United States

Token Taxonomy Act provides favorable virtual currency tax reforms

TAX ALERT  | 

On Dec. 20, 2018, Congressmen Warren Davidson (OH-08) and Darren Soto (FL-09) introduced the Token Taxonomy Act (the Act), H.R. 7356, to provide light-touch regulatory certainty for the blockchain and virtual currency industry. Given the current lack of blockchain guidance, the Act serves as an important first step towards providing much needed regulatory clarity. With Congress having already adjourned, it is expected that the Act will be reintroduced in January, at the start of the next Congress. With its bipartisan support, many are optimistic that the Token Taxonomy Act, or some form of it, will ultimately become law.  

Much of the Act focuses on providing definitions, such as “Digital Token,” and addressing securities law concerns. Specifically, the Act would exempt digital tokens from the definition of a security for purposes of both the Securities Act of 1933 and the Securities Exchange Act of 1934. The Act provides several significant tax law changes, too. For example, one significant provision would add virtual currency to the types of property receiving tax-free, like-kind exchange, treatment under Section 1031. Since the enactment of the Tax Cuts and Jobs Act in 2017, like-kind exchanges have been limited to real property transactions. Enabling tax-free virtual currency-to-virtual currency exchanges could potentially free significant funds for investment into innovative blockchain startups. This is because many blockchain startups are funded through initial coin offerings (ICOs) and their investors often are holding significantly appreciated Bitcoin. During the course of the ICO, newly created digital tokens are exchanged for Bitcoin and other cryptocurrencies. Allowing these transactions to qualify for tax-free treatment could increase the funding available to startups.

The Act would also establish an exception for certain virtual currency transactions. Under the Act, gain of less than $600 from the sale or exchange of virtual currency for property other than cash and cash equivalents would not be included in gross income. This provision is similar to a foreign currency gain exception available to individuals with personal transactions under $200. The idea is to reduce the potential reporting burden of using virtual currencies, such as Bitcoin, on a daily basis, which lawmakers believe would encourage widespread adoption of blockchain technology.

The Act would also instruct the Treasury Department (Treasury) to issue regulations on information reporting for virtual currency. As discussed in a prior alert, Bitcoin tax: More than just reporting income, the information reporting requirements surrounding virtual currency transactions are potentially onerous and complicated. A significant factor behind the complexity is the lack of Treasury guidance on virtual currency transactions. Despite the Internal Revenue Service (IRS) announcement of a targeted enforcement campaign against virtual currency transactions, a 2014 Notice remains the only guidance issued by the IRS on virtual currencies.

Supporters of small to middle-market business and technological innovation should be encouraged by the positive steps taken by the Token Taxonomy Act. Hopefully, further legislative or regulatory guidance on virtual currency will soon clarify the regulatory environment for businesses that adopt blockchain technology or accept virtual currency. Until such guidance comes, taxpayers with virtual currency transactions or using a blockchain should continue to monitor for developments and speak with their advisors to ensure they remain compliant with all rules.

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