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Sens. Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) today unveiled cryptocurrency legislation that seeks to provide regulatory clarity on a range of issues, including taxes. But it also has a surprise for those who haven’t been following the drafting process.
Simply put, their bill would create a huge tax avoidance opportunity for those involved in the crypto business. As written, new cryptocurrency tokens earned by those participating in “mining” or “staking” would not count as taxable income until the tokens were sold.
Crypto supporters argue this is in line with the tax treatment of other industries. But a closer look shows the Lummis-Gillibrand proposal would deviate from one of the tenets of good tax policy: neutral treatment of taxpayers across different parts of the economy. Deferring tax on investment income is one thing. But this bill would essentially allow mining and staking companies to indefinitely avoid tax on earnings from their core business activities, in stark contrast to existing tax law and legal precedents.
Is There a Legal Justification?
First, a refresher on how this stuff works. Most cryptocurrencies, including Bitcoin, involve “miners” that use a lot of computers and electricity to solve complex math problems. Some newer currencies use an alternative “proof of stake” model where token holders can “stake” their own currency on a network and participate in validating the network’s transactions. This model requires far less computing power and electricity. Either way, miners and stakers are rewarded with new cryptocurrency tokens for their efforts.
Fair enough. But why should someone who is paid in fiat currency for their work owe tax on their income, while someone working in exchange for a digital asset can avoid tax until they sell that asset? Many have looked at that question and come to the same conclusion: They shouldn’t.
In April, the New York State Bar Association made a series of crypto tax policy suggestions to the US Treasury. It highlighted a court case in Tennessee where a couple challenged the IRS’s ability to tax staking rewards. The bar group urged Treasury to confirm staking rewards are taxable income based on US Supreme Court precedent and the facts of staking business activity.
Crypto advocates have argued that mining and staking rewards are similar to manufacturing or mineral extraction. The company that makes a widget or mines for real life minerals owes tax only when it sells the widget or mineral. But the bar report notes that, unlike widgets or minerals, new digital tokens aren’t created solely by the crypto miner or staker. It also involves the network protocol developed by other coders.
The case for deferring taxes on mined rewards is just as weak. In fact, when the IRS in 2014 determined that cryptocurrencies are property subject to capital gains taxes, it noted that tokens earned by crypto miners are taxable as gross income upon receipt. In the case of mining, the question of current law is settled. If you want to dig deeper, University of California-Irvine Professor Omri Marian has a new piece in Tax Notes (paywall) that thoroughly picks apart the arguments behind the mining and staking tax preference proposal.
Is This Tax Break Necessary?
Of course, Congress always can change the law. But does the crypto industry need special tax preferences now?
It is hard to make that case. Despite recent price volatility, many cryptocurrencies have seen a meteoric rise in value in the past few years. Venture capitalists remain enthusiastic. And if you haven’t seen some A-list celebrity or prominent professional athlete promoting crypto investing, you clearly haven’t watched television in the past 12 months.
Simply put, the market hasn’t sent any signals to policymakers that tax policy uncertainty or a lack of tax preferences is holding back innovation.
This is also a peculiar time to seek enactment of such a large tax preference. Treasury will soon begin to answer several open crypto questions as prescribed by last year’s infrastructure law. That should give crypto exchanges and their customers clear guidelines for the issuance of 1099 tax forms and allow the IRS to better monitor taxable gains or losses. And a plethora of new crypto tax compliance tools are available to help investors track their tax liability.
Crypto companies will argue that a special income deferral rule is necessary to ease their administrative burdens. As Marian points out in his Tax Notes piece, day traders and algorithmic trading operations already manage these issues. And even with deferral, miners and stakers would still need to monitor the cost basis of new reward tokens and their changes in value, both to track the business’s financial health and in anticipation of converting any of those assets to cash.
The mining and staking tax deferral provisions of the Lummis and Gillibrand bill would give crypto businesses a tax avoidance opportunity they don’t need and one that doesn’t exist in other parts of the economy.
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