Two lawmakers, Jared Polis and David Schweikert, who jointly chair the Congressional Blockchain Caucus, have introduced a new legislation known as Cryptocurrency Tax Fairness Act of 2017. The legislation seeks to create a taxation structure that addresses the burdensome reporting requirements which were introduced by IRS in their March 2014 guidelines.
What are the provisions of the IRS guidelines on cryptocurrencies taxation and what are their implications?
In the March 2014 guidelines, IRS classified cryptocurrencies such as Bitcoin as properties. This had major positive and negative ramifications on the development, application, and usage of the blockchain technology in the payments systems. On one hand, this was a good move since any gains from sale and exchange of cryptocurrencies are taxed as capital gains rather than ordinary income. Capital gains attract lower tax rates than ordinary incomes, resulting in major tax savings for cryptocurrency holders.
On the other hand, the categorization of cyptocurrencies as property introduced two major challenges. One of the problems is the issues of record keeping for tax purposes. In order to report any gains or losses, the cryptocurrency users would have to track price movements between transactions. The guidelines provide that cryptocurrency holders must report the fair market value of their holdings on the date of receiving the currency.
The other problem, and probably the most critical one, is that unlike fiat currencies issued by governments, the de minimis exception is not applicable in properties. The de minimis exception provides tax exception for very small transactions. For example for foreign currency transactions, you do not have to report any gains less than $200 made in a single personal foreign currency transaction. Without the de minimis exception, any gains, no matter how small, made between the time you acquired the currency and the time you used it, must be tracked and reported to the IRS at the end of the year. This means that using cryptocurrencies to make even the smallest transactions such as an MP3 download is a taxable event and requires meticulous tracking of price fluctuations and reporting to IRS.
In addition to the complexities of tracking and reporting such cryptocurrency transactions, it is generally viewed that by taxing these transactions, the IRS is having a second bite at the cherry. This is because the transactions have already been taxed, and regardless of the currency used to settle the payment, no further taxation should be imposed. For example, a customer paying latte at a café using Bitcoin should not pay any extra taxes as compared to a customer paying in dollars.
The provisions of the IRS guidelines created major reporting responsibilities both for casual users and institutional traders of cryptocurrencies. Cryptocurrencies are extremely volatile and tracking this volatility substantially increases the compliance costs. Additionally, the cryptocurrency economy is in itself a complicated concept for most people and adding an equally complex reporting requirement does not help matters at all. Due to this high compliance costs, and partly due to ignorance, most people are in violation.
Naturally, the IRS guidelines create a lot of friction and discourage the application of cryptocurrency in the payments ecosystem. Moreover, this has stifled the growth of this nascent innovative technology since with this complex reporting requirements comes depressed usage and the ROI for developers and investors in the payments systems is therefore extremely low. For investors to put their money in the development of everyday-use payments solutions, they must be assured of critical masses for widespread application of the technology.
What are the provisions of the Cryptocurrency Tax Fairness Act of 2017 and what is their impact?
The Congressional Blockchain Caucus is a collaboration platform for the government and the industry to study and understand the implications, potential, and development of the blockchain technology. The blockchain is a decentralized distributed public ledger and is the technology behind cryptocurrencies such as Bitcoin. Its application goes beyond cryptocurrencies and it has been a major source of disruptions in the global economy. Its main advantages are transparency, security, speed, and reduced transaction cost.
The Cryptocurrency Tax Fairness Act aims to create a structure for the taxation of purchases made with cryptocurrency. The bill introduces two major proposals designed to simplify cryptocurrency taxation in the US, and if passed, would be a major step in encouraging the development of this technology and its application in the payment systems. These two proposals are; the creation of a de minimis exemption for transactions executed using cryptocurrency and a development of a clear guideline for informational reporting.
The de minimis exception proposed in the bill is similar to the one enjoyed for foreign currency transactions. Under the bill any cryptocurrency transaction below $600 would be completely tax exempt. This implies that you would not need to keep tracking gains or losses on every small transaction you made. Additionally, even if there was to be any noticeable gain, you would not owe any taxes on such gains.
This would be a major achievement and a significant departure from the current taxation regime where you have to track and report every little purchase you make using cryptocurrency. Through this, the tax compliance costs would be substantially reduced and fewer people would be in violation.
The second proposal of the bill is to provide for the development of guidelines for informational reporting on digital currency for which capital gains is applicable. These would be the transactions above the $600 threshold such as the one for getting in and out of investment position and for which capital tax would be due. Currently, the cryptocurrency holder is responsible for tracking and reporting all the gains and losses from such transactions. This is in contrast to the transaction for stock holding whereby the stock broker is the one who provides you and the IRS with the statement of your gains and losses.
By developing informational reporting guidelines, the bill seeks to further simplify the reporting requirements of the cryptocurrency users by providing a mechanism through which cryptocurrency supplies such as Coinbase would be able to report on these transactions. This would help to avoid court cases similar to the current one between IRS and Coinbase, in which Coinbase is contesting what it has described as a broad and unnecessarily punitive request by IRS to supply all records for all customers for the period between 2013 and 2015.
These twin proposals of the Cryptocurrency Tax Fairness Act are a priceless contribution towards encouraging the use of cryptocurrency in the payment ecosystem. They will encourage investment thus creating the much-needed good jobs in the economy. Additionally, the consumers will benefit from the convenience, cost effectiveness and security of the blockchain technology.