Cryptocurrency markets have recently been uncertain, leading most Americans who have heard of these digital assets to lack confidence in their safety and reliability.¹ Sadly, many people have invested and lost much of their life savings after being lured into the exaggerated promises of cryptocurrency.² This has only worsened inequities in the financial markets and wealth accumulation³ and led to scams, four alleged Ponzi schemes, and five charges of alleged money laundering⁶—activities that seem to be the primary attraction of these markets.

Still, millions of people continue to own digital assets. Crypto advocates claim that cryptocurrency is innovative unique, and be taxed or treated like other assets and transactions.⁸ Hiding behind unproven claims that cryptocurrency is the answer to wealth accumulation for low-income people, they continue to push policymakers to apply looser standards to cryptocurrency than those that apply to other financial assets.¹⁰

While the future of cryptocurrencies is uncertain, the application of tax laws to cryptocurrency transactions generally is not. With relatively few exceptions, current tax rules apply to cryptocurrency transactions as they apply to transactions involving any other type of asset.¹¹ One simple premise applies: All income is taxable, including income from cryptocurrency transactions.

The U.S. Treasury Department and the IRS should continue to educate taxpayers about how tax laws apply to cryptocurrency transactions and issue guidance in the few areas where there may be uncertainty. Meanwhile, Congress should allow the Treasury and the IRS to act quickly in this regard and avoid confusing consumers with legislation unless there is a broad-based agreement on the need for it.

.The anonymity that makes digital assets attractive to many investors also raises the potential for tax evasion.¹² Failure to report information about cryptocurrency transactions contributes to the tax gap—the difference between the amount of tax that taxpayers legally owe and what they pay. In its most recent projections, the IRS estimated that the tax gap for the tax year 2021 was $688 billion, an increase of more than $138 billion from the prior estimate for tax years 2017–2019.¹³ The report stated, however, that the IRS cannot fully represent noncompliance in certain areas, including concerning nnon-complconcerningd with digital assets.¹⁴

The amount legally owed but unpaid taxes is significant. s Yale Law School professor and former Treasury Department official Natasha Sarin noted in recent testimony before the Senate Budget Committee: “One year’s worth of uncollected taxes would pay for nearly all of the non-defense discretionary spending that the federal government does. One year’s worth of uncollected taxes would shrink our annual budget deficits by one-third to one-half.” ¹⁵ While the magnitude of the gap associated with digital assets is unknown, one estimate by Barclays PLC suggests that at least half of the taxes owed on cryptocurrency transactions go unpaid, costing at least $50 billion per year in lost tax revenues.¹⁶ For this reason, the Treasury Department’s most recent Strategic Operating Plan includes an initiative to “enhance detection of noncompliance and increase enforcement activities” for digital assets and other complex, high-risk, and novel emerging issues.¹⁷

The United States must ensure that using cryptocurrencies does not undermine the tax system and the critical revenues it generates. There are two approaches that Congress and the IRS can take to accomplish that goal:

1. Fix actual problems: Whenever the tax laws are applied to new types of assets or transactions, questions will arise about the nuances of using the rules, and sometimes loopholes are revealed. In most cases, the IRS has sufficient authority to resolve these issues; in others, Congress may need to act. This report identifies problems where immediate action is warranted.
2. Avoid making matters worse: Members of Congress should avoid the temptation to appear crypto-savvy and reject lobbyists’ requests to provide special treatment or legislative exceptions when taxing cryptocurrency assets. A handful of such proposals are discussed below. Meanwhile, the IRS should ensure more robust enforcement of vigorous tax laws. As discussed in this report, the IRS has taken steps to educate taxpayers in the past but more active enforcement. Still, vital taxpayer education ensures that existing digital assets and transactions are applied smoothly.

.All U.S. citizens, residents, and businesses, as well as foreign individuals and companies that transact business or invest in the United States, are subject to the federal tax laws; there are no exceptions for transactions involving cryptocurrencies.¹⁸

In 2014, the IRS sought to highlight this point in guidance.¹⁹ The agency stated that cryptocurrency assets generally are treated as property.²⁰ Thus, a taxpayer who sells or otherwise disposes of cryptocurrency assets may have a gain for tax purposes, depending upon their basis in the property. Any gain would be taxed at ordinary or long-term capital rates, depending on whether the taxpayer held the digital asset as an investment and on the length of time they held the cryptocurrency assets. Some taxpayers may not be aware that this also means that making purchases with purchasing appreciated since they acquired it may give rise to a taxable gain. As with any other noncash property used to purchase goods or services, the purchase using cryptocurrency is treated for tax purposes as if the person sold the asset—in this case, the cryptocurrency—and used the proceeds to make the subsequent purchase.

When a person receives cryptocurrency in exchange for performing services, the basic tax rules also apply: If an implant employer pays them, the currency is subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) tax, and the Federal Unemployment Tax Act (FUTA) tax, and it is reported as income on a Form W-2, the Wage and Tax Statement.²¹ Payments to independent contractors made in cryptocurrency are subject to self-employment taxes (SECA), and depending on the amount of the payment, reporting may be required on Form 1099.^22. Thus, when successful. Miner of virtual currencies receives cryptocurrency in return for their services; the fair market value of the virtual currency on the date it is received is income for tax purposes and subject to income and, potentially, self-employment taxes.

Similarly, businesses that accept cryptocurrency assets as payment must include the value of the assets in income for tax purposes. Companies that invest in cryptocurrency assets for profit must treat those investments like any similar company investment for tax purposes.

Yet more recently, policymakers and tax experts have identified a handful of circumstances in which the application of existing tax laws to cryptocurrency transactions is unclear. The IRS has the authority to clarify most of these circumstances and should take the following steps as soon as possible to protect federal revenues and dispel inaccurate claims made by cryptocurrency advocates.

Clarify broker and other information reporting

.The U.S. tax system relies on individuals and businesses to voluntarily report their income and additional information necessary to determine their tax liability. Because of the potential for tax avoidance and tax evasion, the tax code requires certain third parties to report information needed to verify tax liability. For example, under Internal Revenue Code (IRC) Section 6045, brokers must report information on gains or losses from transactions to their clients, who can then document their income correctly and send it to the IRS.²³ The IRS cross-checks the amount on the tax return with the information it received from the taxpayer’s broker. Tax return items subject to at least some third-party information reporting have an 85 percent compliance rate.²⁴

The Treasury and IRS have long had the authority to determine whether digital asset brokers are required to report position 6045. However, cryptocurrency brokers have leaned on the anonymity of transactions on the blockchain—the underlying technology on which cryptocurrency assets are based—to claim they are not required to comply with tax code reporting requirements that apply to other brokers. As the number of transactions these brokers manage increases, this could enable an ever-increasing volume of transactions in which customer gains go unreported and thus untaxed, with a corresponding loss of revenues to the Treasury.

To avoid this outcome, the Infrastructure Investment and Jobs Act (IIJA) of 2021 clarified that brokers of digital asset transactions should be treated like other brokers who get paid to effectuate transfers of property or services.²⁵ It also clarified that digital assets, defined broadly, constitute “covered securities” for purposes of this disclosure.²⁶ Section 6045 of the tax code requires brokers to furnish the IRS with identifying information about their customers, including gross proceeds of the transactions.²⁷ In addition, brokers are required under IRC Section 6050I to report to the IRS any transactions made with cash or digital currency of more than $10,000²⁸—a provision aimed at detecting money laundering, terrorism financing, and other nefarious activities. After a long delay, the Treasury Department released proposed rules governing the new broker reporting requirements in late August 2023.²⁹ Unfortunately. However, the proposed regulations delay implementation of the new broker reporting requirements until 2026, resulting in a substantial loss of revenue in 2023 and 2024, likely in the range of several billion dollars.³⁰

In addition to clarifying the definition of “broker,” as Congress did in the IIJA, other steps are needed to ensure that individuals and entities engaged in cryptocurrency transactions report information essential to determining tax liability. For example, in follow-up guidance on the IIJA provision, the IRS should require domestic exchanges and wallet providers to report to the IRS the number of coins and tokens that become available to customers or wallets they manage after a contentious “hard fork” or “airdrop” giveaway—two actions described in more detail below that can result in income to recipients.

In another important example, the Biden administration’s fiscal year 2024 budget asks Congress to expressly require brokers, such as U.S. digital asset exchanges, to report gross proceeds and other information relating to sales of digital assets by its foreign account holders and, where the customer is a passive entity, provide information about the entity’s substantial foreign owners.³¹ This proposal is a straightforward clarification that under the provisions of the Foreign Account Tax Compliance Act (FATCA),³² an anti-tax evasion and anti-money laundering statute, the United States, in turn, can provide inf, information on foreign owners of U.S. accounts to foreign governments that provide reciprocal information about U.S. investors using exchanges based in their countries. This reciprocal exchange of information on U.S. taxpayers that directly or through passive entities engage in digital asset transactions outside the country would help the United States combat the rapidly growing problem of tax evasion, whereby U.S. taxpayers transact with offshore digital asset exchanges and wallet providers without leaving the United States, enabling them to conceal assets and taxable income.

The Biden administration has also proposed to expand current tax law requiring individuals to report any interest they hold in a foreign financial account or certain foreign assets on their tax return.³³ This proposal would require tax return information disclosure on any account that holds digital assets maintained by a foreign digital asset exchange or other foreign digital asset service provider.³⁴

Close the wash sale loophole

.Lawmakers have considered language that would explicitly clarify that digital asset transactions fall under an existing law that prevents taxpayers from generating tax-deductible losses from the sale and repurchase of securities within a short period of time. In the known period,” the taxpayer sells securities at a loss and purchases substantially similar ones within the same period, then uses tperiodctible loss to reduce taxable capital gain income on other assets.³⁵ The wash sale rule prohibits the deduction of losses attributable to shares of stock or other securities if, within 30 days before or after the transaction that generated the loss, the taxpayer purchases or enters into a contract to purchase substantially identical assets. The taxpayer must wait until they sell the repurchased security to benefit from a loss deduction.

Cryptocurrency advocates claim that crypto assets are not securities—a position that the chair of the Securities and Exchange Commission has rejected³⁶—and that cryptocurrency transactions are therefore not subject to the wash sale rule. Congress, for its part, For halt the Congress has sought to stop cryptocurrency transactions’ uses. During consideration of the Build Back Better Act, a much larger bill that was ultimately not enacted, Congress debated language that would clarify that wash sale rules apply to any sale or other disposition of a specified asset, including commodities and “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology.” ³⁷ While further clarification may be needed to specify the details of such a proposal,³⁸ cryptocurrency transactions should be subject to the wash sale rule to prevent tax avoidance.

Close the constructive sales loophole

.A related maneuver to avoid tax on capital gain occurs where a taxpayer holding a position in a stock, debt instrument, or partnership where that position has appreciated in value enters into a sale of the appreciated position such that the recognition of gain is deferred and may never occur. To combat this practice, constructive sales rule³⁹ requires the record 39n of taxable gain at fair market value on the date of the constructive sale.⁴⁰ As recognized by the House and Senate proponents in the same Build Back Better bill cited above,⁴¹ digital asset transactions should comply with the constructive sales rule.

Provide clear guidance on rigid forks and airdrops

.A typical cryptocurrency transaction called a “hard fork” occurs when one or more crypto developers modify the software on which a particular cryptocurrency network, such as Bitcoin, is based, creating two blockchain paths—the old and the new. If, at the point of modification (the “fork”), the modified software is fully compatible with the pre-fork version, transactions can continue in what is known as a soft fork.” But if the modified software is inconsistent, either everyone on the network will be required to shift to the new fork (a noncontentious hard fork), and the old fork will be dismantled, or there is no consensus in the community of the network participants. Both forks survive, with different rules for reviewing and verifying transactions (a contentious hard fork).

In October 2019, the IRS issued guidance on applying the applying.⁴² Hoapplyinge then, tax experts have pointed out that the guidance inadvertently caused taxpayer confusion by inaccurately connecting hard forks with another cordinarycryptocuordinary cryptocurrency drops.” ⁴³ Airdrops are simply gifts of coins or tokens that are distributed to wallets, often as part of a marketing scheme. INotably, the recipients of an airdrop do not provide consideration for the airdrop and do not have control over whether they receive it. ATherecipients may not even have access to the gifted coins or tokens in their wallet until they take specified actions, such as signing up on a website and providing specific information or downloading the new product’s dedicated wallet.⁴⁴

While hard forks and airdrops often oco-occur, they are more appropriately treated as separate transactions. Except in rare instances where a hard fork is combined with an airdrop, airdrops are almost always a separate transaction—a gifting transaction—that may or may not occur before, during, or after a hard fork. Indeed, they may occur at any time for any number of reasons.

The IRS should clarify how both contentious and contentious hard forks and, separately, airdrops should be treated for federal income tax purposes. For example, noncontentious hard forks need not be treated as taxable events, where the entire network upgrades to the new system and the infrastructure of the old system is dismantled. INotably, the new coins or tokens should retain the tax basis of the old coins.⁴⁵ Since the 2019 guidance spoke only to airdrops directly combined with a rigid fork—a rare arrangement—the IRS should clarify how to treat the more typical airdrops, which, as explained above, are essentially giveaways as part of a marketing scheme.

Modernize rules for loans of cryptocurrency securities

.Owners of traditional securities—including pension funds, mutual funds, insurance companies, and other institutional investors—commonly loan securities to others, who compensate them fo doing so.⁴⁶ Unforr the securities loan nonrecognition rules, when the original owner gets the securities back at the end of the loan agreement, they are not required to recognize gain or loss on the underlying securities if the loan agreement essentially put them in the same economic position they would have been in had they never loaned out the securities. They must receive the same or virtually the same securities in return, and the agreement must require that any payments on the securities during the period of the loan be paid to the original owner during the loan.

Because the language of the securities loan nonrecognition rules does not expressly include digital assets, nearly all of which are securities, the Biden administration proposed in its fiscal year 2024 budget that actively traded digital assets recorded on cryptographically secured distributed ledgers be included in the definition of “securities” for purposes of the rules.⁴⁷ This would enable such loans to be tax-free, but only if they are of a reasonable period and otherwise have standard market terms.

This modernization of the securities loan nonrecognition rules would ensure that loans of digital assets can benefit from the same treatment as other securities but are also subject to the same limitations.

Ensure accurate accounting of actively traded digital asset income

.Under current law, dealers in securities must account for securities they hold at the end of the year as if they were sold at fair market value, requiring them to recognize taxable gain or loss.⁴⁸ Dealers in commodities and traders in securities and commodities may elect to use this method of accounting for their year-end inventories. This can be less burdensome if the dealer already must use the technique for financial accounting purposes, which is accurate for actively traded securities.

In its fiscal year 2024 budget, the Biden administration proposed to add actively traded digital assets to the categories of securities that fall under this tax provision to ensure that dealers and brokers using this method of accounting accurately report their gains or losses on digital assets they hold at the end of the year.⁴⁹ In addition, the Financial Accounting Standards Board, which oversees U.S. Generally Accepted Accounting Principles, recently affirmed the inclusion of specific specific scope of its Fair Value Measurement guidance.⁵⁰

Impose the digital asset mining energy excise tax

.The process of mining and managing digital assets is hugely energy-intensive. According to a 2022 White House Office of Science and Technology Policy report, crypto assets use between 120 billion and 240 billion kilowatt-hours per year, exceeding the total annual electricity usage of countries such as Australia or Argentina.⁵¹ The same report estimates that crypto-asset operations account for 0.9 percent to 1.7 percent of total U.S. electricity usage.

Out of concern over the climate-related impacts of cryptocurrency operations, as well their implications for the habilitate ability electricity grid, President Joe Biden’s fiscal year 2024 proposed budget would impose an excise tax equal to 30 percent of the cost of electricity used in cryptocurrency mining on any business using computing resources to mine digital assets, phased in over three years.⁵² Currently, there are no federal taxes on electricity, nor are there sector-specific energy taxes.⁵³ Energy taxes vary widely among countries; however, the United States ranks among the lowest-taxed countries: 40th out of 44 countries in average effective energy tax rates—mainly due to its fuel excise taxes—according to a recent Organization for Economic Cooperation and Development (OECD) survey of energy tax policies.⁵⁴

If enacted, the Biden administration proposal would be the first crypto-specific tax. However, concern over the level of energy consumption is not new. Earlier this year, New York state enacted a two-year moratorium within the state on cryptocurrency mining operations powered by carbon-based electricity,⁵⁵ and the Chinese government has directed electricity providers to stop using the country’s power grid to provide service to crypto miners.⁵⁶

.Cryptocurrency advocates continue to push for special tax treatment from Congress. They are focusing on types of tax benefits to lure more Americans into the cryptocurrency markets and ensure that crypto transactions remain hidden from tax and other regulatory authorities.⁵⁷ These goals are evident in the provisions of tax proposals already advanced in Congress. In 2022, more than 50 digital asset bills were introduced,^58, and several of them proposed changes to the tax treatment of cryptocurrency, mostly in ways inconsistent with existing tax law, which could seriously undermine the collective selections. While many proposals were not reintroduced in the current Congress, it is worth looking at a few examples of these flawed proposals to ensure they are not advanced.

The risks of providing special tax treatment to cryptocurrencies cannot be understated. Significant revenue loss will follow as taxpayers move assets and transactions into cryptocurrency to take advantage of special rules. Even more concerning, special tax rules for cryptocurrency could exacerbate the already challenging problem of anonymity in crypto transactions, which makes it difficult to determine who owes tax; it could create opportunities for tax evasion, money laundering, terrorist financing, and other illegal activities. The risk is accurate and, indeed, already happening.

Lessons learned from cryptocurrency scams⁵⁹ demonstrate why the industry should not be subject to preferential treatment.

Gains from the use of cryptocurrency for small purchases should not be excluded from the ax.

As mentioned above, when an individual uses cryptocurrency to purchase goods or services in the real economy, the tax law treats this as two transactions: a transferrin transferring cryptocurrency from the original owner to a third party and purchasing goods. As the 2014 IRS guidance made clear,⁶⁰ when a taxpayer sells or transfers assets they own to another person, they may recognize a gain or loss of income for tax purposes, depending upon the value of what they received in return and their basis in the crypto property. Generally, gains from the transfer of assets held as capital assets for more than a year are considered long-term capital gains, subject to a lower tax rate than short-term gains, which are taxed as ordinary income.⁶¹

Several policymakers have proposed excluding these de minimis gains from gross income because they have the administrative burdens of taxing them. The various proposals define small transactions as less than $50,⁶²,$200⁶³, or $600.⁶⁴.But there is no exclusion for small stock transactions, and there should not be one for cryptocurrency transactions.

Moreover, although the tax benefit per transaction appears small, the cost of lost tax revenue could quickly balloon. While daily Bitcoin transactions dropped significantly after the FTX debacle, they spiked back up in May 2023 and reached more than 4 million per day, though lower now. 65 Also, approximately a significant number still accept cryptocurrency payments.⁶⁶ Although most of these proposals would not allow a significant transaction into smaller transactions to avoid exceeding the reporting threshold, it would be challenging for the IRS to monitor millions of daily transactions to ensure compliance.

EExcluding gains on small transactions is a top priority for cryptocurrency advocates, who cannot profit in the crypto market unless there is significant liquidity—many individuals and businesses invest their real money and savings in the market. But there is no reason why gains from cryptocurrency should be treated any differently than those from other assets.

Advocates claim that a small cryptocurrency transaction exclusion would be similar to the current law exclusion that allows individuals who experience gains from exchanging foreign currency to exclude those gains from gross income for tax purposes.⁶⁷ But the foreign currency exclusion rationale does not parallel U.S. purchases with virtual currencies. A U.S. taxpayer traveling abroad is usually forced to use the local currency, potentially engaging in many transactions per day, with a significant administrative burden to keep track of and report minimal gains or losses from those daily transactions, while U.S. taxpayers are not forced to use cryptocurrencies for purchases in the United States.⁶⁸

Mining and staking rewards are ordinary income when received

Consistent with U.S. Supreme Court case law, which holds that any “accession to wealth, clearly realized” must be included in gross income for tax purposes once the taxpayer has complete dominion or control over it,⁶⁹ cryptocurrency assets received as rewards for validating services are taxable income to the miner or staker at the time they are received.⁷⁰ The IRS explicitly confirmed this concerning mining rewards⁷¹ and, more recently, concerning rewards from “staking,” ⁷² a newer form of validation.

The Responsible Financial Innovation Act, introduced by Sens. Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) in the 117th Congress,⁷³ would have allowed miners and stakers to defer taxation of their mining or staking income until they sell or transfer the reward coins or tokens to a third party, which could occur much later or not at all. As experts at the Tax Law Center at New York University Law School have explained, deferring recognition of this otherwise taxable income constitutes a tax subsidy for a particular group of taxpayers—miners and stakers of cryptocurrency—with no economic rationale to justify it.⁷⁴ Rather, it would create a tax incentive for resources “to flow away from other industries and activities towards digital asset mining and staking.” ⁷⁵ Moreover, this unjustified tax preference would lead to lost tax revenue, affecting the federal budget in much the same way as if the federal government “wrote miners and stakers a check.” ⁷⁶

Some cryptocurrency advocates may try to claim that tax breaks for miners and stakers will promote innovation in crypto markets. But deferral of income recognition could stifle innovation, as it creates an incentive to hold onto assets rather than use them for new transactions, in what is known as the lock-in effect.⁷⁷ Allowing deferral of income recognition for particular groups of taxpayers, especially without a socioeconomic justification, is unfair to others who pay tax on their ordinary income when they receive it.

Decentralized autonomous organizations and decentralized finance should be taxed

.Decentralized independent organizations (DAOs) are decentralized finance (DeFi), which refers to peer-to-peer financial transactions enabled by a computer protocol rather than by traditional intermediaries such as banks, brokers, custodians, and clearing house firms.⁷⁸ DAOs are essentially groups of investors, and when not otherwise incorporated, they claim that they are not taxable as entities because there is no centralized taxable entity.⁷⁹ However, DAOs have centralized managers or a handful of token holders with the most voting power.⁸⁰

Allowing DAOs to go untaxed at the entity level would facilitate enormous opportunities for tax avoidance, especially as these structures become increasingly adept at masking the identity of their owners. In addition to tax avoidance, these organizations raise serious national security concerns, which Sen. Elizabeth Warren (D-MA) has highlighted in public statements⁸¹ and sought to address through legislation.⁸² It would be advisable for Congress to get ahead of the tax and other issues raised by DAOs before these arrangements cause significant harm to U.S. revenue and national security interests.

Events over the past year and a half have focused scrutiny on the outlandish claims of the cryptocurrency industry and how it should be regulated. Much of this turmoil could have been avoided if the industry had been more consistently subjected to long-standing regulatory structures designed to protect consumers and the stability of financial markets. Similarly, the industry’s attempt to exclude itself from established tax laws has fueled a widening tax gap.

Formalizing special treatment or tax subsidies for cryptocurrency would represent tax policymakers’ hand on the scales—incentivizing more significant investment in an unproven and highly volatile asset that diverts capital away from much-needed investments in the real economy. Even worse, policymakers could inadvertently increase the rewards and hence the attraction of cryptocurrencies as a tool used by nefarious actors seeking to launder ill-gotten gains, skirt international sanctions, or finance terrorism.

The Treasury Department and the IRS should act swiftly to issue guidance where it is needed to clarify the application of existing laws governing income recognition and reporting to the cryptocurrency industry and cryptocurrency transactions. Absent broad-based agreement on the need for legislative language, Congress should allow the Treasury and IRS to move forward with educating taxpayers and enforcing the tax laws.