Annette Nellen, CPA, CGMA, Esq. is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, American Bar Association, and California State Bar, and chairs the AICPA Tax Executive Committee. Nellen maintains the 21st century taxation website and blog, including a website on virtual currency and blockchain technology.
The following article is an exclusive contribution to CoinDesk's Crypto & Taxes 2018 series.
We are in the midst of a "Fourth Industrial Revolution" in which technology is advancing at an exponential pace, bringing us mostly digital tools and processes. In the tax world, "digital" translates to: "how do rules designed for a tangible world apply?"
Cryptocurrency is a great example to remind us that tax as well as other laws and compliance processes need to be fluid to keep our economy moving ahead. Inaction or inappropriate responses can shut down or decelerate advancements that benefit society and lead to further technological progress.
From the late 1960s, when software was decoupled from hardware, to the birth of bitcoin nearly a decade ago, what have we learned that can help us deal with this asset and its uses as we encounter even more new forms of technology, uses and ways of doing business? This article suggests four tax lessons.
Strive to understand, not dismiss
Early in the history of cryptocurrency, the focus tended to be more on the bad (or, at least, illegal) uses than the good ones.
Certainly, actors such as the Silk Road marketplace drew a lot of attention to the illicit side. However, there was also potential for good in terms of helping populations living with unstable banking systems, allowing ease of micropayments, allowing immutable transactions, and more.
Fortunately, some of the first government actions did find some good. For example, a hearing of the U.S. Senate Committee on Homeland Security and Governmental Affairs in November 2013, observed the promise along with the risks.
Early government actions also helped to limit the bad and enable the good. For example, the U.S. Treasury Department's FInancial Crimes Enforcement Network (FinCEN), as well as various states, issued guidance to help those aiming to convert U.S. dollars into virtual currency navigate money transmitter laws.
The reaction around the world has also been mixed but with evidence of open-mindedness. For example, a March 2018 report of the Bank for International Settlements (BIS) explores the possibility of central bank digital currencies.
Offer some guidance ASAP
In March 2014, just in time for the filing of 2013 tax returns, the IRS issued guidance on virtual currency. Notice 2014-21 answered 16 questions, but also provided an avenue for answering even more, by stating that virtual currency is to be treated as property for federal tax purposes.
"General tax principles applicable to property transactions apply to transactions using virtual currency," the notice said.
With decades of guidance on the tax treatment of property, the ability to determine how virtual currency is taxed became more manageable. However, more is needed, as pointed out by the tax sections of the AICPA and the American Bar Association.
Don't delay fuller guidance
Bitcoin has spawned hundreds of other cryptocurrencies with varying traits, capabilities and origins (including forks), and new uses including initial coin offerings (ICOs) that often meld this technology with crowdfunding.
Guidance is needed to ensure proper tax compliance for the users of these second-generation cryptos. Timely guidance helps strengthen a tax system and voluntary compliance by ensuring that all players are applying tax rules similarly.
States also need to clarify how their tax rules apply to virtual currencies. Several states have addressed sales tax, typically providing that it doesn't apply to transfer of virtual currency and explaining valuation for when it is exchanged for taxable items. Recently, via legislation, Wyoming indicated that virtual currency is not subject to personal property tax. More such clarity is needed.
In addition to guidance from tax agencies, legislators must also be up to speed on changes to the law needed to support tax compliance and not hinder positive advancement of new technologies.
While congressional hearings on various types of new technologies and their uses occur on a regular basis, they have not been at the forefront for tax reform and modernization.
For example, the House Energy and Commerce Committee has held a series of "disruptor" hearings to understand new technologies including the internet of things (1/18/18 and 6/13/17), fintech, and digital currency and blockchain technology.
Comprehensive tax reform via the Tax Cuts and Jobs Act, however, did not include changes relevant to virtual currency. These omissions included information reporting by money transmitters, clarification of foreign bank and financial account reporting (FBAR), and a de minimis rule for reporting gains and losses (such as in the bill proposed by Reps. David Schweikert and Jared Polis, co-chairs of the Congressional Blockchain Caucus). Such a rule would relieve everyday users from having to report to the IRS and pay taxes every time they buy a cup of coffee with cryptocurrency.
Learn about the tech
New technologies affect tax compliance and administration. For example, bitcoin and some other cryptocurrencies use the blockchain as the underlying infrastructure. The blockchain has uses well beyond this arena as many businesses and others are realizing and continuing to advance.
This affects taxation in that business records kept on the blockchain need to be understood in terms of how to audit such records. Just as businesses find value in use of the blockchain, tax agencies should also find efficiencies in terms of security and assurance if their records are maintained with this technology.
In 2017, Arizona enacted legislation to promote blockchain technology. The law expands the definition of electronic signatures to include ones secured through blockchain technology. The legislation also allows for smart contracts and provides helpful legal definitions of these terms.
Cryptocurrencies should also be considered for payment of taxes. They might also have value where traditional banking does not work, such as for state-legal cannabis businesses and tax payments. Arizona is now considering another bill which would allow tax payments using bitcoin, litecoin or other cryptocurrency recognized by the tax agency.
Cryptocurrencies and other digital technologies will continue to advance with more users and uses. The potential benefits to business and society are tremendous and should not be limited by tax uncertainty or complexities.
Following the lessons mentioned above can help ensure that tax systems don't slow down these advancements.
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