FTX, formerly one of the largest crypto trading exchanges in the world, may be getting a tax break. A proposed settlement would whittle down the company's claim with the IRS to just $885 million.
According to papers filed in the United States Bankruptcy Court for the District of Delaware, FTX, through its lawyers, indicated that it had reached a settlement with the government related to a significant tax liabilities claimed by the IRS. If the settlement is approved, FTX may have to pay just $885 million to resolve existing IRS tax claims.
Background
FTX—short for Futures Exchange—was once the darling of the crypto world, with valuations hitting $32 billion in early 2022. However, in November of 2022, among accusations of financial impropriety, the exchange collapsed as customers scrambled to withdraw their assets, creating the equivalent of a modern-day run. FTX eventually admitted that there were liquidity issues, and on November 11, 2022, the exchange filed for bankruptcy. According to the initial petition, over 100,000 creditors claimed they were owed $10-$50 billion.
(Then CEO Sam Bankman-Fried stepped down on the same day—a month later, he was arrested in the Bahamas and extradited to the U.S. for trial. He was eventually found guilty of seven counts of fraud, conspiracy, and money laundering and sentenced to 25 years in prison—he was also ordered to repay $11 billion.)
The bankruptcy was filed under Chapter 11 of the U.S. Bankruptcy Code. A Chapter 11 bankruptcy is sometimes called a "reorganization" and allows a company to continue to operate while it works to pay back debt. Creditors impacted by the bankruptcy are entitled to be heard in court, so long as they timely file a petition and meet other criteria.
In May 2024, investors were heartened to discover that FTX planned to pay customers 100% of their holdings back with interest.
Tax Claims
The IRS initially filed a tax claim against FTX for more than $44 billion, which was later amended to $24 billion. (It's worth noting that a number of related parties are involved in the bankruptcy petition with the IRS filing claims against FTX and affiliates, but to keep things simple, the debtors are collectively referred to as FTX when discussing these legal maneuvers.)
The sizable claim, if successful, would have precluded much or all of the recovery for any other creditors.
According to the settlement documents, FTX doesn't dispute that there could be a significant tax liability owed to the IRS. They do, however, "vigorously dispute" liability for what they characterized as "misappropriation income" resulting from Bankman-Fried's theft of FTX customer funds, employment tax liability for compensation allegedly paid to Bankman-Fried and others, and the proposed disallowance of a large amount of deductions and losses for lack of substantiation.
(John J. Ray III, FTX's new CEO, referred to the mismanagement at the firm as the worst failure of corporate controls he's seen in his career.)
The IRS has indicated that absent a settlement, it would continue to chase FTX for taxes based on those theories.
Settlement
As part of the bankruptcy process, the parties engaged in discovery—a legal process involving exchanging information about the witnesses and potential evidence that may be presented at trial. According to court documents, the discovery led to a "preliminary statement[s] of facts and issues" in which the IRS purported to calculate approximately $8 billion of income and employment taxes owed. The settlement number represents a substantial reduction of the IRS' claims, but the IRS noted that it was providing those "preliminary statement[s]" only for purposes of the "estimation proceeding, not [as] determination[s] of tax liability." In other words, the $8 billion doesn't represent a tax bill—it's an estimate of what the IRS believes it could prove.
The settlement, the parties agree, would resolve these disputes without expending "significant time and incur expenses on litigation." That's typically a key part of a Chapter 11 bankruptcy.
As a result, FTX and the IRS have agreed that the IRS will accept $885 million. Of that, $200 million would be treated as a priority claim—only 2.5% of the original IRS priority claims—and be payable by wire within 60 days of the settlement's effective date. The remaining $685 million would be considered a lower-priority claim and payable "to the extent of funds available."
Under the terms of the settlement, FTX would not be able to file for a refund for any amount tagged as a priority claim. The settlement would be considered a "full and final satisfaction" of the IRS claims for the 2018-2022 income tax years and employment taxes for various quarters during the same period.
A May 20, 2024, letter from the U.S. Department of Justice Tax Division to Marc De Leeuw at Sullivan & Cromwell (FTX's counsel for the proceedings) confirmed that the offer had been accepted on behalf of the Attorney General. A request for comment made to De Leeuw was not immediately returned.
A hearing on the matter will be held on June 25, 2024, at 10 a.m. ET before Judge John T. Dorsey.
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