Deciphering a tax code written before cryptocurrency

Deciphering a tax code written before cryptocurrency

To better understand how the U.S. tax rules apply to virtual currency, one can view the many technical issues that arise as answering one of four questions. Darío Alatorre, Carlos Gershenson, José L. Mateos   Antifragility was recently defined as a property of complex systems that benefit from disorder. However, its original formal definition is difficult to apply. Our approach has been to define and test a much simpler measure of antifragility for complex systems. In this work we use our antifragility… Marketers can boost their image with tech-savvy consumers by accepting e-cash Marketers can boost their image with tech-savvy consumers by accepting e-cash

The diversity of transactions that occur in the crypto ecosystem touch almost all parts of the U.S Internal Revenue Code. However, the Tax Code contains no reference to “virtual currency” or “crypto currency.” Instead, you will find myriad technical rules that can be hard to understand, or lead to the wrong answer when viewed in isolation or when applied generically. To better understand how the U.S. tax rules apply to virtual currency, one can view the many technical issues that arise as answering one of four questions.

1. When am I taxable on income I receive?

To answer this, one has to consider what income is, whether it was received, and whether an exception applies that does not require the taxpayer to include the item in the taxable income calculation.

What income is: Most people think of income as anything that increases wealth. However, not all accessions to wealth are considered income. For example, a miner who discovers gold has an accession to wealth but is not taxed at that time. With regard to crypto, the notion of an accession to wealth comes up in the context of mining and certain other transactions. However, the IRS has not agreed that income that arises on the grant of rewards is an appropriate departure from the gold-mining paradigm that does not tax the miner upon the discovery of gold.

Whether income was received: The term ‘receipt’ contains nuances in the crypto context. The traditional definition states that receipt arises when a taxpayer has dominion or control over the property that creates the income event. However, an airdropped crypto asset that would meet the traditional definition brings up additional considerations such as whether there are restrictions on the taxpayer’s ability to access or monetize the asset (e.g. due to an exchange not supporting the asset).

Exceptions to recognizing taxable income: All income that is “realized” is potentially subject to tax unless an exception allows for taxation to be deferred. Whether the deferral of taxation is permitted can depend on the nature of the virtual currency at issue, whether the virtual currency is transferred to a partnership or corporation, whether the interest in the virtual currency is a spot contract or derivative, and a number of other factors.

2. What is the amount of income I have to recognize?

The amount of gross income that has to be recognized is based on the proceeds from sale or exchange of an asset, reduced by the taxpayer’s tax basis in the asset and fees incurred on the sale. Valuation for virtual currencies sold between unrelated parties for cash (fiat currency) is relatively straightforward. However, complexity arises when an asset like bitcoin is purchased using another capital asset such as Ethereum, and a fee is paid in a third capital asset such as Ripple’s XRP. In such instances, there may not be a fiat value for one or either of the crypto pairs on the exchange, and the fiat value of each part of the pair may vary among exchanges. Further, the choice of accounting method — first-in, first-out (FIFO); last-in, first-out (LIFO); highest-in, first-out (HIFO); or specific identification — that a taxpayer selects determines the amount of income that is subject to tax (or which losses can be denied or deferred).

3. At what rate is the income taxed?

Tax rates are outlined by statute, but vary based on whether the income at issue is (a) long-term capital gain, (b) ordinary income or short-term capital gain. Classifying income in one of these buckets can mean the difference between a 37 percent tax rate and a 20 percent tax rate.

While there is little question that virtual currency is property, it does not always mean that a taxpayer receives capital gain whenever transacting in virtual currency. For example, receiving virtual currency for performing a service or as a staking reward does not result in capital gain. Likewise, deferring income recognition of a staking or mining reward with the hope of generating capital gain on disposition of virtual currency may be challenged by the IRS.

There are certain statutory rules around tax character that can replace the normal character rules relating to capital vs. ordinary. These rules often pair with timing rules and can depend on a taxpayer’s status. For example, persons who trade in bitcoin futures (and potentially options) may have a portion of their gains taxed as long-term gains even though they have a short-term holding period. Such favorable treatment may be dependent on the virtual currency position at issue and the exchange where it is traded. There are separate character (i.e., ordinary) and timing elections (i.e., mark-to-market) for dealers and traders in actively traded virtual currencies.

4. When can I take a tax deduction for a loss or expense I incurred?

Taxpayers who are on the cash-basis method of accounting can take a deduction when they pay an expense, and taxpayers who are on the accrual method of accounting can take a deduction when all events have occurred that establish their obligation to pay and economic performance has occurred.

There are special rules, however, that can apply to deny or defer a deduction on sales or other dispositions of property. One needs to consider when and how these rules apply to virtual currencies. Where tax rules are indifferent as to the type of property at issue, the rules generally apply to virtual currency. However, where the application of rules differs based on the asset class at issue or particular characteristics of the asset (e.g., actively traded), greater scrutiny must be given to the relevant asset (such as cryptocurrency) to determine whether the particular rule applies to virtual currency.

The lack of detailed crypto tax rules complicates the tax treatment for transactions in the crypto ecosystem. However, this absence does not mean there are no rules. but rather that the existing rules have to be applied with a proper understanding of the transaction at issue and the technological and commercial characteristics that inform the tax treatment. Approaching transactions from the framework outlined in this article can be a helpful starting point.


Author: By Roger Brown

Stocks and Cryptocurrencies: Anti-fragile or Robust?

Stocks and Cryptocurrencies: Anti-fragile or Robust?

Darío Alatorre, Carlos Gershenson, José L. Mateos

Antifragility was recently defined as a property of complex systems that benefit from disorder. However, its original formal definition is difficult to apply. Our approach has been to define and test a much simpler measure of antifragility for complex systems. In this work we use our antifragility measure to analyze real data from the stock market and cryptocurrency prices. Results vary between different antifragility interpretations and for each system. Our results suggest that the stock market favors robustness rather than antifragility, as in most cases the highest and lowest antifragility values are reached either by young agents or constant ones. There are no clear correlations between antifragility and different good-performance measures, while the best performers seem to fall within a robust threshold. In the case of cryptocurrencies, there is an apparent correlation between high price and high antifragility.



Demystifying Cryptocurrencies: Promise and Potential Lead to Growing Appeal

Demystifying Cryptocurrencies: Promise and Potential Lead to Growing Appeal

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Consumers control the cryptocurrencies that they own and have 24/7 access to them. While cryptocurrencies have historically appealed mostly to techies, that’s changing, opening up new ways for marketers to extend their brand reach and build new market share.

Depending on the type of products or services they provide and the market they are attempting to reach, companies can use cryptocurrencies to position themselves as cool; accepting them can lend a marketer a certain degree of prestige, especially among more tech-savvy consumers. While an aging Baby Boomer audience interested in vacation rental properties might not be interested in, or even familiar with, cryptocurrencies, digital natives—generally considered to be Millennials and younger—more than likely will be.

The community around cryptocurrency is highly engaged, Fast says. “They’re a very enthusiastic, engaged, and vocal community. If someone is a holder and supporter of Bitcoin, and they discover that their favorite merchant now supports Bitcoin transactions, it’s very likely—much more likely than you would see in other kinds of communities—for them to actively share and push that development to other people they know,” he says. “There’s a kind of grassroots sort of community power to some of these things.”

One example of just how passionate and engaged—and young—these communities can be is MORE, a Los Angeles-based cryptocurrency-backed nightclub in Hollywood. Peter Klamka, the founder of MORE, which was first launched in Las Vegas at the Bellagio, says, “We created an entire membership club around crypto. Crypto was the marketing approach to start. We have grown from it to include non-crypto members.”

But niche-focused nightclubs and technology firms aren’t the only companies already accepting Bitcoin and other cryptocurrencies. Some very familiar and broadly focused consumer companies, including Starbucks, Nordstrom, and Whole Foods, also accept some cryptocurrencies.

Is this a path that you should consider, and if so, how can you best communicate and educate your current and prospective customers?

First, advise the experts, avoid the tendency to attempt to overexplain. While the technology that makes cryptocurrencies like Bitcoin possible is very complex, Traidman stresses that marketers don’t really need to educate the public on how it works. “The business opportunity for marketers is to educate the public on its practical use cases as a potential safe haven and global currency, rather than focusing too much on the underlying technology,” he says.

He and others note that companies did not need to spend time educating their customers about how credit cards, digital coupons, or services like PayPal and Venmo work. The biggest mistake that marketers can make, Traidman says, is focusing on “advertising the technology rather than the practical uses as a valuable, peer-to-peer cash system owned by the people.”

“Now accepting [insert name of cryptocurrency]” is a simple and obvious way to start down this payment pathway. And, as Fast notes, highly engaged crypto-communities, especially those that are already part of your customer base, are likely to eagerly help you spread the word.

For marketers, the “cool” factor is likely one of the big benefits of accepting cryptocurrencies. But there are other benefits.

David McCarville is an attorney in the Phoenix offices of Fennemore Craig and a thought leader in blockchain and cryptocurrencies. He works with clients on navigating smart contracts and international implications, including R&D tax credits and real estate and supply chain applications. “Cryptocurrencies are capable of providing tremendous value and benefit to marketers across a variety of use cases,” he says. “The first would be to position your product or service and market directly to the existing cryptocurrency networks, such as existing traders or holders of Bitcoin (BTC) or Ethereum (ETH) as just two examples. The second would be to identify opportunities to use cryptocurrencies to replace or enhance customer loyalty rewards programs.”


Demystifying Cryptocurrencies: Promise and Potential Lead to Growing Appeal

Demystifying Cryptocurrencies: Promise and Potential Lead to Growing Appeal

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Even if you don’t fully understand what it is, chances are good that you’ve heard of Bitcoin. Bitcoin is one of the most popular and widely used forms of cryptocurrency, a digital or virtual form of currency or exchange. Cryptocurrency is made possible because of blockchain, which IBM defines as “a shared, immutable ledger for recording transactions, tracking assets, and building trust.” It’s the foundation that makes Bitcoin and other cryptocurrencies possible.

Although Bitcoin was officially launched in 2008-09, the groundwork for its creation actually can be traced as far back as 1982 when computer scientist David Chaum first proposed the concept of e-cash and a blockchain protocol.

Cryptocurrencies, and the technology behind them, allow transactions to be both anonymous and secure. These transactions take place in a peer-to-peer environment that removes the intermediary, like a bank or credit card issuer.

While Bitcoin is the most popular of the cryptocurrencies currently available, with the highest market capitalization, other formats do exist. Facebook is the latest entrant, announcing plans last fall to work with a large network to create a new digital currency called Libra. Partners include payments companies Visa, Stripe, PayPal, and Mercado Pago, as well as other tech companies, including eBay, Lyft, Uber, and Spotify. Facebook is also looking to create a new subsidiary, Calibra, to build a digital wallet for people to store and exchange the currency using Facebook apps. Apple and Google have already put forth their own cryptocurrencies, and another recent addition to the market is Coin Rivet.

Cryptocurrencies still occupy a largely niche market, but for marketing and sales professionals, there is a newfound interest in the technology and what potential it might have.

Marketers of all types of products and services are, of course, familiar with accepting currency—coins and paper bills minted in their countries of origins. Physical currencies, while still traded for goods and services, have given way over the years to credit cards and various online exchanges like PayPal and Venmo.

For online marketers, these online forms of exchange offer a convenient means of receiving payment for products and services. Cryptocurrencies go one step beyond these online services, taking out the financial institution in the middle and adding security that not only keeps the value of the currencies intact but also protects the identity of the purchaser.

As alternative forms of currency emerge, marketers are interested in determining whether it makes sense for them to accept those forms of currencies. There are still small businesses that do not take credit cards, although services like Square have helped to minimize barriers such as cost and approval processes.

Cryptocurrencies are likely the next step in the constantly evolving landscape of payment options.

Marketers aren’t the only group taking an interest in cryptocurrency. Consumers are as well—an interest that certainly helps to fuel marketers’ attention. According to Bitcoin News Network (BTCNN), 13 percent of consumers have used cryptocurrency to pay for online purchases. To meet that demand, thousands of merchants around the world are beginning to accept cryptocurrencies for goods and services.

Adam Traidman, CEO of BRD, a mobile wallet provider, explains how this works: “Just like you can hand someone a dollar bill without permission from a third party, you can send someone a Bitcoin without permission from an entity,” he says. Transferring money from bank to bank requires permission and, often, fees.

Another benefit, Traidman says, is that cryptocurrencies are not subject to inflation or some other market fluctuations. “Bitcoin is essentially minted into circulation through a global mining system, which is quite technical, but no one entity controls the supply and inflation rate of Bitcoin,” he says.

Another relevant comparison to help understand the benefit of cryptocurrencies: the stock market. Ethan Fast, cofounder and chief technology officer at Nash, which provides a platform for decentralized financial services, uses the stock market to help marketers and consumers better understand Bitcoin and other cryptocurrencies. “If I buy a stock, I own that stock, and there’s a digital representation of my ownership, but I don’t directly control that representation. I have to go through my broker to move it around. Whereas with cryptocurrency I have direct control and I can do with it as I wish with no intermediaries.”


Deciphering a tax code written before cryptocurrency

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