Cryptocurrency, a type of digital currency that uses cryptography for security and anti-counterfeiting measures and is not controlled by any bank or government, is becoming more mainstream as more companies and individuals use it. Now, new ways to regulate and tax it are on the table, including the proposed Infrastructure Investment and Jobs Act and SEC regulation of decentralized finance. Changes are being considered, discussed and proposed.
In you already have invested or are thinking about investing in popular cryptocurrencies such as Bitcoin, Ethereum or Dogecoin, here is some important information on how this property may be taxed going forward:
Proposed legislation: the Infrastructure Investment and Jobs Act
As written, the proposed act would explicitly impose information reporting on cryptocurrency transfers in the same way information reporting is required on transfers of stock or securities. If enacted, the new law would have an effective date of Jan. 1, 2023.
The IRS issued Notice 2014-21, 2014-16 I.R.B. 938 PDF in 2014. This notice explained that virtual currency is treated as property for federal income tax purposes and provided examples of how long-standing tax principles applicable to transactions involving property such as stocks or gold apply to virtual currency. The IRS also issued extensive FAQs.
Consequently, taxpayers already are required to report gains and losses on the sale of cryptocurrency: Short-term gains are taxed at ordinary income tax rates (up to 37%) and long-term gains are taxed at capital gains rates (20% rate plus 3.8% net investment income tax), plus relevant state and local taxes. Losses can be used to offset non-crypto-related capital gains in a given tax year. This tax treatment will remain unchanged whether or not the IIJA passes.
The proposed legislation also expands the definition of the term “broker” to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Because this definition is so broad and there are fears it will have a negative effect on innovation and investment, especially foreign investment, in the U.S., an amendment was proposed that excluded miners, software developers and other individuals who do not have access to customer information. The amendment failed to pass, however. The House of Representatives may consider this issue when they debate the bill, but the outcome is far from certain.
If the proposed law is enacted, cryptocurrency brokers would be obligated to collect certain information (e.g., name, address and U.S. tax identification number) about the owners of cryptocurrency accounts and provide certain information identifying information about the seller and the amount recognized from the sale. The proposed legislation also modifies the so-called basis-reporting statute to require brokers to report the price at which a particular unit of cryptocurrency was acquired by a client (subject to certain specified adjustments). This information also would have to be provided to other brokers when cryptocurrency is transferred to another digital wallet or exchange.
Non-fungible tokens (NFTs)
As of this writing, the IRS has not issued specific guidance concerning the tax treatment of non-fungible tokens. Nevertheless, NFTs, which are unique digital codes that represent one or more specific items of text, image, video or music, are considered crypto assets that are taxed as “collectibles” under IRS Section 408(m)(2). According to that section, “any work of art” is considered a collectible. As a result, (1) NFT creators pay ordinary income taxes and self-employment taxes and (2) investors report NFT-related income on the applicable business tax return (Form 1120, Form 1120S or Form 1065).
It is clear that while cryptocurrency and crypto assets are relatively new, they are here to stay, and the laws, rules, regulations and guidance around them will only become clearer and more defined over time. As this area of the tax law evolves, the most important thing taxpayers who buy, sell or create these assets can do is keep detailed records they can rely on in the event the IRS questions their tax returns.