Tax Perks for Crypto in the Lummis-Gillibrand Bill
Just when you think lawmakers couldn’t possibly be any dumber, they go and write a bill like this…
AND TOTALLY REDEEM THEMSELVES!
This month, Congress took its first real swing at drafting meaningful laws and regulations around crypto in the form of a 69 page document called the “Responsible Financial Innovation Act” (or RFIA). This bill is chock-full of great ideas, and in this blog post we’ll focus on the bill’s tax proposals.
Before we dive in, there are three reasons to be optimistic about the RFIA’s odds of eventually becoming law:
First, this is a bipartisan bill. What a breath of fresh air to see anyone in Congress shaking hands across the aisle these days! And in our currently split senate, very little legislation can pass without bipartisan support. Although this bill is just a draft and has a long way to go before it becomes law, it’s starting off on the right foot.
Second, just the name of the bill sets the proper tone. It is encouraging to see that they named it the “Responsible Financial Innovation Act” and not the EVIL Act (“Eliminating Virtual Internet Lucre”) or the SCAM Act (“Scuttling Crypto Artifice Money”). Clearly they want America to reap the wealth and prosperity that comes from fostering free trade with a healthy dose of consumer protection.
Third, we’ve got the right people leading this charge. Senator Cynthia Lummis hails from Wyoming which is the birthplace of the Limited Liability Company (circa 1977) and, more recently, became the OG of the DAO LLC. Lummis is in close contact with the leaders in the crypto community, was on a panel at Bitcoin Miami earlier this year, and personally owns hundreds of thousands in crypto herself according to her personal financial disclosures.1 If there is anyone in Congress you’d want drafting a bill, it’s her.
The bill has excellent proposals to help average investors distinguish between “payment stablecoins” and the riskier not-so-stable algorithmic stablecoins, as well as great ideas to force state jurisdictions to line up on their money transmitter licensing requirements. But hell must be getting a lot colder these days, because I’m writing these words: the RFIA’s new tax rules will make everyone’s lives easier. Here are the highlights:
Mining & staking rewards are not taxable, initially.
Yes, you read that right. In a stark contrast from the IRS’s 2014 statement that mining income is immediately taxable2, the RFIA instead states:
“In the case of a taxpayer who conducts digital asset mining or staking activities, the amount of income relating to such activities shall not be included in the gross income of the taxpayer until the taxable year of the disposition of the assets produced or received in connection with the mining or staking activities.”3
In other words, you don’t pay tax on earnings from mining or staking until you eventually sell or trade the tokens you earned. Currently, the rule is that you must count any rewards or yield as taxable income today regardless of whether you sell them or not.
Anyone who has mined or staked knows that tracking the fair market value of staking rewards is impossible for anyone who isn’t Data from Star Trek. We non-android folks have to use third-party wallet tracker services to figure out how much we earned (expressed in US dollars), but even then these services fall short. For example, what if you earn tokens from staking but never harvested them into your wallet? Third party apps can only see transactions hitting your wallet so these get missed, which means you just evaded taxes (and that’s a bad thing, no matter what your crazy uncle Joey says).
Another problem this solves is that frequently stakers get rewards from minting new tokens which can reduce the price of the token itself. Under today’s rules, that means we have ordinary income from the staking rewards today and down the road a capital loss on the depreciation of those same tokens, so you pay a higher tax rate on the income and a lower tax rate on the losses. To make matters worse, capital losses generally can’t be used to offset ordinary income4, so you’re just plain hosed on your tax return. We love the RFIA’s fix of this problem with every fiber of our crypto-holding hearts.
Paying for goods or services in crypto is not taxable as long as the corresponding gain or loss is under $200.
Collect $200 and pass Go, tax free!5 While the dollar amount may seem small, remember that it’s the gain on the currency we’re talking about here. So say, for example, that you decide to split the cost of lunch amongst your friends and pay them back in crypto. You will no longer have to report that transaction in your income even if it was with those staking rewards that you never paid tax on initially. Likewise, if you buy a car using a stablecoin which hovers between $1.000001 and $9.999999 when you sell, you again wouldn’t need to go through the hassle of reporting that tiny gain or loss.
Plus, this number is indexed for inflation, so in a year or two the threshold will be $2,000. Kidding, kidding! (Sort of…) Also of note here, this is set to go into effect in 2023, so if the law does pass in the near future we won’t have to wait long for this sigh of administrative relief to take effect.
There is an anti-abuse provision that groups a series of payments which are part of the same transaction together for purposes of this rule, so if you were hoping to sell off all your earnings in $200 increments, sadly that strategy won’t work. Nice try, though.
Form 1099 reporting delayed until 2025.
You may recall that Congress passed the Infrastructure Bill last fall and required just about anyone who facilitates crypto trades whatsoever to report all transactions on a Form 1099. This law is currently set to go into effect beginning in 2023 (meaning early 2024 would be when you get your first 1099), and it is a hot mess of confusion for crypto companies and tax practitioners alike.
For example, say that I use a centralized exchange like Kraken to buy some ethereum. I then move it to a MetaMask noncustodial wallet which I connect to SushiSwap to trade my ethereum for matic. I then reverse all these steps to pull my money back out of Kraken with a small gain (hooray!). Under the Infrastructure Bill, all three of these parties have a 1099 reporting obligation, and they could double count the same transaction (e.g. both Sushi and MetaMask) or may not have enough information to properly report (e.g. Sushi & MetaMask don’t know who you are and Kraken doesn’t know your tax basis on the ethereum coming back from MetaMask).
The RFIA prudently reduces the breadth of the Infrastructure Bill’s immensely wide net to only those who “[stand] ready … to effect sales of digital assets at the direction of their customers.”6 So clearly custodial crypto companies fall under this category; however, when users hold their own private keys, they call the shots directly on the blockchain so a DEX like Sushi or a noncustodial wallet provider (like Giddy!) would not have a reporting obligation.
There are still more issues to tackle here, so the RFIA hits the snooze button on the 1099 reporting obligation until 2025, presumably to sort these details out.
Staking & unstaking crypto is not considered a sale and does not trigger tax.
Did you know staking into a DeFi protocol could be treated just like selling your crypto under today’s laws? That feels wrong because staking crypto is economically identical to lending crypto to the protocol because you still participate in the ups and downs as if you’d held it the entire time. The RFIA clarifies that this is not a taxable transaction by modifying the code section pertaining to lending securities and applying it to digital assets.7
The IRS has one year to iron out the nitty-gritty details.
DeFi is complex and is constantly conjuring creative contracts. That’s why the RFIA includes a section that directs the Treasury Department (i.e. the branch of the U.S. government where the IRS lives) to iron out the details and nuances of DeFi.8 This typically is in the form of everything from Treasury Regulations all the way down to the instructions that accompany the forms the IRS produces.
Lest the response be a meager Q&A posted on the IRS website, the RFIA specifically outlines where it wants to see new regulations. My favorite task on this to-do list: the RFIA instructed the Treasury to make it easier to donate large amounts of crypto to charitable organizations. Currently, it’s more complicated and may require hiring a valuation expert to claim a charitable deduction.
The RFIA will be introduced to Congress this session, but, as with all laws, it must get passed by both the House and the Senate and may be edited and revised by the various Committees before it lands on the President’s desk for signature. That means realistically the earliest this could become law would be 2023. That may be far away, but the old adage seems to ring true: good things come to those who HODL.
- Her annual report is available at https://efdsearch.senate.gov/search/
- See Notice 2014-21, §4, Q&A-8 https://www.irs.gov/pub/irs-drop/n-14-21.pdf
- RFIA §208
- See IRC §1211(b) for the full rules
- RFIA §201
- RFIA §202
- RFIA §205 which modifies IRC §1058. This section commonly applies to mutual funds which hold massive amounts of stocks and commonly will “lend” their securities to stock brokers who use them to quickly settle transactions with clients. The brokers promise to repay identical stocks back to the mutual funds including any dividends during the lending period. Even if there is appreciation or depreciation of the lended security during this time, no gain or loss is recognized by the lender.
- RFIA §206