As we’ve written before, blockchain technology allows for a new wave of business model innovation that we think will make the internet work better for all of us. Unfortunately, there are some public policy issues that need to be addressed before these networks can reach their full potential, including tax law.
The tax code has a reasonable de minimis exemption for personal foreign currency transactions
To understand the burdens imposed by the US tax code on the emerging decentralized blockchain economy, think back to the last time you traveled internationally. When you got off the plane, you probably visited an exchange kiosk to acquire a few hundred dollars worth of local currency. Perhaps you used that cash to pay for a taxi to your hotel, or to purchase breakfast at a café up the street. Depending on your destination, you may have needed to rely more extensively on cash for things like lodging and local tours. When you returned home, did you painstakingly review each of these transactions to calculate any foreign exchange gains for tax purposes? Of course you didn’t. That would be a logistical nightmare.
The US tax code recognizes the prohibitive complexity of keeping track of personal transactions in foreign currency. To address this complexity, section 988(e) of the code provides a very reasonable exception for exactly the situation described above. The exception works by excluding any gain that an individual realizes as the result of a personal transaction in foreign currency from the individual’s taxable income so long as the gain is less than $200.
Virtual currencies should also have a de minimis exemption
Currently cryptocurrencies and blockchain tokens do not qualify for this exception. Based on guidance issued in 2014, the IRS treats virtual currencies as property under US tax law. This means that the sale or exchange of blockchain tokens for fiat currency or other goods and services is a taxable event. Consequently, if a user spends $0.09 worth of Bitcoin to buy candy from a vending machine, she is required to calculate (and pay) the tax liability associated with that transaction.
While this may seem like an inconvenience derailing the plans of a small number of ideologues that want to use bitcoin to buy coffee, it is actually a much bigger problem. Many of the imaginative business models that innovators are developing in the blockchain industry become untenable under the weight of this type of tax treatment. Open blockchain networks promise to enable these new business models by providing efficient payment rails that don’t currently exist for traditional fiat currencies. Requiring users to track gains and loses on each micro-transaction they engage in across dozens of different digital currencies significantly erodes these efficiency gains.
The ecosystem needs the Cryptocurrency Tax Fairness Act
As our friends at Coin Center have pointed out, cryptocurrency taxation is broken and needs to be improved in order for the full potential of blockchain technology to be realized in the US. Luckily, the solution is relatively simple. We believe that the smoothest approach is for lawmakers to extend the de minimis exemption for personal transactions in foreign currency to cover transactions in blockchain tokens as well. The legislative language required to extend the exemption is minimal and, in the last congressional session, Representatives Polis and Schweikart introduced a bill that would have made the required changes. We are working with lawmakers and other allies to get this bill reintroduced and moved in this new legislative session.
We believe that the provisions of this bill are crucial for ensuring that the US remains competitive in the quickly evolving and highly promising blockchain industry. As the tax code currently stands, US citizens and entrepreneurs are at a significant disadvantage to citizens of countries like Germany and Italy, which both already exempt personal cryptocurrency transactions from the burdensome requirements that our tax code currently imposes. While it may seem like a relatively minor policy wrinkle given the nascent state of the open blockchain economy today, addressing this issue sooner rather than later will more fully allow all Americans to benefit from the advantages offered by the emerging new internet.