September 22, 2021
Cryptocurrency and other digital assets would be affected by tax proposals in budget reconciliation bill
The tax portion of the budget reconciliation bill, which was approved the House Ways and Means Committee on September 15, 2021, included several proposals that would affect taxpayers that hold or transact in digital assets such as cryptocurrency (the HW&M Proposal). Key proposals would:
With important exceptions, most of these changes would be effective for tax years beginning after December 31, 2021. Notably absent from the budget reconciliation bill, however, were any further information-reporting requirements beyond what has already been proposed in the Senate-passed Infrastructure Investment and Jobs Act bill.
To supplement the HW&M Proposal, the House Ways and Means Committee also released a section-by-section summary, and the Joint Committee on Taxation released a description of the proposed changes (the JCT report).
Provisions applicable to digital assets
The HW&M Proposal would modify the wash sale rule under IRC Section1091 to include digital assets. IRC Section 1091 generally prohibits deductions for losses realized from the sale or other disposition of shares, stock or securities where it appears the taxpayer has acquired (or has entered into a contract or option to acquire) substantially identical stock or securities in the 60-day period beginning 30 days before the date of the original disposition. The rule generally prevents taxpayers from claiming losses on assets while still retaining an interest in that asset. However, under current law, the basis of any stock or securities acquired in a wash sale increases for the loss disallowed by IRC Section 1091. Thus, any loss is generally preserved.
Under the HW&M Proposal, IRC Section 1091 would apply to "any digital representation of value [that] is recorded on a cryptographically secured distributed ledger or any similar technology," i.e., digital assets.
Implications: Application of IRC Section 1091 to digital assets would add complexity to broker information reporting on Form 1099-B, as brokers would need to ensure transactions subject to IRC Section 1091 are properly identified. Furthermore, taxpayers should consider both the US federal income tax implications of the possible permanent disallowance of these losses.
IRC Section 1259 generally requires taxpayers to recognize gains with respect to an appreciated financial position as if the position was sold for its fair market value on the date of the constructive sale. An appreciated financial position generally means any position with respect to any stock, debt instruments, or partnership interests with built-in gain. A taxpayer is treated as having made a constructive sale of an appreciated financial position if the taxpayer (or a related person) (1) enters into a short sale of the same or substantially identical property, (2) enters into an offsetting notional principal contract with respect to the same or substantially identical property, (3) enters into a futures or forward contract to deliver the same or substantially identical property, or (4) acquires the same or substantially identical property in the case of an appreciated financial position that is a short sale or a contract described in (2) or (3),. The rules are generally intended to prevent taxpayers from monetizing investment gains without realizing taxable gains.
The HW&M Proposal would expand the definition of an "appreciated financial position" to include positions in "digital assets." New IRC Section 1259(d) would define "digital asset" in the same manner as the proposed modifications to IRC Section 1091, discussed previously. In addition, the Proposal would modify IRC Section 1259(c)(1)(D) to provide that a constructive sale occurs when a taxpayer acquires "or enters into a contract to acquire" the same or substantially identical property when the appreciated financial position is a short sale or contract described in IRC Section 1259(c)(1)(B) or (C). The modified rules generally would apply to constructive sales entered into after the date the legislation is enacted.
Implications: Taxpayers, particularly those active in cryptocurrency transactions, should consider identifying positions that may be affected by the Proposal.
The HW&M Proposal would increase the capital gains rate in IRC Section 1(h)(1)(D) to 25% for tax years ending after the date that the reconciliation bill was introduced. Under a transition rule, the current 20% rate would continue to apply to (1) gains or losses for the portion of a tax year preceding the bill's introduction date, and (2) gains that are recognized after the introduction date and stem from a transaction entered into under a binding contract before the introduction date. These changes would apply to tax years ending after September 13, 2021.
Implications: Individuals who report capital gains and losses from the sale or exchange of digital assets including cryptocurrency should be mindful of the higher rate at which those items would be taxed under the Proposal.
The HW&M Proposal would increase the top marginal income tax rate for individual in IRC Section 1(i)(2) to 39.6% from 37%. The increased rate would apply to married individuals filing jointly who have taxable income exceeding $450k; heads of households with taxable income exceeding $425k; unmarried individuals with taxable income exceeding $400k; married individuals filing separately with taxable income exceeding $225k; and estates and trusts with taxable income exceeding $12.5k. These changes would apply to tax years beginning after December 31, 2021.
Implications: Individuals who are subject to the top marginal income tax rate and report income from cryptocurrency transactions should be mindful of the higher rate at which such income would be taxed under the Proposal.
The HW&M Proposal would increase the federal corporate income tax rate to 26.5%. Specifically, this rate would apply to the highest bracket of a new graduated corporate income tax rate, starting at 18% on taxable income of $400,000 or less, then 21% on income from $400,000 to $5 million, and finally 26.5% on income over $5 million. For corporations whose taxable income exceeds $10 million, the benefit of the lower rates would be effectively phased out through a top-up tax to equal the 26.5% rate on all income.
Implications: Corporate taxpayers that engage in taxable transactions involving cryptocurrency should be mindful of the higher rate at which such transactions would be taxed under the Proposal.