Proposed legislation would subject cryptocurrency to tax rules for wash sales
On July 12, Senators Cynthia M. Lummis (R-WY) and Kirsten E. Gillibrand (D-NY) reintroduced the Lummis-Gillibrand Responsible Financial Innovation Act, an expanded version of legislation the senators originally introduced in 2022. The Act is designed to create a comprehensive regulatory framework for digital assets. The Act also provides for $1.4 billion in appropriations over five years to the Treasury Department, CFTC, SEC, and other agencies to implement this new framework, which would be paid for by revenue generated from two tax provisions that were not included in last year's version of the Act:
- Subjecting digital assets to the wash sale rule. A wash sale occurs when a taxpayer sells or trades securities at a loss and then buys them or substantially identical securities within 30 days before or after the sale. The wash sale rule prevents a taxpayer from deducting losses relating to a wash sale. Digital assets (such as cryptocurrency) are currently classified as property by the IRS and therefore are currently not subject to the wash sale rule. The Act would make digital assets explicitly subject to the wash sale rule, but would not treat such assets as securities for tax purposes.
- Requiring electing intermediaries to mark their digital assets to market for tax purposes. Section 475(e) of the Code allows commodities traders and dealers to elect mark-to-market accounting similar to that currently required for securities dealers. The Act would expand the definition of “commodity” for this purpose to include digital assets.
The latest iteration of the Act recycles a number of its previous tax-related proposals, including:
- A de minimis exclusion of up to $200 per transaction from a taxpayer’s gross income for personal use of digital assets for payment for goods and services
- Clarification of the definition of “broker” for the purposes of the Infrastructure Investment and Jobs Act’s reporting requirement on digital assets (which we reported on here), and delaying implementation of those rules to January 1, 2025. Specifically, validators and miners would not be treated as “brokers” under the Act.
- Extension of the current safe harbors for securities and commodities trading activity made by non-United States persons who use a United States financial institution to conduct crypto asset trading activities under specified conditions, including that the non-United States person does not have an office in the United States.
- Establishing that crypto asset lending agreements are not generally taxable events, in the same way that securities lending transactions are not today.
- Providing that the IRS must not recognize crypto assets provided to a taxpayer through a fork or airdrop as gross income until the taxpayer exercises control over the asset.
- Declaring that crypto assets obtained from mining or staking activities do not form part of a taxpayer’s gross income until the disposition of those assets.
The Act also (i) would provide that a qualified appraisal of crypto assets is not required as a condition of a charitable contribution, and (ii) unlike last year’s version of the Act, does not include any provision regarding the classification of decentralized autonomous organizations (DAOs) for tax purposes.
In addition, the Act would also address the following1:
Create clear definitions
As there is not one set of clear definitions pertaining to the crypto and digital asset , the Act would create definitions to allow for digital asset regulation to take place in a consistent way.
Assign regulatory authority to CFTC
The Act would also give the CFTC clear authority over virtual currency spot markets as most digital assets are more like commodities than securities. Additionally, digital assets that meet the definition of a commodity, such as bitcoin or ether will be regulated by the CFTC.
Given the widespread adoption of stablecoins as a means of making payments, the Act would implement the 100% reserve model, which guarantees that a stablecoin holder can always exchange the stablecoin with the issuer for fiat currency, which may decrease risk and encourage further adoption.
Create an advisory committee
The Act would create an advisory committee composed of industry leaders, advocacy groups, regulators and other stakeholders with diverse and relevant experience to respond in real time to developments in the crypto industry and make recommendations to regulators on how to react and address new industry changes and challenges.
Expand disclosure requirements
Consumer education and understanding of the industry is key in the Act, which would require that digital asset providers provide appropriate disclosures to consumers related to the products they are purchasing/earning, the rights associated with those products, and risks in engaging with the product, including source code changes and digital asset lending.
Report on energy consumption
The Act also directs the Federal Energy Regulatory Commission to provide reports on energy consumption in the digital asset industry as the energy consumption related to mining has been raised.
Develop a self-regulatory organization
Under the Act, the CFTC and SEC would develop a self-regulatory organization which would play a complementary role with regulators providing strong supervision and enabling them to be efficient and nimble.
Direct regulators to report on anticorruption and cybersecurity
Given the global participation in the digital asset markets, the Act would direct relevant regulators to study and report on sanction avoidance, money laundering, terrorist financing and developing appropriate cybersecurity standards providing for threat identification and mitigation, security operations, auditing, and penetration testing.
The Act provides for collaboration between state and federal regulators to collaborate with other industry stakeholders and financial technology companies. The collaboration would allow regulators to become familiar with technology in a controlled environment and as a result provide accurate educational materials related to consumer financial literacy.
Support crypto investments in retirement savings accounts
Because the retirement account industry has shied away from crypto investments due to the perceived risk, the Act would allow retirement accounts to benefit from the growing digital asset market, while also ensuring that the investments can be made safely.
Evaluate information security around digital yuan
The national security implications of the digital yuan would be evaluated under the Act as central bank digital currencies are growing in presence and may have unknown risks or challenges associated with their usage.
To become law, the Act would have several more rounds of scrutiny to clear, notably related to Senate Banking Committee Chair Sherrod Brown (OH-D), who has long been an outspoken critic of crypto and would require persuasion to enhance the prospect that the Act becomes law. While this is more proposed legislation, there has yet to be any crypto legislation that has become law despite years of promises from multiple regulators.