Crypto Assets and the Problem of Tax Classifications
61 Pages Posted: 6 Apr 2023
Date Written: March 24, 2023
To date, Internal Revenue Service (I.R.S.) guidance on cryptocurrencies has been thin. When the I.R.S. has issued guidance, it occasionally mishandles the technical details (such as confusing air drops and hard forks). More personnel (and personnel with greater technical expertise) would allow the I.R.S. to keep pace with the explosive growth of cryptocurrency. Nevertheless, the I.R.S. could better leverage its existing resources by focusing on select issues and seeking enabling legislation from Congress. Specifically, the I.R.S. should focus on crypto issues occurring on a system-wide basis and not requiring taxpayer-specific considerations.
For example, determining whether Bitcoin is a “security” under various provisions of the Internal Revenue Code (“Code”) does not require the I.R.S. to examine specific taxpayers. It must, though, examine Bitcoin itself and the provisions using the term. Under current law, Bitcoin would not be a security under most of these provisions. The purposes of these provisions is to apply special treatment to fungible and liquid investments like stock, and they should apply to Bitcoin. Thus, Congress should enable the I.R.S. to make such classifications, even if the current language of the Code does not permit them.
The classification power should be flexible, allowing for carveouts and exceptions for provisions of the Code and cryptocurrencies. Some provisions using the word securities should not apply to cryptocurrency because they exist to promote specific activities (e.g., retirement savings). Some cryptocurrencies should not be considered securities at all. In particular, thinly traded assets and nonfungible tokens (NFTs) should not qualify because they do not function like securities. Over time, classifications may need to change as new, thinly traded securities become widely adopted. Similarly, stablecoins—cryptocurrencies pegged to the dollar—should be considered securities today. With different usage or non- tax regulation, they may evolve into money under the Code.
Classifications can also be comparative (rather than categorical). Are Bitcoin and Wrapped Bitcoin (an Ethereum token pegged to the value of Bitcoin) so different that their exchange is a realization event, triggering taxation? Such questions also operate on a system-wide basis and can be answered for all taxpayers. In all likelihood, these exchanges are taxable, but they should not be as a normative matter. A broad grant of authority from Congress would allow the I.R.S. to make the correct classifications and tax cryptocurrency the right way.
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