The incoming Trump administration has been sending strong signals of reversing course on cryptocurrency and embracing the nascent industry. Not only is Trump selecting Paul Atkins to replace Gary Gensler as SEC Chair, he is forming a presidential crypto advisory council. Replacing Gensler with a pro-crypto SEC Chair could signal the end of aggressive SEC enforcement actions against crypto companies.
Up to now, securities issues have been front and center for new token projects. Because classification as a security could be a death knell to a new token, the securities classification of tokens was a mission-critical issue for crypto projects. However, if a new SEC Chair eases the way for token offerings, securities issues may begin to fade in importance.
If securities issues begin to fade, expect tax issues to bloom, especially in the area of information reporting.
Tax Information reporting for Crypto
As the saying goes in crypto, “not your keys, not your coins”. Whoever controls the private keys to a crypto wallet controls the disposition of the crypto inside that wallet. This makes cryptocurrency the digital equivalent to a “bearer” instrument, such as bearer bonds or cash. With a bearer instrument such as cash, physical possession shows ownership and physical exchange transfers ownership. Just as physical possession of cash shows ownership, control over the private keys of a wallet shows ownership for crypto.
This feature of crypto creates the potential for anonymity and hence tax evasion in cryptocurrency transactions. Of course, crypto leaves behind an immutable digital trail of transactions – there’s a public digital history that is unlike cash transfers. Nevertheless, it’s not always possible or easy to connect that digital trail to an actual individual.
Recognizing this potential, Congress has already made crypto transactions subject to certain reporting rules that apply to cash transactions over $10,000, although the IRS has called off the reporting rules until regulations are issued. Just a few days ago, the IRS passed sweeping broker and intermediary reporting rules for DeFi platforms that provide trading front-end services.
However, the potential for anonymity and tax evasion in crypto transactions will persist. Will Congress seek even greater information reporting or will the new Trump administration give DeFi more breathing room and loosen the regulations? If history is any indicator, the trend has been in favor of more information reporting.
Increasing Information Reporting: Bearer Bonds and Swiss Bank Accounts
In 1982, Congress passed sweeping legislation that, outside of limited circumstances, imposed tax penalties on issuers of “bearer bonds.” Lawmakers wanted to trace interest income to taxpayers by requiring the bond issuers to track the beneficial owners of the bonds and report interest income to the IRS. This legislation essentially eliminated all U.S. bearer bond issuances.
In 2007, Bradley Birkenfeld revealed that UBS was involved in assisting U.S. taxpayers in evading taxes. This led Congress to pass the “Foreign Account Tax Compliance Act” (FATCA) in 2010, in an effort to shut down the use of offshore bank accounts to stash assets and avoid reporting income.
In between these two dates, and since 2010, Congress has steadily increased the amount of required tax information reporting. Congress has been seeking ways to narrow the “tax gap,” the difference between the true tax liability in a given year and the amount actually paid. The most reliable way to do this is by mandating more information reporting.
Brewing Tax Battle for Crypto
Will Congress seek to do something similar for crypto? The IRS has launched the first salvo with its new broker information reporting rules. But these new rules are quite different from the past because, among other reasons: (i) crypto activity can’t always be tied to a specific physical location and therefore there is no easy way to determine if it is taking place in the US or involving a US taxpayer and (ii) there is not always a central organization in place to perform reporting and tracking. The implications of requiring information reporting for crypto is more drastic, potentially threatening the very existence of DeFi platforms, than for U.S. bond issuers or Swiss banks.
Nevertheless, as crypto activity increases, expect information reporting to remain a huge issue as Congress seeks ways to reduce the potential for tax evasion
