The awareness and popularity of Bitcoin have continued to grow dramatically in recent years. More and more people are hearing about the perceived advantages and disadvantages of this new medium of currency which its most ardent supporters believe will inevitably decouple the entanglement between government and money. Many people who would like to interact with the new currency are intimidated by the technical requirements surrounding custody. This is an obstacle many companies in the ecosystem are trying to solve. Fortunately, one company allows its users to acquire bitcoin by making purchases individuals are already making and, if the user would like it to, it even holds its users’ bitcoin.
Lolli (which can be found at Lolli.com) allows its users to make purchases at participating partners and receive bitcoin back. The stores that Lolli currently has partnered with are extremely well known and range from grocery stores, pet stores, the secondary ticket market, and so many more. Recently, Lolli released a feature that allows its users to link a credit card and earn bitcoin with in-store purchases at companies like CVS, Starbucks, McDonalds, and many more. It is not a stretch to say everyone in the United States could use Lolli’s services to purchase products the individual is already purchasing on a weekly basis at a discounted price all while acquiring bitcoin.
The structure of Lolli is not new as several companies have utilized the concept of providing an incentive to users for purchasing items at participating partners. Credit card companies and start-ups like Rakuten (formerly known as Ebates) and Lemoney provide their users cashback for purchases at participating partners. The concept of Lolli is similar except Lolli provides its users satoshis (a satoshi is one hundred millionth of a single bitcoin) instead of cash for purchases at participating partners.
According the Lolli’s Terms and Conditions, Lolli receives a fee (presumably in the form of US dollars) from participating partners when a Lolli user makes a qualifying purchase. Lolli then provides a portion of the fee that the participating partner paid Lolli to the user who made the qualifying purchase in the form of bitcoin. Thus, the innovation of Lolli is that it allows its users to acquire satoshis (i.e. stack sats) while shopping at Lolli’s participating partners. Lolli makes it easy for everyone in the United States to acquire some bitcoin and it will even hold the bitcoin for its users so long as the user wishes (although Lolli does limit its liability to $50 in its terms of service so when a user’s bitcoin value eclipses that threshold, finding an alternative custody solution would be prudent).
Aside from spreading the word about Lolli’s great services the purpose of this article is to discuss the tax consequences of a Lolli transaction. There are three important questions that need to be examined when determining the tax consequences of the Lolli incentive program. First, does the bitcoin accumulated through the Lolli program count as gross income for the Lolli user? Second, what is the Lolli user’s basis in the bitcoin accumulated through the Lolli program? Finally, when does the holding period for the Lolli user’s bitcoin acquired through the Lolli program begin? The remainder of this article explores each of these questions.
Does the Lolli Program Create Gross Income for its Users?
As a general rule the Internal Revenue Code (IRC) instructs that gross income means all income from whatever source derived (see IRC section 61(a)). Therefore, barring an exemption or exception any bitcoin accumulated through Lolli would need to be included in an individual’s gross income. However, there is a clear exception that applies to rebate programs. It is well established that a rebate received by a buyer (in this case a Lolli user) from a party to whom the buyer directly or indirectly paid the purchase price for an item (in this case the Lolli participating partner) is an adjustment in purchase price, not an accession to wealth, and is not includible in the buyer’s gross income. (emphasis added)(see (PLR – 141607-09, Rev. Rul 76-96, 1976-1 C.B. 23, as modified by Rev. Rul 2005-28, 2005-1 C.B. 997). Therefore, it is clear that a Lolli user does not need to include the value of the bitcoin it receives in the user gross income for a year.
What is a User’s Basis in the Bitcoin Acquired through a Lolli Transaction?
The next important tax question is what is a user’s tax basis in the bitcoin a user acquires in a Lolli transaction. In general, a taxpayer’s basis in property is the cost of such property. The main purpose of basis can best be thought of as trying to prevent the dollars used to purchase an item to not be taxed twice. In general, once a taxpayer’s basis is established, the owner will only be taxed on the appreciation from the basis amount or able to claim a loss from the basis amount. In the case of a Lolli transaction, the property in question is the bitcoin acquired.
In a Lolli transaction the structure of the deal allows the participating partner to provide a discount to the Lolli user. Lolli charges the participating partner a fee for creating the purchase of a Lolli user from a participating partner. Lolli then takes a portion of the fee it charges and provides the Lolli user with satoshis and keeps the other part as its fee.
The Lolli user has already been taxed on the dollars it is spending to purchase the item in the Lolli transaction. Remember the IRS treats the reduction in price as an adjustment to the purchase price. Therefore, to achieve the goal of preventing double taxation the Lolli user must take a basis in the satoshis it receives equal to the dollar price of the discount it receives from Lolli.
A simple example will help explain the concepts. Suppose McGee wants to take his best friend Riley to Hawaii. McGee uses Lolli’s services and books his hotel and airfare through Expedia receiving 5 percent back on his purchase. The trip costs McGee $2,000 and the price of bitcoin is $25,000 at the time of McGee’s purchase. McGee would receive $100 ($2,000 * 0.05 = $100) worth of bitcoin from the Lolli transaction. Lolli transfers McGee the $100 worth of bitcoin which would equate to 0.004 ($100/$25,000) bitcoin or 400,000 satoshis (0.004 * 100,000,000). McGee’s basis in the 400,000 satoshis would be $100 or if you want to get really granular every one of the satoshis would have a basis of $0.0003. We plan to explore why this will likely matter in a future publication and why it is such a daunting task for the bitcoin community to tackle.
When Does the Holding Period Begin for a Lolli User?
As discussed in our previous publication, when an individual’s holding period begins is critical to determining if future transactions will be taxed at the ordinary income rate (short-term capital gains) or the preferrable capital gains rate (long-term capital gains). The sole question is whether the taxpayer held the asset, in this case bitcoin, for longer than one year. If the taxpayer held the bitcoin for a year or less, any future transaction would be treated as short-term capital gain (or loss). Conversely, if the taxpayer held the bitcoin for more than a year, any future transaction would be treated as long-term capital gain (or loss). We encourage you to review our previous publication for additional details.
The key for a Lolli user is determining when it takes possession of the bitcoin (or satoshis) so it knows when it can start counting days to make the bitcoin fall into the preferential long-term umbrella. We believe the correct time to start a Lolli user’s holding period is when the Lolli user receives an email confirming the reward. The timing of these emails differs depending on which participating partner is involved in the transaction. For instance, a Lolli user could expect to receive an email confirming the reward for a purchase at CVS within a few days of the actual purchase. However, if a Lolli user earned rewards for a purchase of travel, like McGee in the example above, through one of the many participating partners, the Lolli user may not receive an email confirming the reward until after the travel occurs. This could take some time. Regardless, the email confirming the reward is a logical time for the Lolli user to start counting days for the Lolli user’s holding period.
Circling back to our example from above, assume McGee purchased the trip from Expedia on July 2, 2022. McGee and Riley set off on their adventure on October 31, 2022 and return November 7, 2022. Lolli provides McGee an email confirming the reward on November 10, 2022. For the purposes of McGee’s holding period with respect to the 400,000 satoshis involved with the transaction, November 10, 2022 would be the relevant date.
Conclusion
Lolli offers individuals a way to gain bitcoin exposure through every day purchases. The initial Lolli transaction does not create any tax obligations for the Lolli user. However, a Lolli user should keep track of each transaction so it knows its basis and when its holding period begins. These numbers will be unique for each Lolli transaction. If you have any questions regarding the concepts discussed in this article, please don’t hesitate to contact us.
