This is post is general insight as to why crypto is taxed, written from the perspective of how the IRS determines taxable income.
The purpose of this article isn’t to admonish or praise the practice of taxation, but to understand why (at least according to the IRS) crypto is taxed
We begin by understanding what “gross income” is to the IRS.
"Gross income includes all income from whatever source derived, unless specifically excluded under the Code”
- This concepts is determined broadly by the courts, which is why we have things like tax attorneys. taxable stuff isn’t always black and white.
"Income is recognized whether it is in the form of cash, or “in kind” cash equivalents” (i.e., property or services)
- The amount of income from “in kind” receipts is equal to the fair market value (FMV) of the property or services. For example, if you sell a baseball card on eBay for $150. That is the fair market value.
Which brings us to crypto.
Let’s decimate that definition of income real fast.. the important words are bolded below:
“Gross income includes all income from whatever source derived, unless specifically excluded under the Code”
"Income is recognized whether it is in the form of cash, or “in kind” cash equivalents
The phrase “”from whatever source derived” is a really empowering phrase for the IRS.
It does’t matter if the income came from a person, or a cat, or spawned out of some blockchain. The point to IRS is that it came from somewhere. And under the scope of the law, that’s all that matters.
Second, while crypto is not cash, it is property, a cash equivalent, albeit digital property.
And the whole idea of fair market value is what empowers the IRS to determine a specific tax liability. The fair market value of crypto is what the currency trade for on exchanges.
How broad and empowering the tax code is written leaves the IRS the power to tax even the most ridiculous things.
Remember Cryptokitties? Well, technically, the money earned from those digital cat pictures via either breeding or selling them is taxable income. Should you report it? I’’m sure they’d like you to, but the chance you’ll be hooked for failing to report earnings of renting our a digital cat picture is laughable.
Let’s take it one step further. Say you play a popular video game. Let’s go with World of Warcraft or Counterstrike here..
In both of these games, players can earn/discover rare and unique in game skins (costumes) to use or trade amongst other players. And the best part? There are entire marketplaces out there for players to buy/sell/trade these in game goods amongst each other.
That’s right. The way the tax code is written, the IRS can tax you on making a some money off of a shiny gold AK-47 in a video game. Because…
- It came from somewhere
- it is property
- there is a market to establish fair market value for the item/service
It think it’s interesting to play through how many layers of abstraction we can get from what is considered real income, before it’s no longer income.
In each of my examples, the property/services derived technically meet the IRS’s very broad definition of income, so the question is… is there a threshold where the IRS will stop pursuing goods/services as income even if it qualifies?
Clearly, cryptocurrencies have fallen under the purview of “what is income”….. because it is a digital asset but crypto kitties? ether tanks? etheremon? These are all digital property as well.
Take it a step further… will the IRS ever get around to taxing gains on other digital assets like guns in Counterstrike? Or special Paladin armor in Warcraft? Who knows..
But really, in practice, everything is taxable only when the market for that thing gets large enough. Only when something is worth the IRS’ while. And with the cryptocurrency market cap over $500 Billion right now, you can bet your ass it’s worth their while.
Since Bitcoin’s inception in 2009, the IRS likely wouldn’t bat an eye to the gains made. Fast forward to today and they’ve forced Coinable to fork over user information, likely for tax purposes.
So what’s the next “arbitrary” form of income that’ll be taxed? Digital Cats Pictures? Virtual Guns? I’d love to see them try.
Thanks for reading.