Proposed Legislation Would Make Bitcoin Virtually Un-taxable

UPDATE: Congress adjourned for 2017 without further action on this bill. It was not part of the tax reform legislation passed in December.

On September 7, 2017, Representatives Jared Polis (Democrat) and David Schweikert (Republican), who co-lead the Congressional Blockchain Caucus, announced the Cryptocurrency Tax Fairness Act. The Act, if passed, would amend the Internal Revenue Code to provide that “gross income shall not include gain from the sale or exchange of virtual currency for other than cash or cash equivalents.” The Act specifies that the exemption would apply to transactions with gain of up to $600.

At only three pages, the Act is short. Besides the exemption provision, the Act maintains the distinction between Virtual Currency and Foreign Currency by excluding the former from the Code Section that governs transactions involving the latter. Additionally, the Act directs the IRS to develop and implement reporting rules for transactions that are not exempt. Essentially, this means that exchanges would be required to issue 1099-B forms to traders and also file them with the IRS.

Dead on Arrival

Here is my prediction: this act has practically no chance of passing as written. It will most likely be referred to the House Ways and Means Committee, where it will die at the end of the current Congressional Session. Here’s why:

Unlike Section 988, which exempts up to $200 in gain on “personal” transactions, the Cryptocurrency Tax Fairness Act makes no such distinction. Broadly speaking, Section 988 defines personal transactions as those that are not entered into for the production of (business or investment) income. Additionally, the $600 limit is not an aggregate per year, but a per transaction limit, which means that any disposal with less than $600 in gain is not only non-taxable, it isn’t even reportable.

Tax Free Trading

Consider the following scenario: a bitcoin trader creates software to take advantage of small arbitrage opportunities on an automated basis (a “bot”). The bot is programmed not to permit gains of more than $600 on any lot of virtual currency, or to trade into anything other than virtual currency. Since all lots are disposed of of at gains of less than $600, the bot never allows a transaction that is taxable. There is also no need to fully and finally close a position if the trader wants to hodl. The bot could simply sell to harvest gain, then immediately re-buy to setup a new tax-free exchange.

Nothing in the Act would prevent the trader from harvesting losses in a down market. That’s right, friends: in this scenario, all losses can be claimed, no gains need be declared. What’s more, nothing in this strategy prevents it from being implemented manually- a casual trader could do this without the aid of advanced computer skills.

Tax Free Buying

Once our trader has built up a size-able portfolio of virtual currencies, he may way to spend some. As long as he doesn’t trade into “cash or cash equivalents,” he won’t trigger taxable gain. Even if he did, the gain would only be on the difference between the basis of the most recent transaction, and the ending value. The remainder of the gain could have been taken tax free over time. Want to buy a yellow Lamborghini, or a villa in Nevis? Those assets aren’t cash equivalents, so the disposal of virtual currency in exchange would be tax free. What about a cup of coffee with your bitcoin-backed debit card? Coffee isn’t equivalent to cash. Tax free.

I would love to see this bill make it through the Congress, I just don’t think that it will. No public purpose is served by exempting virtual currency activity from tax, or setting up a favored competitor to the US dollar. The Congressional Blockchain Caucus includes only eleven members, but anything that increases awareness among lawmakers is likely to be a welcome development.