One of the biggest issues bitcoin and other cryptocurrencies face as a payment mechanism is taxation, an issue so complex that it takes it beyond day-to-day reality.
It’s something Sen. Cynthia LummisR-Wyo., intends to lay down with its highly anticipated Responsible Financial Innovation Act, which it described as “a bill to fully integrate digital assets into our financial system.”
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A staunch crypto supporter and bitcoin owner since 2013, the freshman senator said she was working with colleagues and advocates in the crypto industry to put “the finishing touches” on it in a Wednesday Twitter announcement. March 9.
It’s been a long time coming, but my bill to fully integrate digital assets into our financial system is almost ready! I’m putting the finishing touches on it with some key Senate advocates and partners, but watch out for an unveiling soon! pic.twitter.com/gpHh2JVgKd
— Senator Cynthia Lummis (@SenLummis) March 9, 2022
Lindholm described the purpose of the legislation as providing clarity to the digital asset industry and retail cryptocurrency users on several issues, including taxation and the codification of the Bill $1 trillion infrastructure last year that sought to prevent a poorly worded definition of “broker” from making it impossible to legally mine or validate cryptocurrency.
A key idea
The biggest issue, by far, is capital gains tax as it applies to cryptocurrencies.
Specifically, that means applying an exclusion for small sales, Lindholm said. The senator is currently considering $600, he said. He added that Lummis would like it to be higher but the Senate can only pass a bill with a lower amount.
“What we’re really looking for there is just bringing digital assets into the taxation system,” Lindholm said.
Currently, the law considers any gain from the sale of cryptocurrency a taxable event, which doesn’t seem particularly unreasonable. But the devil is in the details.
The IRS requires people to determine if they have made money from selling crypto by comparing its price from the day it was bought and the day it was sold. Again, quite reasonable.
However, right now that means any gain, no matter how small. The industry favorite example is buying a cup of coffee for $5 a day with bitcoin, for example with a crypto debit card or your PayPal account.
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If you acquired this bitcoin for $3.75, for example, you would have to pay taxes on $1.25. And since the IRS requires all capital gains to be listed separately, you have to figure it out 365 times – the amount changing every day based on the highly volatile bitcoin price.
Now consider that you may have bought bitcoins multiple times and thrown them all into one wallet. Then figure out how much you paid for the particular bitcoin used to buy that coffee and then the value when you spent it. And keep in mind that bitcoin has been known to go up and down as much as 10% in a day.
Although some card providers and exchanges provide this information, the breadth of it would mean that even buying a daily coffee would require the services of an accountant – presumably with a background in cryptocurrency. Daily use of BTC for many purchases would be – and technically is – effectively impossible, even if the IRS has yet to prosecute.
Another way the bill would impact capital gains, Lindholm said, is to clarify that it doesn’t apply to what he calls “productive” activities, in which you don’t sell the earned asset.
More specifically, this means earning “block rewards” of newly minted cryptocurrency coins by validating transactions so they can be added to a blockchain. This is mining in the case of proof-of-work blockchains like bitcoin and ethereum, or crypto staking in the case of proof-of-work blockchains like “Ethereum killers” like Cardano, Solana or Avalanche.
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This is a doubly serious problem in the case of staking, as many people simply lend their crypto to the staker in exchange for a share of the newly minted coins, usually leaving the winnings in the staking pool.
“The current gray area is that you could accumulate a taxable capital gains event under proof of stake as it currently stands, even if you are only delegating,” Lindholm said.
Notably, Decrypt said, the IRS has declared that tokens earned through proof of work are taxable the day they are mined.
Lindholm said the bill would also allow people to withdraw money from retirement accounts like 401(k)s and IRAs to reinvest in crypto without early withdrawal penalties and other tax consequences. Currently, there is no effective way to directly invest retirement account savings in cryptocurrencies.
The battle for infrastructure
Finally, Lummis’ bill would seek to codify changes unsuccessfully sought by 99 senators, to add to last year’s $1 trillion infrastructure bill.
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This would have clarified that miners and stakers are not “brokers” for the purposes of collecting know-your-customer (KYC) information – something they couldn’t do because they didn’t have access to this personal information.
Although the IRS has said it will not read the law as written in the now-passed law, as crypto industry advocates feared, that promise does not have the force of law.