taxes

Breaking Down The Cryptocurrency Tax Proposals In Congress

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Jordan Bass of the firm Taxing Cryptocurrency discusses the proposed cryptocurrency tax changes that Congress is considering and how they could affect taxpayers and the digital asset industry.

This transcript has been edited for length and clarity.

Marie Sapirie: Thank you, Jordan, for joining me today to discuss the rapidly changing tax rules and in particular, the tax information reporting rules for digital assets.

Jordan Bass: Thank you for having me. Looking forward to having this discussion.

Marie Sapirie: There are proposed legislative changes to tax information reporting for digital assets that are included as an offset in the infrastructure bill that Congress is currently working on. Before we get to those proposed changes, would you give us an overview of how the tax rules for cryptocurrencies and other digital assets have developed so far?

Jordan Bass: Of course. The taxation and treatment of digital assets and cryptocurrencies has kind of been stagnant for a long period of time, ever since we had the initial guidance released by the IRS in 2014. Even though people hadn’t necessarily reviewed that guidance, there’s been very, very straightforward treatment of most transactions since then.

A trade for crypto to crypto would constitute a taxable event. A trade for crypto to cash would constitute a taxable event. If you’re just purchasing the asset with U.S. dollars, you’re going to set up your basis in that asset, but that’s not going to trigger any tax. That was basically the initial taxation treatment of these transactions.

Over time, the market kind of became more sophisticated, developed. There’s been different structures of transactions that have been created with borrowing and lending on chain, providing liquidity on chain in some of these decentralized exchanges.

Because the structures of the transactions have changed, the way that it’s taxed has also changed. There were initial coin offerings, or ICOs. There were airdrops that people would receive. There were forks from different chains. All of those events that changed how the initial tax treatment would be, where it was just a simple swap going from one coin to another, or going from U.S. dollars to a cryptocurrency or vice versa, created some complexity that caused confusion for a lot of taxpayers. There wasn’t really any guidance on those particular transactions until recently.

There’s so many different ways that a taxable event could arise in the digital assets space. Not just what we’ve mentioned already, but even mining and staking your tokens. They’re income generation events that haven’t necessarily had that sort of guidance released by the IRS. But we can take existing tax principles and apply it to those transaction structures.

That’s what we’ve been doing mostly for the last six, seven, eight years that we’ve seen tax reporting done with crypto and digital assets. The main thing that has advanced the ability to report these transactions in a more clean way is there’s been a lot of infrastructure built out from a software perspective and also an analytic perspective. You can actually see your transactions allocate cost basis and then also determine what your proceeds were if there was a taxable event, if it was a trade, or see what the fair market value of the tokens were that you received on a day when you had an income-generating event.

But early on, that wasn’t necessarily the case. That may have caused a level of confusion and created additional complexity that maybe didn’t need to necessarily be there with early crypto adopters. But all of that has led us to the point where we are today, where there’s a regulatory framework and governmental bodies that are trying to regulate the space in an effort ultimately to, in their mind, protect investors, but also generate tax revenue from a space and a market that there may be an underpayment, so they believe, of tax liabilities from a lot of U.S. individuals and entities.

Marie Sapirie: Turning to the current debate in Congress, in the August draft of the infrastructure bill, changes were proposed to the definitions of the terms broker and digital asset. These changes have attracted some criticism, especially around the process through which the proposed changes are being introduced. The IRS had guidance under section 6045 on its priority guidance plan in 2019. But the legislative process is relatively new.

First, let’s look at the definition of broker because brokers are who’s required to submit information returns to the IRS and to customers. Would you take us through the proposed definition of broker and the implications of this change?

Jordan Bass: There were multiple amendments that were offered in the Senate to address this issue that we’re going to be discussing. But ultimately the current definition is very, very broad for people in the crypto space. I’m sure on the other side, in the regulatory space, maybe there needs to be additional guidance to further define what this means.

But, the definition is any person for consideration that’s responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person. In a way, this makes sense if the target is centralized cryptocurrency exchanges, which honestly in many ways function like the traditional broker-dealers or traditional centralized exchange sort of platforms in traditional security markets. The Coinbases, the Krakens, the Geminis, the FTX U.S., the Binance U.S. They have the ability to take on a lot of this information and report some of the transactions directly to, let’s say, the IRS. They may have the infrastructure to do so.

But the problem that a lot of people in the industry expressed concern with, and really we’re looking for that revised definition is that definition of any person. It’s very broad and could be interpreted to include people that are mining Bitcoin or other currencies. People that are maintaining a DeFi platform, a decentralized finance platform. Even though they don’t have that information readily available to report some of the transactions, they would still be included in that.

For example, the miners in this space validate transactions. In theory, they could be responsible for regularly providing any service that effectuate transfers of the digital assets on behalf of another person. But they don’t have that information on who’s the underlying parties in the transactions.

Same thing goes with these DeFi platforms and protocols. They execute transfers. They execute transactions of crypto or help facilitate that based on something that’s established in the code. But they don’t really need any human intervention.

This could also include many, many other noncustodial sort of actors in the crypto…

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