Crypto tokens, such as Bitcoin, can be used as cash or traded like stocks. Most often, crypto is used as an investment tool, with users buying and selling different tokens and converting them to traditional fiat currency. Because the value of crypto tokens changes frequently, policymakers have struggled to outline clear rules to ensure crypto businesses and asset holders pay the appropriate amount of income and capital gains taxes.

The first and most well-known digital currency is Bitcoin, which started in 2009 with the publication of a blueprint for an open-source, decentralized currency and a digital payments platform using blockchain technology. When it first launched, one Bitcoin was worth less than one cent, but its value first began to spike in 2013, reaching a high of $1,100, before breaking the $20,000 threshold in 2017. The value of one Bitcoin peaked at nearly $70,000 in 2021, before a series of controversies took the trading value below $20,000.

For tax purposes, the IRS has ruled cryptocurrencies that can be traded for real currency meet the definition of property. Thus, each trade or transaction is a taxable event for recording gains and losses.

By 2021, the total market capitalization for all traded cryptocurrencies was $3 trillion, but little crypto-specific tax guidance had been issued to that point. During a congressional hearing that year, then-IRS Commissioner Charles Rettig said that crypto activity was a big reason for the growing tax gap—the difference between the amount of tax collected versus what taxpayers legally owe by law.

Information Reporting

Soon after Rettig’s testimony, Congress took its first major legislative step on crypto tax policy. Although the core technology behind crypto is decentralized, intermediary trading platforms handle a bulk of crypto economic activity. A provision in the bipartisan infrastructure package adopted in late 2021 included requirements for these platforms and others in the crypto space to collect customer information and report it to the IRS, similar to stock brokerages. The IRS also recently issued draft Form 1040 guidance on digital assets (see p. 16) to help crypto investors better understand their tax obligations.

There are still disputes about which crypto businesses—other than more formal crypto trading platforms that offer custodial accounts—are capable of tracking customer data. Things were further complicated in 2022 with the collapse of the trading platform FTX, whose executives have since been convicted of various financial crimes.

If customers flee centralized exchanges for more decentralized options, it would force policymakers to consider other options for improving crypto tax enforcement. Decentralized exchanges offer similar trading services without collecting the same customer information as their centralized counterparts.

Other Unresolved Crypto Tax Policy Issues

As a relatively new asset, crypto is not currently subject to wash-sale rules, which disallow the deduction of losses on an investment if the taxpayer repurchases an identical asset within 30 days. Given recent volatility of cryptocurrencies, investors can thus continue to take advantage of price dips to maximize any tax losses without too much change to their crypto portfolio.

Lawmakers sought to close off this tax planning maneuver as part of legislation to implement President Joe Biden’s Build Back Better agenda. At the time, the Joint Committee on Taxation estimated that the proposed wash-sale restrictions would raise $16.8 billion over a decade. However, the larger legislative package stalled in Congress and was later replaced with the scaled-back Inflation Reduction Act, which left out the crypto wash-sales language.

Biden’s budget proposals have included other measures to clarify how existing tax laws apply to crypto activity. The 2021 infrastructure law laid the foundation for classifying US-based crypto exchanges as brokers who must meet information reporting requirements. To deal with exchanges based overseas, The administration’s budget request called for bringing crypto into the Foreign Account Tax Compliance Act (FATCA) regime.

FATCA generally requires overseas financial institutions to register with the IRS and report information on US account holders. But some jurisdictions bar financial firms from sending data directly to the IRS. In those cases, the US signs information sharing agreements that allow governments, rather than financial institutions, to share tax and financial data on the other country’s respective citizens.

The Biden budget proposal would have utilized the same approach for crypto transactions. US-based crypto exchanges would report to the IRS information on foreign account holders. The IRS would then share that information with foreign governments that provide reciprocal information about US investors using exchanges based in their jurisdictions.

Alternative Legal Theories

Although IRS guidance from 2014 classifying crypto assets as property for tax purposes, some crypto advocates have argued for a more favorable tax treatment of cryptocurrency companies.

Crypto’s decentralized structure provides “rewards” for those who participate in a crypto network by verifying valid transactions and offering up their own computing power to help run the system. Under the familiar Bitcoin model, “miners” use computers (and a lot of electricity) to solve complex math problems and create currency tokens. This is called a “proof of work” model.

The IRS guidance from 2014 focused on mining and proof-of-work networks, but some newer currencies instead a “proof of stake” model. Using far less computing power than with mining, token holders can “stake” their own currency on a network and participate in validating transactions. In exchange, they are rewarded with new tokens.

Most tax experts believe that under existing statutes and US Supreme Court precedent, mining and staking rewards should be treated as ordinary income at the time they’re earned. However, crypto advocates have suggested that crypto rewards should not be taxable until they’re sold. Previously introduced legislation in the Senate would allow crypto mining and staking businesses to defer tax until token rewards are sold.

Updated January 2024