As part of his 2024 budget plan, President Joe Biden has proposed reforming crypto taxation. This could generate up to $24 billion in additional revenue over the next decade.
Key changes include the prohibition of tax loss harvesting for cryptocurrency investors and doubling of capital gains for those with $1 million or more - changes which could have significant effects on the industry.
1. Tax-loss harvesting for crypto-assets will be banned
The Biden administration is working to modernize crypto taxation and plug a variety of loopholes. Notable among them is their proposal to stop tax-loss harvesting for crypto assets and double the capital gains tax rate for those making $1 million or more annually.
This move is part of a wider initiative to plug tax loopholes and generate revenue for the government. Additionally, it aligns with federal administration efforts to regulate cryptocurrency and initial coin offerings (ICOs).
Under current US tax law, crypto-assets such as cryptocurrencies are classified as commodities and therefore subject to the CFTC and SEC's regulations. These two powerful watchdogs regulate markets and oversee the purchase and sale of raw materials like coffee, gold and oil.
These markets can be highly volatile, and many traders lose money on their crypto assets. Loss harvesting allows investors to reduce their taxable income by selling assets at a loss and then repurchasing them within 30 days - an effective strategy for experienced crypto investors.
However, this tax-loss harvesting strategy can come with some drawbacks. Firstly, it could result in higher transaction fees for buyers and sellers of crypto assets - these fees could range anywhere from 4% to 10% depending on which exchange you use to acquire and dispose of your digital assets.
Second, the IRS is expected to eventually close the wash sale loophole for crypto-assets, effectively nullifying any tax benefits associated with them. Traders could then only repurchase securities that are substantially identical to the ones they sold at a loss, potentially making the crypto tax loss harvesting strategy harder to implement.
Third, if a trader sells a crypto asset at a loss and then immediately purchases it back, they could be caught by the IRS under its wash sale rule, which prevents tax-deductible losses for transactions that could potentially be considered wash sales. This is especially relevant when it comes to high-value crypto assets.
Crypto tax loss harvesting remains an invaluable tool for informed investors looking to reduce their overall tax burden. It's wise to consult your tax accountant to learn more about how this strategy may benefit you and your financial situation.
2. Tax-deductible losses for crypto-wash sales will be eliminated
On March 8, 2022, The Wall Street Journal reported that President Biden is looking to reform crypto taxation as part of his upcoming budget proposal. This could have an immediate impact on crypto investors and traders.
Biden's plans are part of his administration's larger effort to eliminate loopholes and generate revenue for the federal government. They come after a bipartisan infrastructure bill that will increase spending on highways, bridges, airports, and the electric grid without raising taxes.
Crypto investors are concerned about how these changes will affect their long-term profitability. While some tax breaks may benefit short-term investors, they could have an adverse effect on long-term growth prospects.
First, Biden wants to stop investors from using tax-deductible losses as a way to offset other capital gains. This practice, known as "tax loss harvesting," can significantly reduce taxable income.
Investors will also be barred from deducting losses on their taxes when they sell stock or securities and then repurchase them within 30 days. This rule, known as the wash sale rule, was implemented in the 1990s to prevent taxpayers from selling a security and then immediately repurchasing it at a loss to lock in profits.
Reinvesting a security before it's repurchased can present a risk, as the value of the security may increase before purchase, increasing any losses you attempt to offset. Thus far, however, the IRS has allowed this strategy due to their belief that cryptocurrencies are property rather than securities and do not fall under the wash sale rule.
But if the IRS decides to apply wash sale rules to crypto, it will present a challenge for tax professionals and investors alike. Cryptocurrencies do not qualify as stocks or securities, making it difficult for a tax professional to track the basis behind a particular transaction in cryptocurrency.
Investors in cryptocurrency must be more meticulous when reporting their transactions. They should monitor their cryptocurrencies' prices and bases during the period they hold them, as well as when they sell or buy the same asset. Doing this allows them to accurately report capital losses and unrealized gains in accordance with IRS guidelines.
3. Unrealized gains for crypto-assets will be taxed at a flat rate of 20%
Crypto assets (also referred to as digital assets) are tokens that represent ownership of something. They can be digital or physical and may or may not be backed by real-world resources.
Crypto-assets are classified as securities under US federal securities laws and can be sold for taxation purposes. They can be traded on margin or through CFDs, and their gains are taxed at the same capital gains rates as other investments.
Calculating Capital Gains Tax for a cryptocurrency disposal requires determining the cost basis of the crypto you purchased and comparing that with its value at disposal. You also need to know whether you spent or transferred the cryptocurrency to another wallet.
The IRS recently provided guidance on reporting these transactions, which is useful as it clarifies the distinction between spending and selling your crypto for tax purposes. When spending cryptocurrency, you will need to subtract its cost base from its fair market value in USD on the day you disposed of it; this will determine how much Capital Gains Tax you owe per transaction.
Transferring cryptocurrency to another wallet without paying tax can be done, provided there isn't a transfer fee involved in the process. Nonetheless, you should exercise caution as not to transfer to an unregistered wallet and thus breach anti-money laundering legislation.
Finally, gifting your cryptocurrency in the US is generally tax exempt. Depending on how much you give away, this could be considered either a deductible expense or non-deductible expenditure.
Therefore, it is wise to gift crypto in cash or fiat rather than donating it in cryptocurrencies in order to avoid any taxation. This is especially pertinent if you have a large amount of cryptocurrency that will be used for trading; making a cash donation will result in a Capital Gains Tax deduction while donating cryptocurrency will be taxed at its full rate.
The IRS will be closely monitoring crypto transactions to guarantee tax compliance, including performing Know Your Customer checks (KYC checks) on all major exchanges that accept fiat payments for cryptocurrency. They also have the capability to track your custodial crypto addresses. Therefore, if you get caught out and don't report all your transactions to the IRS, a hefty fine could result.
4. Foreign digital asset accounts will be required to be reported
Biden Calls for Reform of Crypto Taxation: What Should It Include?
Digital assets offer the United States an exciting economic development prospect. But they also pose significant challenges, such as threats to financial stability, consumer and investor protection, and combatting illicit finance. To better safeguard our national interests, the federal government is taking a whole-of-government approach in tackling these challenges.
One way the Biden Administration plans to address these challenges is through tax policy. Specifically, the Treasury Department wants to guarantee that American investors and consumers can easily access and purchase digital assets while being safeguarded against fraudulence and abuse.
In response, the Biden Administration is proposing a set of new policies and guidelines that will encourage responsible development of digital assets in America. These strategies aim to address risks related to these assets as well as their underlying technology, creating an resilient financial system.
To this end, the Treasury Department has proposed several modifications to the tax treatment of digital assets. These include expanding mark-to-market rules to encompass actively traded digital assets, derivatives on those digital assets, and hedges of those same digital assets for taxable years beginning after December 31, 2022.
The Treasury also wants foreign exchanges and service providers to report information on significant foreign owners of some passive entities that trade in digital assets. This is an essential step toward guaranteeing U.S companies are held accountable for their activities in this rapidly developing industry.
The Treasury Department is also exploring ways to align digital assets with transitioning towards a net-zero emissions economy and improving environmental justice. To this end, they plan on tracking digital asset environmental impacts and developing performance standards as necessary.
The Biden Administration also wants to extend the Foreign Account Tax Compliance Act (FATCA) in order to include a reporting requirement category applicable to all taxpayers who hold an aggregate value of $50,000 or more in crypto and related digital assets in a "foreign digital asset account." This requires any account holding crypto or related digital assets held by a foreign exchange or service provider must report that information to the IRS even if its owner is not a US citizen or resident. This move will restrict tax avoidance behavior by crypto investors and take effect starting with returns filed after December 31, 2022.
The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.