Cryptocurrency Income Is Taxable Income

Introduction and summary

Cryptocurrency markets have recently been plagued with uncertainty, leading a majority of Americans who have heard of these digital assets to lack confidence in their safety and reliability.1 Sadly, many people have invested and lost much of their life savings after being lured into the exaggerated promises of cryptocurrency.2 This has only worsened inequities in the financial markets and wealth accumulation3 and led to scams,4 alleged Ponzi schemes,5 and charges of alleged money laundering6—activities that seem to be the primary attraction of these markets.

Still, millions of people continue to own digital assets.7 And crypto advocates continue to claim that cryptocurrency is somehow innovative and special and therefore should not be taxed or treated like other assets and transactions.8 Hiding behind unproven claims that cryptocurrency is the answer to wealth accumulation for low-income people,9 they continue to push policymakers to apply looser standards to cryptocurrency than those that apply to other financial assets.10

Current tax rules apply to cryptocurrency transactions in exactly the same way they apply to transactions involving any other type of asset.

While the future of cryptocurrencies is uncertain, the application of tax laws to cryptocurrency transactions generally is not. With relatively few exceptions, current tax rules apply to cryptocurrency transactions in exactly the same way they apply to transactions involving any other type of asset.11 One simple premise applies: All income is taxable, including income from cryptocurrency transactions.

The U.S. Treasury Department and the IRS should continue to educate taxpayers about how tax laws apply to cryptocurrency transactions and issue guidance in the few areas where there may be uncertainty. Meanwhile, Congress should allow the Treasury and the IRS to act quickly in this regard and avoid confusing consumers with legislation unless there is broad-based agreement on the need for it.

Lax reporting standards for cryptocurrency transactions have fueled the tax gap

The anonymity that makes digital assets attractive to many investors also raises the potential for tax evasion.12 Failure to report information about cryptocurrency transactions contributes to the tax gap—the difference between the amount of tax that taxpayers legally owe and what they actually pay. In its most recent projections, the IRS estimated that the tax gap for tax year 2021 was $688 billion, an increase of more than $138 billion from the prior estimate for tax years 2017–2019.13 The report stated, however, that the IRS cannot fully represent noncompliance in certain areas, including with respect to noncompliance associated with digital assets.14

The amount of legally owed, but unpaid, taxes is significant. As Yale Law School professor and former Treasury Department official Natasha Sarin noted in recent testimony before the Senate Budget Committee: “One year’s worth of uncollected taxes would pay for nearly all of the non-defense discretionary spending that the federal government does. One year’s worth of uncollected taxes would shrink our annual budget deficits by between one-third to one-half.”15 While the magnitude of the gap associated with digital assets is unknown, one estimate by Barclays PLC suggests that at least half of the taxes owed on cryptocurrency transactions go unpaid, costing at least $50 billion per year in lost tax revenues.16 For this reason, the Treasury Department’s most recent Strategic Operating Plan includes an initiative to “enhance detection of noncompliance and increase enforcement activities” for digital assets and other complex, high-risk, and novel emerging issues.17

One estimate by Barclays PLC suggests that at least half of the taxes owed on cryptocurrency transactions go unpaid, costing at least $50 billion per year in lost tax revenues.

The United States must ensure that the use of cryptocurrencies does not undermine the tax system and the critical revenues it generates. There are two approaches that Congress and the IRS can take to accomplish that goal:

Fix actual problems: Whenever the tax laws are applied to new types of assets or transactions, questions will arise about the nuances of applying the laws, and sometimes loopholes are revealed. In most cases, the IRS has sufficient authority to resolve these issues, and in others, Congress may need to take action. This report identifies issues where immediate action is warranted.
Avoid making matters worse: Members of Congress should avoid the temptation to appear crypto-savvy and reject lobbyists’ requests to provide special treatment or legislative exceptions when taxing cryptocurrency assets. A handful of such proposals are discussed below. Meanwhile, the IRS should ensure stronger enforcement of existing tax laws. As discussed in this report, the IRS has taken steps to educate taxpayers in the past, but stronger enforcement and better taxpayer education are essential to ensure that the application of existing tax laws to digital assets and transactions runs smoothly.

Congress and the IRS should close cryptocurrency tax loopholes and fix problems that actually exist

All U.S. citizens, residents, and businesses, as well as foreign individuals and businesses that transact business or invest in the United States, are subject to the federal tax laws, and there are no exceptions for transactions involving cryptocurrencies.18

In 2014, the IRS sought to highlight this point in guidance.19 The agency stated that cryptocurrency assets generally are treated as property.20 Thus, a taxpayer who sells or otherwise disposes of cryptocurrency assets may have a gain for tax purposes, depending upon their basis in the property. Any gain would be taxed at ordinary or long-term capital rates, depending on whether the taxpayer held the digital asset as an investment and on the length of time they held the cryptocurrency assets. Some taxpayers may not be aware that this also means that making purchases with cryptocurrency that has appreciated in value since they acquired it may give rise to a taxable gain. As with any other noncash property used to purchase goods or services, the purchase using cryptocurrency is treated for tax purposes as if the person sold the asset—in this case, the cryptocurrency—and used the proceeds to make the subsequent purchase.

Learn more about crypto assets

When a person receives cryptocurrency in exchange for performing services, the basic tax rules also apply: If they are paid by an employer, the value of the cryptocurrency is subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) tax, and the Federal Unemployment Tax Act (FUTA) tax, and it is reported as income on a Form W-2, the Wage and Tax Statement.21 Payments to independent contractors made in cryptocurrency are subject to self-employment taxes (SECA), and depending on the amount of the payment, reporting may be required on a Form 1099.22 Thus, when a successful miner of virtual currencies receives cryptocurrency in return for their services, the fair market value of the virtual currency on the date it is received is income for tax purposes and subject to income and, potentially, self-employment taxes.

[There are] a handful of circumstances in which the application of existing tax laws to cryptocurrency transactions is unclear. The IRS has the authority to clarify most of these circumstances and should take … steps … to both protect federal revenues and dispel inaccurate claims made by cryptocurrency advocates.

Similarly, businesses that accept cryptocurrency assets as payment must include the value of the assets in income for tax purposes. And companies that invest in cryptocurrency assets for profit must treat those investments the same as any similar company investment for tax purposes.

Yet more recently, policymakers and tax experts have identified a handful of circumstances in which the application of existing tax laws to cryptocurrency transactions is unclear. The IRS has the authority to clarify most of these circumstances and should take the following steps as soon as possible to both protect federal revenues and dispel inaccurate claims made by cryptocurrency advocates.

Clarify broker and other information reporting

The U.S. tax system relies on individuals and businesses to voluntarily report their income and other information necessary to determine their tax liability. Because of the potential for tax avoidance and tax evasion, the tax code requires certain third parties to report information needed to verify tax liability. For example, under Internal Revenue Code (IRC) Section 6045, brokers must report information on gains or losses from transactions to their clients, who then can report their income correctly, and to the IRS.23 The IRS cross-checks the amount on the tax return with the information it received from the taxpayer’s broker. Notably, tax return items that are subject to at least some third-party information reporting have an 85 percent compliance rate.24

The Treasury and IRS have long had the authority to determine whether digital asset brokers are required to report pursuant to Section 6045. However, cryptocurrency brokers have leaned on the anonymity of transactions on the blockchain—the underlying technology on which cryptocurrency assets are based—to claim that they are not required to comply with tax code reporting requirements that are applicable to other brokers. As the number of transactions these brokers manage increases, this could enable an ever-increasing volume of transactions in which customer gains go unreported and thus untaxed, with a corresponding loss of revenues to the Treasury.

To avoid this outcome, the Infrastructure Investment and Jobs Act (IIJA) of 2021 clarified that brokers of digital asset transactions should be treated like other brokers who get paid to effectuate transfers of property or services.25 It also clarified that digital assets, defined broadly, constitute “covered securities” for purposes of this disclosure.26 Section 6045 of the tax code requires brokers to furnish the IRS with identifying information about their customers, including gross proceeds of the transactions.27 In addition, brokers are required under IRC Section 6050I to report to the IRS any transactions made with cash or digital currency of more than $10,00028—a provision aimed at detecting money laundering, terrorism financing, and other nefarious activities. After a long delay, the Treasury Department released proposed rules governing the new broker reporting requirements in late August 2023.29 Unfortunately, however, the proposed rules delay implementation of the new broker reporting requirements until 2026, a move that will result in a substantial loss of revenue in both 2023 and 2024, likely in the range of several billion dollars.30

In addition to clarifying the definition of “broker,” as Congress did in the IIJA, other steps are needed to ensure that individuals and entities engaged in cryptocurrency transactions report information that is essential to determining tax liability. For example, in follow-up guidance on the IIJA provision, the IRS should require domestic exchanges and wallet providers to report to the IRS the number of coins and tokens that become available to customers or wallets they manage after a contentious “hard fork” or “airdrop” giveaway—two actions described in more detail below that can result in income to recipients.

In another important example, the Biden administration’s fiscal year 2024 budget asks Congress to expressly require brokers, such as U.S. digital asset exchanges, to report gross proceeds and other information relating to sales of digital assets by its foreign account holders and, where the customer is a passive entity, provide information about the entity’s substantial foreign owners.31 This proposal is a straightforward clarification that under the provisions of the Foreign Account Tax Compliance Act (FATCA),32 an anti-tax evasion and anti-money laundering statute, the United States in turn can provide information on foreign owners of U.S. accounts to foreign governments that provide reciprocal information about U.S. investors using exchanges based in their countries. This reciprocal exchange of information on U.S. taxpayers that directly or through passive entities engage in digital asset transactions outside the country would help the United States combat the rapidly growing problem of tax evasion, whereby U.S. taxpayers transact with offshore digital asset exchanges and wallet providers without leaving the United States, enabling them to conceal assets and taxable income.

The Biden administration has also proposed to expand current tax law requiring individuals to report any interest they hold in a foreign financial account or certain foreign assets on their tax return.33 This proposal would require tax return information disclosure on any account that holds digital assets maintained by a foreign digital asset exchange or other foreign digital asset service provider.34

Close the wash sale loophole

Lawmakers have considered language that would explicitly clarify that digital asset transactions fall under an existing law that prevents taxpayers from generating tax-deductible losses from the sale and repurchase of securities within a short period of time. Known as a “wash sale,” the taxpayer sells securities at a loss and purchases substantially similar ones within the same time period, then uses the tax-deductible loss to reduce taxable capital gain income on other assets.35 The wash sale rule prohibits deduction of losses attributable to shares of stock or other securities if, within 30 days before or after the transaction that generated the loss, the taxpayer purchases or enters into a contract to purchase substantially identical assets. The taxpayer instead must wait until they sell the repurchased security to get the benefit of a loss deduction.

Cryptocurrency advocates claim that crypto assets are not securities—a position that the chair of the Securities and Exchange Commission has rejected36—and that cryptocurrency transactions are therefore not subject to the wash sale rule. Congress, for its part, has sought to halt the use of cryptocurrency transactions to harvest loss deductions. During consideration of the Build Back Better Act, a much larger bill that was ultimately not enacted, Congress debated language that would clarify that wash sale rules apply to any sale or other disposition of a specified asset, including commodities and “any digital representation of value…

This article was originally published by a . Read the Original article here. .