United States: Crypto tax proposals in the 2024 Greenbook

Tax News and Developments March 2023

In brief

On 9 March 2023, the Biden administration released its revenue proposals for fiscal year 2024 (the "Greenbook"), which included several proposals to revise the tax Code related to cryptocurrency and other digital assets. Taylor Reid provides an overview of these proposals and why they may be the ones to watch.


In more detail

The Greenbook contains a number of tax proposals relating to digital assets, which are defined in section 6045(g)(3)(D) as: "any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary". Some of these proposals were included in the Biden administration budget proposals for fiscal years 2022 and 2023, or in bills introduced in the last session of Congress. While many question the likelihood of any tax legislation being passed in the near future, there is bipartisan support for crypto legislation and it is possible that the proposals described below could be included in a broader crypto bill.

Excise tax on digital asset mining

In the Greenbook, the Biden administration expressed concern with the negative environmental and economic impact of mining as a consensus mechanism for blockchains. To discourage digital asset mining, the administration proposes to impose on miners an excise tax equal to 30% of the cost of the electricity used in mining digital assets. Miners that lease computational capacity from others would be required to report the value of the electricity consumed by the lessor, which would serve as the base upon which the excise tax would be imposed. Miners that produce or acquire off-grid power would be required to estimate the amount of such power and pay excise tax on the estimated cost of such power. The proposed excise tax would be effective for taxable years beginning after 31 December 2023, but would be phased in over three years at a rate of 10% in the first year, 20% in the 2nd year, and 30 percent thereafter.

Given the nature of current proof-of-work algorithms, it is not clear that this excise tax will actually discourage mining activity. The rate of issuance of new coins in many proof-of-work blockchains is predetermined. So imposing an excise tax on mining will simply reduce the amount that miners are willing to pay for computing power and electricity. The excise tax may reduce the energy consumption of mining by substituting tax expense for the cost of electricity. But in the long run, digital asset mining, and the energy consumption associated with it, will continue.

Application of wash sale rules to digital assets

Ordinarily, a loss realized on the sale of stock or securities is disallowed under the "wash sale" rules of section 1091 if the same or substantially identical stock or securities are purchased within 30 days before or after the sale, unless the loss is sustained in the ordinary course of business by a dealer in stock or securities. The Biden administration proposes to amend section 1091 to add digital assets to the list of assets subject to the wash sale rules. Treasury would be authorized to issue regulations defining the term "substantially identical" and provide exceptions for ordinary course business transactions involving digital assets. The wash sale rules would also be broadened to cover transactions where a taxpayer realizes a loss on an asset that is subject to the wash sale rules and a related party purchases substantially identical assets within 30 days before or after the sale. For this purpose, related parties include family members and two entities where one controls the other, directly or indirectly, or both are under common control. The extension of the wash sale rules to digital assets was also proposed as part of the Build Back Better Act in 2021, but was not ultimately enacted.

Application of securities lending rules to digital assets

No gain or loss is recognized on a loan of securities if transferred pursuant to an agreement that meets certain requirements, the essence of which is that identical securities must be returned to the transferor upon the termination of the loan and the transferor must retain the economic benefits and burdens of ownership of the securities during the term of the loan. The Biden administration proposes to apply equivalent nonrecognition treatment to loans of actively traded digital assets that have terms similar to those currently required for loans of securities. For example, the loan should provide that income or other distributions to the holder of the digital asset, such as staking rewards or air drops, earned during the term of the loan will be transferred by the borrower to the lender. The lender would be required to take into account such income, presumably at the time income arises rather than deferring recognition until the termination of the loan. Treasury will have authority to issue regulations extending nonrecognition treatment to non-actively traded digital assets where appropriate. Senators Lummis and Gillibrand offered a similar proposal for digital asset lending agreements as part of the Responsible Financial Innovation Act in 2022.

Application of mark-to-market rules to digital assets

Dealers in securities are generally required under section 475 to use the mark-to-market method of accounting for securities held at year end. Dealers in commodities and traders in securities or commodities may elect to use the mark-to-market method of accounting. With certain exceptions, gain or loss recognized under the mark-to-market method is treated as ordinary income or loss. These rules can result in simpler accounting and tax compliance for taxpayers that actively trade securities and commodities. The Biden administration proposes to allow a dealer or trader in actively traded digital assets (including derivatives on, or hedges of, those digital assets) to apply the mark-to-market method of accounting to such assets under rules similar to those that apply to actively traded commodities. For purposes of the mark-to-market rules, actively traded digital assets would be treated as a separate category of assets from securities and commodities, and no inference is intended as to whether particular digital assets might be treated as securities or commodities for purposes of the mark-to-market rules under current law. This proposed change to the mark-to-market rules is consistent with the recent decision of the Financial Accounting Standards Board on 12 October 2022, to require fair value measurement of crypto assets, with increases and decreases in fair value recognized in income in each reporting period.

Information reporting for digital assets

Under current law, certain financial institutions in the United States are required to report to the IRS certain information about their customers and income earned on accounts held at such institutions. There are limits, however, on the information required to be reported with respect to foreign recipients and foreign owners of U.S. entities. In contrast, the Foreign Account Tax Compliance Act (FATCA) mandates broader information reporting by foreign financial institutions with respect to accounts held by U.S. owners. The Biden administration argues in the Greenbook that a willingness to exchange comparable information on foreign owners of U.S. accounts will encourage greater compliance with FATCA, and therefore proposes to expand the information reporting requirements for U.S. financial assets and accounts held by foreign owners. For U.S. brokers, this would include reporting information on substantial foreign owners of passive entities that hold digital assets.

Current law also requires individuals that hold certain "foreign financial assets" in excess of USD 50,000 to attach a statement disclosing such holdings on their tax return. The administration is concerned that digital assets may provide U.S. taxpayers with the opportunity to conceal assets and taxable income by using offshore digital assets exchanges and wallet providers, and therefore proposes to amend section 6038D to treat as a "foreign financial asset" any digital asset account that is maintained by a foreign digital asset exchange or other foreign digital asset service provider. Whether an account is foreign would be based on where the exchange or service provider is organized or established. Therefore, the proposal would appear not to apply to non-custodial wallets.

Interestingly, the Greenbook does not contain a proposal to address an information reporting issue of significant concern to the crypto industry, and which received a lot of attention in 2022. Section 6045(a) requires any person doing business as a "broker" to file information returns that show the name and address of each customer and details of gross proceeds and other information as required by regulations. As amended by the Infrastructure Investment and Jobs Act of 2021, the definition of "broker" under section 6045(c)(1)(D) includes "any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person." This definition has been criticized as overly broad. For example, it has been suggested that the rule could be interpreted as applying to miners, stakers, or even someone who merely programs the smart contracts underlying a decentralized exchange through which individuals swap crypto tokens. A number of bills, including the Keep Innovation in America Act and the Responsible Financial Innovation Act, proposed to narrow the definition of broker in section 6045 to "any person who (for consideration) stands ready in the ordinary course of a trade or business to effect sales of digital assets at the direction of their customers." While this important fix is not reflected in the Greenbook, the Keep Innovation in America Act was reintroduced in the House of Representatives on 7 March 2023, and contains the same legislative fix that was included in the 2021 version of the bill. Finally, proposed Treasury Regulations on information reporting by cryptocurrency brokers are currently awaiting final approval and are expected to be published shortly.

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