Proposed US tax reform could severely impact crypto investors

Some subtle policy changes in the tax bill could perhaps would dire consequences for cryptocurrency investors.
US Congress has passed a new tax bill that is now being reconciled by both the House and the Senate. The new bill does not specifically address cryptocurrency, however, several subtle rule changes affect cryptocurrency investors, specifically those who’ve been riding the bitcoin mania wave during 2017. However, according to the respective parties who approved the tax reform, including President Donald Trump, the tax reform was put in place to make paying taxes easier and more convenient.

Currently, both versions of the proposed tax bill have done away with the “like-kind” mechanism. So far, the majority of crypto holders have used the like-kind mechanism. Instead, the Senate proposes to use a “first-in, first-out” (FIFO) accounting system, which will make tax reporting severely complex for cryptocurrency holders.

In an interview with CoinDesk, the Arizona Republican Representative, David Schweikert, stated that the simplified tax process will allow bitcoin and cryptocurrency holders to avoid certain challenges that the previous tax system imposed. Schweikert also serves as co-chairman of the Congressional Blockchain Caucus and the Ways and Means Committee. However, neither version of the tax reform includes the Cryptocurrency Tax Fairness Act. In addition, both versions failed to modify current capital gains tax rates. This means that cryptocurrency holders are still subject to the 2014 guidance structures of the IRS.

The new bill appears to be very crypto-unfriendly. While crypto holders have widely used the like-kind structure, the new bill reserves that process purely for the real estate industry.

Lisa Zarlenga, from Steptoe & Johnson, argued that once they swap one kind of token for another, that counts as a like-kind exchange. Zarlenga also serves as the co-chair of Steptoe & Johnson’s tax group. Once a crypto holder swaps between tokens, there’s no need to pay short-term capital gains tax. Instead, they can pay the lower rate of long-term capital gains of 20%, once the asset is sold.

The Goodwin Procter partner, Kelsey Lemaster, noted that it’s not yet clear whether the like-kind system can be used by crypto holders. She did note that crypto holders made a compelling argument, especially when it comes to assets swaps occurring within the same blockchain network, such as swapping ethereum for ethereum classic. Lemaster added that the new tax reform would prohibit crypto holders from using the like-kind system.

The most alarming aspect of the new FIFO system is it's "specified securities" which could have dire consequences for the crypto community. Essentially the FIFO system requires individual to sell their oldest assets first. However, as the Deloitte tax partner, Jim Calvin, explains this process is very counter-intuitive. Generally, individuals request their brokers to sell off their most valuable assets first. In contrast, the FIFO system would require that individuals sell their oldest existing assets.

For example, let’s say that an individual bought $1,000 worth of bitcoin in 2013, and then bought another $10,000 worth this year. If the individual decides to sell, it has to be the first token he bought. While he could sell the token for $15,000, the individual will be facing taxable gains of $14,000 on his first bought token. This means that the individual has not even made a profit.

Bitcoin has already been categorized as a commodity by the Commodities Futures Trading Commission (CFTC). This has caused many to wonder if cryptocurrency could perhaps escape the new tax reform as the FIFO system would only technically count towards securities. However, Calvin believes that bitcoin will likely be in the firing line, especially considering the launch of bitcoin futures trading earlier this week. In addition, Zarlenga noted that ICOs are likely to be affected as well. All tokens issued by ICOs are considered securities, which could hugely damage the industry.

However, the daunting new tax reforms have not yet been signed into law. The House and Senate are currently reconciling their versions into one coherent draft. The FIFO system was mentioned only in the Senate’s draft, and could perhaps still be done away with, especially in light of the powerful interests of cryptocurrency in the US. Several powerful firms, such as the Investment Company Institute have demanded that the FIFO system be removed.

However, Calvin feels that there good be some benefits to the FIFO system as well. First, FIFO is only applicable on a single account-basis. This means that if a user chooses to move their oldest bitcoins to a separate account, the system would not apply. However, Calvin noted that he personally would be withdrawing all his holdings off the exchange before the year’s end. Lemaster also added that crypto holders should perhaps look into selling off a large portion of their current holdings before 2018 in order to minimize the damage of the proposed capital gains tax.