Into The Woods: US Congress Provides A Roadmap To Solving Cryptocurrency Tax Issues

• Published date: 20 July 2023
• Subject Matter: Corporate/Commercial Law, Technology, Corporate and Company Law, Securities, Fin Tech
• Law Firm: Mayer Brown
• Author: Mr Mark Leeds

Many aspects of the US federal income taxation of cryptocurrency and non-fungible token transactions are uncertain. So much so that in June 2023, the Joint Committee of Taxation (the "JCT") issued a White Paper to assist Congress in both identifying and resolving such uncertainties.¹ Not coincidentally, senators Cynthia Lummis and Kirsten Gillibrand have (again) proposed legislation that would bring more clarity to the taxation of digital asset transactions.² While today even the most banal pieces of legislation seem to get weighed down with culture war riders, it's certainly worth examining these developments to see what we can expect if and when Congress acts in this realm. These developments also shed light on how the Internal Revenue Service (the "IRS") is likely to interpret existing rules as applied to cryptocurrency transactions.

I. The JCT Report

The JCT Report covers nine issues of keen importance to cryptocurrency market participants: (1) the mark-to-market election for dealers and traders; (2) the trading safe-harbor for non-US investors; (3) loans of digital assets; (4) wash sales; (5) constructive sales; (6) the de minimis safe-harbor for gains from the dispositions of non-functional currencies; (7) the timing and source of income from staking; (8) the valuation of charitable contributions of digital assets; and (9) FBAR and FATCA reporting. We'll explore each of these topics in turn.

A. The Mark-to-Market Rules

Code ' 475(e)(1)³ provides that a dealer in commodities may elect to use mark-to-market accounting for federal income tax reporting purposes.⁴ Concomitantly, Code ' 475(f) allows traders in commodities to elect to use mark-to-market accounting. For those familiar with the rules for securities dealers, these Code sections provide that the rules apply in the same manner as Code ' 475(a) applies to a dealer in securities. The mark-to-market election only applies with respect to commodities that are actively traded.⁵ The JCT Report finds that the application of the mark-to-market election for cryptocurrencies is "uncertain," apparently because the JCT believes that it is uncertain as to whether cryptocurrencies should be considered to be actively traded for federal income tax purposes. In contrast, the actions of the Securities and Exchange Commission support the conclusion that cryptocurrencies are actively traded, as it has sued centralized cryptocurrency exchanges for running unregistered exchanges.⁶

The use of mark-to-market accounting results in all gains and losses being treated as ordinary in character, even if the digital assets in the hands of a trader are capital assets. Mark-to-market accounting can be a double-edged sword, beneficial when losses are accelerated and converted to ordinary, and disadvantageous in that gains are accelerated and long-term capital gain treatment becomes unavailable.

B. The Trading Safe-Harbor

Code ' 882(a)(1) imposes the regular corporate tax specified by Code ' 11 (as well as certain other taxes) on net income earned by non-US corporations that is effectively connected with the conduct of a trade or business within the United States. However, even though trading in certain commodities for one's own account (i.e., acting as a commodities trader) otherwise constitutes a trade or business for general US tax purposes,⁷ Code ' 864(b)(2) provides that the conduct of these activities in the United States by a foreign person is not treated as the conduct of a US trade or business for purposes of the tax imposed by Code ' 882(a):

"A foreign person who trades . . . commodities for the persons' own account . . . generally is not considered to be engaged in a US business so long as the foreign person is not a dealer in . . . commodities."⁸

Specifically, a non-US person is not treated as engaged in a trade or business within the United States if the activities of such person are limited to effecting certain commodity transactions in the United States for the taxpayer's own account, regardless of whether the person conducting the trading in the United States has discretionary authority to make decisions in effecting the transactions, and regardless of whether...