during wartime), tax courts have struggled with the tax implications of the ever widening specie/paper purchasing power gap. During the 20-year moratorium (1965 to 1985) on U.S. mintage of specie legal tender, the courts developed the judicially-crafted rule of non-circulating and/or numismatic specie legal tender being treated as taxable “property other than money” pursuant to 26 U.S.C. § 1001(b). See, Rev. Rul. 68-634, 1968-2 CB 46; Rev.Rul. 78-360, 1978-2 C.B. 228; Cordner, 45 AFTR2d 80-1677 (DC Calif., 1980); California Federal Life Insurance Co. v. Commissioner of Internal Revenue, 680 F.2d 85 (9th Cir. 1982), affg. 76 T.C. 107 (1981); Joslin v. United States, 666 F.2d 1306 (10th Cir. 1981), affg. 1981 WL 186; Cordner v. United States, 671 F.2d 367 (9th Cir. 1982); Lary v. Commissioner of Internal Revenue, 842 F.2d 296 (11th Cir. 1988). All of these cases involved tax years which occurred within the mintage moratorium. So arguably specie coin was not technically “circulating,” as legal tender at that time.

However, following the resumption of specie legal tender mintage pursuant to the Liberty Coin and Gold Bullion Coin Acts of 1985, some courts have continued to uncritically extend the rule developed during the moratorium into the new era of specie legal tender circulation. See, Smith v. Commissioner of Internal Revenue, T.C. Memo. 1998-148 and United States v. Kahre, 2007 WL 1521064. Notably, none of the cases which have embraced the “non-circulating” rationale reference or in any way acknowledge the Supreme Court’s holding in Thompson v. Butler, supra, which draws into question their validity.

A legal tender statute that just passed the Arizona House expressly provides that “legal tender is money and is not subject to taxation or regulation as property other than money.” This is significant not only as a repudiation of the foregoing line of federal cases which rely on 26 U.S.C. § 1001(b) to characterize specie coin as taxable “property other than money”, but also because as a general rule federal law first looks to state law to determine the characterization of property rights: 

The federal tax lien statute itself creates no property rights but merely attaches consequences, federally defined, to rights created under state law.” [citations omitted.] Accordingly, “[w]e look initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach … United States v. Craft, 535 U.S. 274, 278, 122 S. Ct. 1414, 1420, 152 L. Ed. 2d 437 (2002).

Accordingly, state legal tender laws may well play an important role in shaping national monetary and tax policy going forward.

6. Monetary Intent? One important factor in determining the tax treatment of a particular transaction appears to be taxpayer intent. In Thorne and Wilson, Inc. v. Utah State Tax Commission, 681 P.2nd 1237 (1984), the Utah Supreme Court considered the applicability of sales tax to the purchase of precious metal coinage. Following the holding in Michigan National Bank v. Department of Treasury, 339 N.W.2d 515 (1983), the court in Thorne determined that:

[W]here Krugerrands are transferred as a medium of exchange … the coins remain intangible personal property, not subject to tax. But where … they are transferred as an investment commodity, they become tangible personal property within the meaning of the General Sales Tax Act.” Thorne, supra at 1239.

The Thorne court expanded on the Michigan National Bank holding applying it to both “United States and foreign coins, when they are not used as currency or a medium of exchange”. Ibid. at 1239. Significantly, Thorne was handed down during the specie legal tender mintage moratorium. Even then, the court found that whether specie is used as money or as investment property is determinative of its tax treatment.

More recently, an Ohio federal district court ruled that where coins are “not used as legal tender, but instead … traded and converted based on their intrinsic or tangible metallurgical value”, such lose their monetary status. U.S. ex rel. Holbrook v. Brink’s Co., 2015 WL 196424 (S.D. Ohio Jan. 15, 2015). Thus, intent becomes paramount.

7. Tax Strategies In light of the foregoing, taxpayers who make use of specie legal tender in the course of their financial dealings may reasonably and in good faith calculate their tax liabilities using the nominal face value of the legal tender with which they transact. Nevertheless, to remain well within the “monetary intent” safe harbor, prudence would dictate consideration of the following precautions: Choice in Currency—Overview Page !4 of 6. Legal Tender Exchange © 2015

1. Use gold clause contracts with counter-parties whenever possible;

2. Make payments though escrow to those unwilling to commit to gold clause provisions;

3. Freely convert paper legal tender to specie legal tender, but avoid exchanges in the opposite direction;

4. When consummating transactions involving specie legal tender, maintain some tie to a state which expressly recognizes U.S. specie coin as legal tender;

5. Use custom specie legal tender tax forms (samples attached) to make full, good faith disclosure to taxing authorities of the specific types of legal tender underlying tax liability calculations;

6. Consider tendering tax payments in proportion to the actual type of currency used in the underlying transactions, even though “a dollar is a dollar regardless of the physical embodiment of the currency”;

7. Deposit funds with the U.S. Secretary of the Treasury pursuant to 26 U.S.C. § 6603(a) to stop the accumulation of interest liability in the event of a subsequent determination of tax underpayment; and

8. Apply for reimbursement of 6603 deposits under subsection (c) only after the applicable statute of limitations period has run.

The foregoing considerations constitute suggested “belt and suspenders” approaches that taxpayers may wish to employ in whole or in part in consultation with their own tax and legal advisors. Over the past several decades hundreds of tax returns incorporating these principles have been filed with the IRS. A few of these have been subjected to IRS audit scrutiny and all survived without major modification. Other alternative approaches exist as well.

For example, a taxpayer using specie legal tender could translate gold, silver and platinum dollars into paper dollars as would be done with foreign currencies pursuant to the regulations found in 26 C.F.R. §§ 1-985-0 through 1-985-7, as well as in the Financial Accounting Standards Board (FASB) Statement no. 52 protocols. However, one problem with this approach is that specie legal tender is not a foreign currency, it is in fact United States legal tender.

A related strategy would be to claim a currency conversion loss on paper to specie legal tender exchanges necessitated by gold clause contractual obligations. Assuming a 25 to 1 paper/ specie exchange rate, $100,000 would convert to $4,000, yielding a $96,000 loss in nominal face value of the currency. At least one U.S. taxpayer has claimed such losses for the past 30 years with full IRS knowledge and acquiescence. For consistency sake, that taxpayer has committed that any exchange in the opposite direction would be recognized as a gain.

Another alternative approach would be to treat specie legal tender as partly money and partly property other than money as certain tax courts have done. However, this approach is problematic as well since the underlying case law supporting it was developed during the 1965-1985 precious metal mintage moratorium. Now that specie legal tender has been reintroduced into circulation, the court-developed rationale has become obsolete.

8. Conclusion As illustrated above, a solid historic, judicial and statutory basis exists for U.S. citizens to exercise informed choice in currency. Nevertheless, because of the tax implications of incorporating specie legal tender into one’s financial life, certain precautions are advisable. The United Precious Metals Association (UPMA) incorporates many of these best practices into the programs and services it provides to its members. For additional information, visit upma.org. 9.

Disclaimer The information provided herein is intended for general informational purposes only. This document is not to be construed as having created any attorney/client relationship. Interested persons are encouraged to seek independent, professional advice from qualified professionals. Legal Tender Exchange © 2015

Other states that has passed Legal Tender statutes are Utah, Colorado, Missouri and Oklahoma.  Others are now taking a serious look at this protective step to give the American economy a choice.

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