Proposed Tax and Reporting for Digital Assets | McDermott Will & Emery
On June 7, 2022, Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) introduced the highly anticipated Responsible Financial Innovation Act (the Bill), which aims to create the first comprehensive regulatory and bipartisan framework for digital assets. . The bill aims to establish legal clarity for regulators and industry and to protect consumers by providing a series of disclosures and clarifying settlement terms and digital property rights. The bill would also treat all digital assets that are not treated as securities as commodities regulated by the Commodity Futures Trading Commission. This article discusses the key tax considerations raised by the proposed legislation regarding taxation and reporting requirements for participants in the digital asset industry.
IRS GUIDELINE AND DE MINIMIS EXCLUSION
The bill requires the Internal Revenue Service (IRS) to adopt guidelines or clarify important issues regarding digital assets, including mining and staking activities. Currently, the only government guidance on virtual currency mining is IRS Notice 2014-12 (2014-16 IRB 938, Q&A-8, 9), which does not have the force of law and can be ignored by the courts. . In Notice 2014-12, the IRS asserts that by performing proof-of-work validation services, the fees miners receive in units of virtual currency are ordinary income and taxable at fair market value on the date at which they receive the units (for a discussion of proof-of-work mining activities, see “Taxation of virtual currency mining activities.”) The government has been silent on the tax treatment of staking activities that support blockchain networks or verify payments (for a discussion of staking activities, see “Taxation of virtual currency staking activities. “) The bill allows cryptocurrency miners and stakers to defer taxes related to these activities until these assets are disposed of.
The bill also directs the IRS to issue guidelines that (1) classify forks, airdrops, and similar transactions that are considered taxable events of “subsidiary value” based on the claim and disposition of “subsidiary value” by taxpayers; (2) implements the broker reporting and cash reporting rules enacted by the Infrastructure Investment and Employment Act (HR 3684); (3) allows charitable contributions greater than $5,000 without the need for a qualified appraisal; and (4) characterizes stablecoins as debt. However, the bill does not specify what a “subsidiary value” is. The bill also exempts from tax up to $200 of gains or losses from the disposition of virtual currencies in personal transactions and treats a series of “linked transactions” as part of the same transaction for the purposes of this exemption, but does not provide further details on what constitutes a related transaction.
The bill clarifies that the term “broker,” as used in HR 3684, excludes miners and stakers as well as wallet providers and developers, relieving them of certain IRS reporting requirements.
Under current law, those involved in mining, staking, or providing hardware or software wallets of digital assets may fall under the definition of “broker” for tax purposes and be subject to additional requirements. of declaration. Section 6045 of the code generally imposes reporting requirements on “any person carrying on business as a broker” with respect to sales affected by the broker on behalf of its clients, where “broker” is defined to include a ” dealer, barter exchange and any other person who (for remuneration) regularly acts as an intermediary in respect of goods or services” and “any person who (for remuneration) is engaged to regularly provide any service performing transfers of digital assets on behalf of another person”.
The bill defines a “broker” as anyone who stands ready, in the ordinary course of a trade or business, to make sales of digital assets to customers for consideration, which likely indicates that miners, wallet providers and software developers will not fall under this definition. . This definition also exempts them from the reporting obligations imposed by the law in force.
LOAN AGREEMENTS AND COMMERCIAL SECURITY DOORS
The bill ensures that digital asset lending arrangements would be taxed in accordance with existing rules for securities lending, where the gain or loss is not realized in the exchange – if certain conditions are met – by expanding the definition of “securities” to include digital assets (for US federal income tax purposes related to lending transactions only).
The bill also expands the current commercial safe harbors under section 864(b)(2) of the Code, which currently covers securities and commodities trading activities conducted by non-U.S. persons, to include the trading digital assets through a US broker, custodian, commission agent, digital asset exchange, or other independent agent without risk of being treated as engaging in a trade or business in the USA. Further, trading in digital assets on a non-U.S. person’s own account, whether by the taxpayer, the taxpayer’s employees, or through an agent, would not be considered a commercial or commercial activity. business in the United States, provided that the taxpayer is not a reseller of digital assets. . Notwithstanding the foregoing, Safe Harbor does not apply if the Non-U.S. Person has an office or other fixed place of business in the United States through, or at whose direction, transactions on the digital assets are affected.
DECENTRALIZED AUTONOMOUS BODIES
The bill declares certain incorporated Decentralized Autonomous Organizations (DAOs) to be, by default, business entities for tax purposes by including them in section 7701 of the code. It defines a DAO as an organization that uses smart contracts to conduct business, commerce, or charity that is governed primarily on a distributed basis and is incorporated or organized under the laws of a state or foreign jurisdiction. By classifying DAOs as business entities, the bill seeks to tax them as a corporation or partnership for U.S. federal income tax purposes and provides them with tax advantages not generally available to unincorporated associations.
The bill requires the United States Government Accountability Office (GAO) to explore potential opportunities and risks associated with retirement investing in digital assets and to report to the United States Congress, the United States Department of the Treasury, and the US Department of Labor. Specifically, it directs the GAO to study the potential benefits of diversification and yield in an investor’s retirement portfolio, appropriate asset allocations, digital asset consumer education and financial literacy, risks and barriers to effective retirement by investing in digital assets.
Although generally considered “friendly” legislation for the digital asset industry, the bill attempts to strike a balance between responsible innovation and consumer and investor protection. It also aims to create the first digital asset regulatory framework for the industry by providing a framework for integrating digital assets into existing US tax laws. Time will tell if some (or all) of these provisions will eventually be enacted.
Sama Kaseer, summer associate in the Miami office, also contributed to this article.