New Crypto Law Would Ease Tax and Reporting Headaches

by Prof. Robert Bloink and Prof. William H. Byrnes

It’s no secret that cryptocurrency regulation has been high on the list of Congress’ priorities this year. Early in June, a bipartisan group of senators introduced the Responsible Financial Innovation Act. If enacted into law, the bill would clarify some key issues related to cryptocurrency taxation and regulation. These provisions are designed to address some significant concerns that cryptocurrency insiders have raised following the most recent round of cryptocurrency-related legislation, contained in President Biden’s Infrastructure Investment and Jobs Act. As cryptocurrency investments become more and more mainstream, it’s more important than ever for advisors to stay abreast of the latest regulatory developments that could impact their clients now and going forward.

New Regulatory Scheme

The Responsible Financial Innovation Act would classify most types of digital assets as ancillary assets (in other words, intangible and fungible assets that are offered or sold in connection with the purchase and sale of a security). The assets would therefore be treated as commodities, like oil, gold or beef. The Commodity Futures Trading Commission (CFTC) would therefore be given authority to regulate much of the industry.

The law would not treat cryptocurrencies as traditional securities subject to the SEC’s jurisdiction unless the investor’s rights mirror those typically associated with securities (for example, dividend rights or some type of financial stake in the issuer).

Clarifying the Definition of “Broker”

Back in November 2021, President Biden signed the Infrastructure Investment and Jobs Act into law. The law contained provisions designed to increase reporting obligations from facilitators of digital asset transactions. More specifically, the law expanded the definition of “broker”, defining the term as “any person who (for consideration) is responsible for providing any service effectuating transfers of digital assets on behalf of another person”.

A ”broker” is obligated to report virtual currency transactions to both the IRS and the investor. Many industry players argued that the new definition was overly broad, and could trap software developers, miners and others who may lack sufficient access to information necessary to provide accurate reporting.

The new legislation narrows the definition of broker to address these concerns. The new definition would only apply to anyone who, for consideration, is ready to effect sales of digital assets at the direction of their customers in the ordinary course of business. While the new definition would not limit reporting obligations to cryptocurrency exchanges themselves, it is significantly more narrow.

The new law would also delay the reporting obligations from 2023 until 2025.

New Safe Harbor Rules

The law also contains safe harbors designed to protect certain smaller and foreign investors. A de minimis exception would allow individual investors to exclude up to $200 in gains from digital asset transactions from gross income. The safe harbor would only apply if the transaction was a personal transaction (presumably, as opposed to a transaction involving an ongoing trade or business). This provision could encourage virtual currency to function more like currency, as the de minimis exemption could make it easier for businesses to accept virtual currency for everyday transactions.

Existing safe harbors for securities and commodities trading by foreign persons who use U.S. financial institutions to effect their trading would also be extended to transactions involving virtual currency. Application of this safe harbor would allow non-U.S. persons to escape U.S. reporting solely based on their cryptocurrency trading activities.

The bill would also include earlier proposals to tax cryptocurrency loans in accordance with the existing Section 1058 securities lending rules. If enacted into law, it would mean those cryptocurrency loans could be made without recognizing gain or loss on the transaction.

Conclusion

The new law aims to address a wide range of issues surrounding cryptocurrency taxation and regulation. While the legislation continues to evolve, it’s likely that we’ll see some type of new legislation in the near future—and many expect that the law will be much more investor-friendly than previous proposals.

For previous coverage of planning for digital assets in Advisor’s Journal, see https://nationalunderwriteradvancedmarkets.com/articles/fc101018-a.aspx?action=16

For in-depth analysis of investment planning options, http://www.advisorfx.com/articles/nuco-article.aspx?filename=1177-00-tf2§ion=Investments&subsection=see Advisor’s Main Library: https://nationalunderwriteradvancedmarkets.com/mainlibraries/Investment%20Planning/13.aspx?action=12

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