Cryptocurrencies have attracted a wide audience of investors, but many remain on the sidelines because of the uncertainties surrounding digital asset markets. One big source of consternation for many would-be crypto investors is the way crypto transactions get taxed, especially given the large long-term gains in the value of Bitcoin (BTC -0.50%) and other digital assets.
However, a new bill set to be introduced in Congress could make dramatic changes to the regulatory framework for cryptocurrencies. The bill, dubbed the Responsible Financial Innovation Act (RFIA), is comprehensive, covering a wide range of provisions such as which digital assets could be exempt from regulation as securities, how regulatory authority could get split between the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission, and the oversight and banking treatment of stablecoins. However, the provisions governing taxation of digital assets could be game changing for users of cryptocurrencies, potentially making many transactions tax-free.
Why crypto has been a tax nightmare
The problem with crypto and taxes is that although many people who use it for regular transactions think of it as a digital substitute for money, when you use money to buy something at the store, you don't have to report anything on your tax return. Crypto investors argue the same thing should be true when you use cryptocurrency to buy something.
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However, the IRS has disagreed. Instead, anytime you use a digital asset to pay for something, you're treated for tax purposes as selling that digital asset for the value of what you buy with it. That's a taxable event, and you'll owe taxes on any corresponding gain from what you paid for the digital asset.
What the Responsible Financial Innovation Act does to crypto taxes
What the RFIA has drafted would change the current IRS tax treatment of crypto use. For any personal transaction that would generate a gain of less than $200, the bill would exclude any gain from the owner's gross income. Moreover, crypto exchanges and brokers wouldn't be subject to the rules that require them to track cost basis and provide gain and loss information to customers and tax authorities.
For crypto miners, the bill would offer a big tax break. Digital assets from mining operations wouldn't get treated as taxable income until the miner sold the assets. Miners also wouldn't be treated as brokers.
Those involved in a host of crypto-related transactions would also get more clarity. Perhaps most importantly, lending agreements using digital assets, which have become immensely popular as prices have risen, would receive the same favorable tax treatment as securities lending and avoid creating a taxable event. In addition, the IRS would have to come up with reasonable rules governing crypto-specific events like forks, airdrops, and staking.
Does the RFIA stand a chance?
Just because a bill gets proposed in Congress doesn't mean it will pass. However, the RFIA does have bipartisan support, with longtime crypto proponent Sen. Cynthia Lummis, a Republican, finding support from Sen. Kirsten Gillibrand, a Democrat. Gillibrand has predicted that the legislation will go through several committees, including those covering banking and financial services, before gaining approval and moving on to the floor of the Senate. Final provisions could see a lot of tweaking along the way.
The big question lawmakers will have to answer is whether the IRS and other regulators can appropriately police the limit on the capital gains exemption. The bill's language should nominally prevent someone from making multiple transactions that are each individually below the tax-free limit but that exceed it when taken together. However, the decentralized nature of crypto ownership already makes it a challenge to detect step transactions from multiple sources owned by the same taxpayer. It's a big ask for the already-underfunded IRS to take on this task as well.
Crypto investors can count on the RFIA seeing substantial revisions if it moves forward in Congress. With a lot of effort and some good fortune, though, patient crypto users might eventually get a big tax break.
