Only three days into his second term, President Donald Trump issued Executive Order 14178, to “promote United States leadership in digital assets and financial technology.” Among other things, the order established the President’s Working Group on Digital Asset Markets (the Working Group). On 30 July, the Working Group released a comprehensive set of recommendations on the treatment of digital assets titled “Strengthening American Leadership in Digital Financial Technology.” The report provides policy direction across a range of issues, including Bank Secrecy Act changes, regulatory oversight, and law enforcement efforts. Every stakeholder in the digital asset space should know what is in this report and how they could be affected.

This alert focuses on the extensive set of recommendations in the report pertaining to the taxation of digital assets. This alert also discusses the Internal Revenue Service’s (IRS) existing guidance, providing a historical lens through which readers may view the Working Group report.

Historical Taxation of Digital Assets

Because the world of digital assets is relatively new and fast changing, there is a limited amount of guidance on how digital assets should be taxed and even existing guidance may be outdated.

The IRS 

In 2014, the IRS released Notice 2014-21,¹ containing 16 frequently asked questions (FAQs), advising taxpayers on how virtual currency should be taxed. At that time, the larger world of digital assets had yet to evolve, so the notice is limited in its scope to virtual currency. Despite its name, the IRS determined that virtual currency should be taxed as property and not currency. This approach has significant implications on how gains and losses from virtual currency are taxed, which are beyond the scope of this alert. The notice also addressed the tax treatment of mining virtual currency and when income is recognized, an issue that has been the subject of debate in the courts. Later guidance, Rev. Rul. 2019-24,² considered the taxability of common practices in the industry like airdrops and hard forks. Again, the IRS approach was met with significant pushback from stakeholders.

In light of the evolution of the industry from virtual currency to non-fungible tokens to stablecoins,³ existing guidance on the taxation of digital assets either is inadequate to cover all scenarios, may not reflect the shift in their acceptance and use, or has not kept pace with legislative and regulatory developments.

Future Taxation of Digital Assets

Legislative Proposals

Legislative proposals on digital assets in this Congress have primarily focused on market structure and stablecoin so far, culminating in the passage of the CLARITY Act in the U.S. House of Representatives and the enactment of the GENIUS Act into law. While there is still work to be done on the CLARITY Act, crypto-minded lawmakers are beginning to turn their attention to the tax treatment of digital assets. 

Proposals seeking to clarify the tax treatment of digital assets are emerging in Congress as the Senate and House consider digital assets from the perspectives of financial markets and oversight. Senator Cynthia Lummis (R-WY) has introduced comprehensive legislation defining what is a digital asset and establishing rules on the treatment of de minimis transactions, lending agreements, wash sales, mark-to-market valuation, mining activities, and charitable contributions. Representative Max Miller (R-OH) has indicated his intent to introduce legislation addressing similar issues and has released an initial outline of his proposals. Both of these proposals likely will attract co-sponsors and undergo changes and may provide the basis for a legislative vehicle to advance certain of the recommendations from the Working Group report.

The President’s Working Group on Digital Assets Recommendations

The Working Group report includes dozens of recommendations addressing the taxation of digital assets. Many of them are consistent with the approaches taken by Senator Lummis and Representative Miller but the report goes well beyond the scope of their proposals. The following list includes several of the recommendations:

• Updating IRS guidance, including FAQs;
• Clarifying when digital assets should be treated as securities or commodities;
• Addressing the treatment of digital assets treated as debt or loans;
• Including digital assets within wash sale rules;
• Addressing the treatment of de minimis transactions, including airdrops, staking, hard forks, and mining rewards;
• The timing of income from staking and mining, including potential changes to IRS guidance;
• Coordination of reporting for the Report of Foreign Bank and Financial Accounts, Bank Secrecy Act, and IRS purposes; and
• Modifying existing information reporting requirements to reduce the burden on brokers and taxpayers

Conclusion

Any of the issue areas addressed in the Working Group report have the potential to significantly impact digital asset stakeholders, no matter where on the spectrum of the industry they operate. As policymakers are responding to this fast-paced sector, this is a critical time to pay close attention to legislative developments. It is important for stakeholders to assess which issues may have the most potential impact, and to take action so that administration and congressional officials are aware of issues, concerns, industry practices, and the practical challenges facing the industry and investors as they try to adapt to rapidly shifting dynamics.

Footnotes