Senate panel looks into changing tax treatment of crypto

Leaders of the Senate Finance Committee began an effort Tuesday to address the many uncertainties around the tax treatment of digital assets, sending an open letter seeking input from experts, stakeholders and interested parties about how to adjust the rules. 

"The rapid emergence of digital assets has raised novel regulatory issues, including the appropriate treatment under our federal tax law," said Senate Finance Committee chairman Ron Wyden, D-Ore., and ranking member Mike Crapo, R-Idaho, in the letter. "The [Tax Code] draws distinctions between types of property, with no straightforward classification for digital assets. This uncertainty creates complex reporting issues for taxpayers, and warrants examining how the [code] can provide clearer guidance for taxpayers on the treatment of digital asset transactions."

The effort comes as Sen. Kirsten Gillibrand, D-New York, Cynthia Lummis, R-Wyoming, are expected to reintroduce the Responsible Financial Innovation Act, as soon as Wednesday, according to Fortune. The bill was originally introduced over a year ago and aimed to overhaul regulation of the cryptocurrency and stablecoin industry (see story). It was supported by the crypto industry and would have moved some of the key oversight functions from the Securities and Exchange Commission to the Commodity Futures Trading Commission, sparking opposition from the SEC.

Donnie Shackleford/doncon402 - Fotolia

The sector has been weakened over the past year after the implosion of several prominent crypto exchanges and companies like FTX, Voyager Digital, BlockFi and Celsius, along with regulatory crackdowns on other high-profile exchanges like Binance and Coinbase. The IRS has come out with only limited guidance so far on the tax treatment of crypto, releasing notices in 2014 and earlier this year saying virtual currency should be treated as property for tax purposes, guidance in 2019 on a "hard fork," along with a set of frequently asked questions and answers that is updated periodically. 

The letter from the bipartisan leaders of the Senate Finance Committee is addressed to members of the digital asset community and other interested parties and asks about mark-to-market valuation. The Financial Accounting Standards Board has also been working on a digital assets accounting standard that focuses on cryptocurrency and has proposed to require fair value measurement for the assets (see story).

Among the questions in the letter from Wyden and Crapo deals with marking to market for traders and dealers, asking: 

• Should traders of digital assets be permitted to mark to market?  Why?
• Should dealers of digital assets be permitted or required to mark to market? Why?  
• Should the answer depend on the type of digital asset? How should digital assets be determined to be actively traded (under IRC Section 475(e)(2)(A))?

Other questions involve the trading safe harbor in Section 864(b)(2)) of the Internal Revenue Code:

• When should the policies behind the trading safe harbor (of encouraging foreign investment in U.S. investment assets) apply to digital assets? If those policies should apply to (at least some) digital assets, should digital assets fall under IRC Section 864(b)(2)(A) (trading safe harbor for securities), IRC Section 864(b)(2)(B) (trading safe harbor for commodities), or should the answer depend on the regulatory status of the specific digital asset? Why?
• Another possibility is that a new, separate trading safe harbor could apply to digital assets. In that case, should the additional limitation on commodities eligible for the trading safe harbor apply? Why?
• To the extent that the additional limitation on commodities for the trading safe harbor applies, how should the terms "an organized commodity exchange" and "transactions of a kind customarily consummated" (in IRC Section 864(b)(2)(B)(iii)) be interpreted in the context of different kinds of digital asset exchanges?

Other questions involve the treatment of loans of digital assets, wash sales and constructive sales, the timing and source of income earned from staking and mining, nonfunctional currency, FATCA and FBAR reporting, nonfunctional currency, valuation and substantiation.

The Senate Finance Committee plans to collect answers to the questions on a rolling basis until Sept. 8, and is asking interested parties to submit electronic copies of their answers to the following questions to the committee staff at responses@finance.senate.gov.