America’s Misguided Crypto Tax Policy
We are a month into the new year and tax season is upon us, so of course I’ve been thinking a lot about the sad state of America’s crypto tax policy.
Warning: Rant ahead!
First of all, aside from a “Notice” the IRS posted back in 2014, which for years seemed to be widely ignored, there doesn’t seem to be a clear crypto tax policy other than the IRS warning everyone to make sure to pay your taxes, or else! This past year (2021), Congress attempted to clamp down on crypto tax enforcement by including a provision in the Infrastructure Bill that requires “brokers” to start issuing Form 1099-Bs to customers, which to most people, this seems appropriate and long overdue.
The trouble is, crypto is not traditional finance and instead of bringing long sought clarity to investors, this new provision actually creates even more confusion. For one, the language can be considered ambiguous. According to the bill, a digital asset broker is:
“… any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.”
Traditionally speaking, that would refer to your banks, stock brokers and asset managers, etc. Makes sense right? However, thanks to the decentralized aspect of crypto (which is a key strength), that could technically refer to everyone who is mining or staking, which could literally be anyone! I’m not going to dive into the details because that wasn’t my initial intention for this article, but you can read more about it here and here.
The other issue at hand is the fact that unlike traditional finance, where all of your transactions are controlled by centralized servers and services who collect and control your data, crypto is decentralized and trustless, meaning services don’t need you to “prove who you are” to function. This is arguably the most revolutionary aspect of crypto… as well as the primary reason central authorities from banks to governments feel threatened by it.
What does this have to do with the new tax mandates you ask? Great question.
Since crypto users have the option (and are in fact encouraged) to self-custody, the centralized services they use as on and off ramps to and from USD, such as Coinbase or Binance, are likely to have significant gaps in their reporting. This is not to be confused with having a gap in your transaction history, which remains 100% complete, secure, and verifiable on the blockchain. The aforementioned gap is a reference to the fact that centralized exchanges may not be able to take into account your initial cost basis for an asset and will therefore inaccurately report your tax obligations. This of course will lean heavily in the government’s favor and cause many crypto investors to unwittingly overpay their taxes.
The emergence of decentralized finance (DeFi) and more specifically decentralized exchanges (DEXs) is something we should all celebrate, as they have become the engine of the economic evolution that is giving power back to the people. That said, these new tax mandates are creating a nightmare scenario and will ultimately increase anxiety and frustration for crypto investors who utilize DeFi platforms.
If you ask me, this is more than an attempt to reel in tax dollars the government believes are owed to them. No, this is an attempt to crush the decentralized aspect of crypto by encouraging (aka: forcing) participants to link their decentralized accounts to a centralized authority; ultimately creating a dystopian surveillance state and eliminating one of the core pillars of the Crypto Revolution!
