By Joyce Beebe, Ph.D.
Fellow in Public Finance
Senate Proposal’s Cryptocurrency Tax Overhaul
Cryptocurrency definitely looks like an out-of-favor asset class over the last six months: Bitcoin traded at $65,000 last November, but hovered around $30,000 in early June; ethereum surpassed $4,700 last November and was at 40% of that price in recent trading days. Considering the contrast to the skyrocketing price trajectory that preceded this sharp decline — bitcoin was traded at $6,000 and ethereum at merely $120 in March 2020 — it is certain that cryptocurrency prices are anything but stable.
These nascent and ever-evolving assets have generated headaches for regulators, created tax avoidance opportunities and initiated numerous lawsuits. Some incremental actions have been taken from a tax perspective: most notably asking taxpayers to report their cryptocurrency transactions on Form 1040 and requiring cryptocurrency brokers to report digital asset transactions to the IRS. In addition, the Biden administration issued an executive order in March that directs the Department of the Treasury to develop policy recommendations regarding the changes imposed by digital assets on financial markets.
Last week, a bipartisan plan (S.4356, temporarily titled the Responsible Financial Innovation Act) proposed to address many open issues in the field of cryptocurrency regulation. This blog post reviews key provisions in this proposal and their implications to the cryptocurrency taxation.
A Comprehensive Proposal
Before the proposal, the most concrete guidance from the IRS has been its 2014 notice that treats cryptocurrency as property for federal income tax purposes. However, many aspects of cryptocurrency taxation remain unaddressed. A major contribution of the bill is that it points out all contentious and uncertain issues cryptocurrency participants currently face, and either provides clarification or demands regulators to answer them. Below are five tax-related provisions.
First, the bill provides a de minimis exclusion of up to $200 per transaction from a taxpayer’s gross income when using cryptocurrency for payments of goods and services.
Although this provision alleviates taxpayers’ record-keeping burdens, a $200 per transaction exclusion is generous. This is especially true when considering other types of payment methods that do not receive similar preferential treatments. It may also create loopholes if taxpayers break one large transaction into several smaller transactions below the threshold to avoid tax consequences. This provision, if it passes, is expected to boost the popularity of cryptocurrency as a payment method for daily purchases.
Second, the proposal formally narrows the definition of broker to “any person who stands ready in the ordinary course of a trade or business to effect sales of digital assets at the direction of their customer.”
The broker reporting requirement has caused criticism from industry participants since the passage of the infrastructure bill. They believe that tasking any person “responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person” with reporting responsibility is overreaching. Specifically, industry participants claim that software or hardware providers and miners (people who help verify and support cryptocurrency transactions) will have reporting responsibilities under that language. However, they usually do not possess the information needed for reporting. As such, this is a welcoming development by the cryptocurrency industry.
Next, the bill formally states that digital assets obtained from mining or staking activities do not represent a taxpayer’s gross income until they are disposed — in other words, these digital assets will be taxed when they are sold instead of when they are created. If this provision becomes law, it will put an end to the ongoing court case that disputes whether a taxpayer should pay taxes on his staked, but unsold, Tezos tokens. However, it will also alter part of IRS’s 2014 guidance, which indicates in answer to FAQ No. 8 that “when a taxpayer successfully ‘mines’ virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.”
In addition, the proposal requires the IRS to issue guidance on key topics related to digital asset taxation within a year. These include treatment of airdrops and forks, digital asset mining and staking, and charitable contribution treatment of digital assets, among others.
Finally, the bill requires the Government Accountability Office (GAO) to prepare a study and evaluate the suitability of having digital assets as part of the retirement investment portfolio, including potential opportunities and risks.
Non-Tax Provisions
Besides tax-related provisions, the proposal highlights other important areas of responsible innovation. Specifically, a section of the bill (Title III) illustrates distinction between digital assets that are securities and commodities. If a digital asset is security, it will have to follow SEC rules and disclosure requirements. Some practitioners interpret this as the SEC will primarily oversee companies that use cryptocurrency to raise funds from the public, akin to stock offerings.
Title IV of the bill grants the Commodity Futures Trading Commission (CFTC) authority over fungible digital assets that are not securities, technically including bitcoin and ethereum. It also seeks to have digital asset exchanges, which will be viewed as financial institutions, register with the CFTC.
In light of recent incidents of stablecoins — mainly terraUSD and tether fell below their 1-to-1 peg to U.S. dollar — another section of the bill (Title VI) focuses on stablecoins. In particular, the bill requires stablecoins to maintain high-quality, liquid assets valued at 100% of the face value of outstanding stablecoins, essentially requiring 100% reserves. The proposal also requires issuers provide public disclosures of these assets, as certain stablecoins have not been transparent of their holdings. In addition, stablecoin issuers have to maintain the ability to redeem all outstanding coins at par in legal tender.
Finally, the proposal requests the Federal Energy Regulatory Commission, in coordination with other agencies, to study energy consumption in the digital asset industry. For instance, the study will analyze the amount of energy used for mining and staking cryptocurrencies, and among which, how much renewable energy is used. Given the high energy consumption reported for mining bitcoins, the report will shed light on this ongoing debate.
Conclusion
Despite the recent drop of cryptocurrency prices, the Senate proposal is meaningful and timely. The importance of the issue does not fade because of the lower market capitalization. As many practitioners believe, cryptocurrency has created new avenues of tax evasion and clear regulations are needed.
Despite the concern of siding too closely with the industry (including the de minimis exclusion, limiting the definition of broker, declaring mining or staking are non-taxable until disposition of assets, granting CFTC expanded oversight on cryptocurrencies) the proposal declares a position on most of the unclear yet critical issues on which industry participants have been requesting guidance for years. The proposal is unlikely to experience smooth sailing as is written; however, the efforts of putting a stake in the ground and attempting to resolve the issues should definitely be applauded.