Digital Assets As Securities
Classifying digital assets as securities create similar issues as classifying them as commodities – there is no single definition.
“The use of the word ‘security’ is found in a number of provisions splattered throughout the Internal Revenue Code and is used in different ways and for different purposes,” Amie Colwell Breslow, of counsel at Jones Day, said during the presentation.
“I’ll also point out that all of the definitions and the term ‘securities’ within the Internal Revenue Code are not interchangeable,” Colwell Breslow said, adding that different regulatory agencies may be approaching digital assets differently.
For example, the Securities and Exchange Commission “has treated many token and coin offerings in initial coin offerings as securities,” she said, “but that definition does not necessarily dictate how the IRS is going to treat cryptocurrency as securities.”
Cryptocurrency As Currency
For the moment, the clearest treatment may be how the IRS looks specifically at cryptocurrency in the context of currency.
“In 2014, the IRS said virtual currency is not currency because it is not legal tender in any country, and that was correct at the time,” Roger Brown, global head of tax strategy at Chainalysis, said during the presentation. “That said, El Salvador enacted a law that said Bitcoin is legal tender in El Salvador. So does that mean now that Bitcoin is a currency from a tax perspective?”
He noted that what the IRS said in 2014 was not the result of a new law being made, but rather the application of current legal principles. Across U.S. law, currency is legal tender generally defined as something that is issued and backed by the full faith and credit of a sovereign nation.
Brown suggested that despite El Salvador recognizing Bitcoin as currency, most practitioners see it and other cryptocurrencies as not being currency from a tax perspective. However, stablecoins that reference fiat currencies like the U.S. dollar or the Euro could be treated as currency for tax purposes.
Colwell Breslow noted the question of whether to treat cryptocurrency as currency under tax law becomes important as more lending transactions and loan repayments are being conducted in cryptocurrencies.
Non-fungible Tokens
Non-fungible tokens (NFTs) also have different tax rules that might apply. An NFT is something that has a unique digital certificate that is stored on a blockchain, which may represent a work of art, a photograph, a musical composition or some other digital asset of value.
Brown compared an NFT to a physical work of art. In the case of the creator who sells it, that work would be covered under income rules (which may be impacted if it is done as a hobby or as a professional). But once it is on the market, the buying and selling of it would be treated as the purchase and sale of a capital asset.
NFTs can be treated the same way, with those who mint the NFT originally treating it as income on the first transaction to move it to market. After that, capital gains and losses are recognized in subsequent transactions as the NFT changes ownership.
Are Digital Asset Activities a Trade or Business?
Another issue that still needs IRS guidance is whether engaging in digital asset transactions is a trade or business for domestic tax purposes.
Mowbray highlighted the need for clarity on this as it will determine whether and how much expenses related to these transactions will be deductible, among other considerations.
As the use of digital assets continues to rise, the panelists expect more legislation and regulation surrounding them.
