Crypto is amazing. Crypto is the future. Crypto is here today and crypto is here to stay. But the reality is that the IRS and other tax authorities worldwide are taking very long to offer guidance in many areas. The crypto industry is moving very fast whereas most lawmakers are not necessarily crypto-savvy and have many other problems to tackle, including a pandemic and inflation. Yet millions of people around the world are using DeFi platforms and have no clue what to do come tax time. So, what are the complex transactions you better watch out for?
As I covered in my recent article, lending can be very lucrative during inflationary times. The problem is that some technicalities within the tax law open up the door of uncertainty as to how tax authorities will see crypto lending once they get around to tackling the issue.
How should staking be taxed? There are millions of people across the many different Proof-of-Stake (PoS) networks accumulating massive amounts of staking rewards – Ethereum 2.0, Cardano, Tezos, Polkadot, Solana. But the IRS has only commented on mining income – they have offered no guidance on staking income. Could it be taxed the same as mining? Certainly, and this is the conservative approach, but other schools of thought exist as evidenced by the Jarrett v. United States Court Case, in which Joshua Jarret argues that he should not be taxed on staking income because he created the coins, and should be treated as a writer writing a book – only taxed upon disposing of the coins. What about when you lock-in your coins? What about slashing penalties for validators?
How should we tax someone providing liquidity on Uniswap, receiving an LP token back, getting rewards, and then trading the LP token back for his original coins? Should it be a taxable event when you exchange your coins for an LP token? Certainly an argument can be made that it should not be taxable and it should be treated as a deposit. However, if we are simply following today’s guidance – cryptocurrencies are property and every trade is taxable – then the LP exchange is taxable. If you are doing this with appreciated crypto, the tax result could be extremely different and an unsuspecting taxpayer could have a bad surprise.
The concept of a rebasing cryptocurrency is a very unique idea in that the protocol automatically adjusts its circulating supply by issuing or burning coins to adjust the supply and therefore the price of the coin. So, when you receive additional coins, is this a taxable event? What about claiming losses when you lose coins? If you own 1/1000th of the network, and then additional coins are distributed proportionally to all coin holders, do you really own anymore of the network? Again, no parallel in CeFi tax law to this type of transaction. Good luck!
Lost and Worthless Coins
Imagine you are one of the unlucky ones to lose access to your private keys and you lose your crypto. Can you write this off on your taxes? Not based on today’s tax law – maybe if the President declares you losing your Bitcoin a federal disaster, but something tells me that’s not likely to happen. What about a coin that goes to zero? Can you write this off? If you trade it, then yes. Though what happens when there is no liquidity? You’ll have to get creative – maybe even send it to someone else in exchange for $.01. But the issue here is that creativity and tax law do not mix – we need guidance.
We can lump yield farming with staking and liquidity pools. The issues are mostly the same – point being, we need guidance.
In traditional markets there are special tax rules that apply to trading of derivatives and very complicated tax laws apply depending on many factors. However, we have no guidance on cryptocurrency derivatives, which can be very different from any traditional financial products. If you have significant income from trading crypto derivatives, it’s highly recommended that you seek the help of a professional who understands these products as you will have to take a position on how to report this for tax purposes.
NFTs, Play-to-Earn, Metaverse, DAOs
Have you considered that we are barely scratching the surface of the crypto universe’s potential? We have not even begun speaking of the implications that NFTs, Play-to-Earn games, the Metaverse and DAOs will have on tax reporting. When you consider that all these are centered around digital assets, whether ERC-20, ERC-721, ERC-1155 or whatever other blockchains, all of these assets have value and most have the ability to generate yield – income that is taxable. How do we go about taxing income earned from playing Axie Infinitiy? What do we do when people are making money inside the Metaverse? How should Decentralized Autonomous Organizations (DAOs) be taxed? What about NFTs?
You get the Point
The bottom line is that there are many amazing developments happening in the crypto industry, and each and every day more and more people are joining the crypto community and using these platforms. But what will they do when it comes time to file their taxes? The IRS and other tax authorities want their share of this income and have been targeting crypto investors with unreported income. So what can you do? You can start today with fully understanding each platform you are using, getting your hands on a good crypto tax software tool to help you, and understanding the risks and options of how to report your taxes so that you are comfortable with the positions you are taking. Otherwise, stay tuned as we will update you as soon as new developments happen in the crypto tax landscape.