By Jonathan Weil

If you think MicroStrategy's business model is wild, wait until you see its tax issues.

After years of raising money through stock and debt offerings to buy bitcoin, MicroStrategy owns a stash worth about $47 billion, which includes $18 billion of unrealized gains. In an unusual twist, it could have to pay federal income taxes on those paper gains -- even if it never sold a single bitcoin. The tax bill could total billions of dollars starting next year, according to a new disclosure this month by MicroStrategy that has received little attention.

Usually investment gains aren't taxed until the assets are sold. But under the Inflation Reduction Act passed in 2022, Congress created a "corporate alternative minimum tax" in which MicroStrategy now finds itself ensnared. The tax rate would be 15%, based on an adjusted version of the earnings that MicroStrategy reports on its financial statements under generally accepted accounting principles. Its best hope is that the Internal Revenue Service adopts new rules that let MicroStrategy off the hook.

The IRS already has written exemptions into the currently proposed rules so that companies such as Berkshire Hathaway don't have to pay taxes on unrealized gains from securities such as common stocks. However, the IRS so far hasn't included any exemptions for companies' unrealized gains on crypto assets such as bitcoin.

MicroStrategy has been pressing its case with the IRS, and it could be reasonable to expect the government will bend its way, given the Trump administration's outward affection for the crypto industry. The IRS is still in the process of drafting rules to implement the new corporate alternative minimum tax.

Robert Willens, a longtime tax analyst who has been tracking MicroStrategy's IRS issues, said he expects the IRS would decide in MicroStrategy's favor and exclude unrealized gains on cryptocurrencies under its proposed rules, but he noted there is no guarantee it would do so. "If the Biden group was still in place, they probably wouldn't get the exemption," he said. He added that "it would be easy to slot crypto assets into the same exemption that stocks are going to enjoy, because there's no real difference in the accounting."

Meanwhile, the company is in a bind. With a $92 billion stock-market value, MicroStrategy still trades at a substantial premium to the value of the bitcoins it owns. The mere possibility it could have to pay taxes on the unrealized gains is a further reason the premium makes no sense.

If it did have to pay taxes on unrealized bitcoin gains, the company might have to sell some of its bitcoins to come up with the cash, because the rest of MicroStrategy's businesses aren't profitable. Doing that would defeat the purpose of its bitcoin roll-up strategy. It also would make MicroStrategy one of the least tax-efficient ways imaginable for investors to get exposure to bitcoin.

One of the reasons the U.S. enacted the corporate alternative minimum tax was to rein in companies that aggressively recognize earnings for GAAP purposes while at the same time showing little or no taxable income on their IRS returns. Enron, for example, was infamous for posting outsize GAAP earnings during the 1990s while paying no federal income taxes.

In MicroStrategy's case, the company could end up getting hit with the equivalent of a wealth tax -- paying taxes on paper gains that could prove transitory if bitcoin's value falls.

Before this year, companies that owned crypto assets didn't report them at fair market values on their GAAP financial statements. The accounting rules instead treated cryptocurrencies as intangible assets that could be written down in value, but not up. Thus, MicroStrategy didn't include the unrealized gains from its bitcoin holdings in its GAAP earnings.

All of that is changing this year under new rules passed by the Financial Accounting Standards Board, which sets U.S. GAAP. Starting this year, MicroStrategy will show the fair value of its bitcoins on its balance sheet, and the fluctuations in value will be included in earnings.

MicroStrategy in a Jan. 6 filing disclosed numbers for the first time quantifying the impact of the tax and accounting changes. The company said it would add as much as $12.8 billion to its GAAP retained earnings, effective Jan. 1. That figure, which is a component of shareholder equity, would be part of the calculation when determining its financial-statement income for purposes of the corporate alternative minimum tax.

The company also said it would increase its GAAP deferred tax liabilities by as much as $4.0 billion. That figure could be seen as a rough guide for the total tax bill MicroStrategy might face if one assumed that bitcoin's price stayed where it was at the end of 2024.

The company said it could become subject to the corporate alternative minimum tax starting in 2026. The 15% minimum tax would apply if its average annual financial statement income exceeds $1 billion over a three-year period before the initial tax year.

Here is where individuals who buy bitcoin for their own accounts have an advantage over MicroStrategy: If the bitcoin they buy goes up in value, they won't have to pay taxes on the gains until they sell it. MicroStrategy would like to be able to say the same for itself. It will need the IRS to agree first.

Write to Jonathan Weil at jonathan.weil@wsj.com

(END) Dow Jones Newswires

January 24, 2025 06:00 ET (11:00 GMT)

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