Last week, Reps Miller & Horsford released a discussion draft of the PARITY Act, which would modify the tax code to address crypto taxation. This thread summarizes the provisions of the Act.

STABLECOIN TREATMENT. Under current law, if you dispose of a stablecoin at a gain or loss, you need to report that gain or loss. The Act would instead treat, as zero, any gain or loss from a stablecoin you bought within 1 penny of the dollar.

This provision might not make a meaningful difference for most stablecoin users. Gain or loss on stablecoin txns can be eliminated if the merchant denominates in USD, effectively agreeing to treat 1 stable as 1 dollar.

It would be more helpful if the Act turned off broker reporting on stablecoin txns, as discussed under "stablecoin reporting" here. Otherwise, every intermediated stablecoin txn results in a 1099 to the IRS and to the taxpayer, notwithstanding the absence of taxable gain or loss.

In addition, no stablecoin de minimis rule is complete unless it also applies to gas fees, as discussed under "de minimis for gas" here. Without that, taxpayers still have gain or loss on stablecoin txns.

TRADING SAFE HARBOR. Very generally, under current law, foreigners can be subject to US income tax if US asset managers are engaged in a crypto trading business on their behalves, unless the crypto is a commodity of a kind regularly traded on an organized commodity exchange.

Most crypto tokens likely satisfy the commodities exemption. However, the Act would create an explicit exemption for certain digital representations of value that are designed and function primarily as a medium of exchange, store of value, or unit of account.

While the provision represents a welcome effort to add clarity, it ultimately muddies the waters. It is often difficult to determine the purpose for which a token was primarily “designed” to function. There’s also an argument that most do not “represent” value.

The Act also provides that “passive staking” through a US agent does not cause foreigners to be subject to US income tax. Passive staking means staking by someone with no deductible expenses from staking.

Unfortunately, the passive staking provision effectively excludes an investment fund that regularly trades crypto—which is exactly the sort of vehicle foreigners would invest in. Thus, the provision might hurt US asset managers by preventing them from staking for foreigners.

LENDING. Under current section 1058 of the tax code, loans of stocks and securities generally are treated as nontaxable dispositions, so long as the lender can call back the stocks or securities within a short period (proposed regs say 5 days).

Many taxpayers have gotten comfortable that a similar rule applies to digital assets, but the Act would explicitly extend 1058 treatment to digital representations of value that are designed and function primarily as a medium of exchange, store of value, or unit of account.

Similar to the trading safe harbor, while the provision represents a welcome effort to add clarity, its definition of digital assets muddies the waters because it is difficult to know the purpose for which a token was primarily designed to function.

WASH SALES. Unfortunately, like other legislative proposals we’ve seen, the Act would extend the tax “wash sale rules” to crypto. Under those rules, losses on a use or sale of crypto are suspended if substantially identical crypto is acquired within 30 days.

So, assume you acquire SOL or jitoSOL and, within 30 days (looking back and forward), you use it in DeFi, to buy NFTs, and/or as gas. The wash sale rules would require you to look at each of those uses and, if SOL has gone down, the loss is suspended (but gains aren’t).

There’s a reason the wash sale rules historically have not applied to commodities: people regularly use commodities in non-tax-motivated transactions. Applying the wash sale rules to crypto assumes that any use of crypto within 30 days of acquiring it is tax-motivated.

MARK-TO-MARKET. Under current law, traders and dealers can elect to mark actively traded commodities to market each year, and pay tax at ordinary rates (or take ordinary losses) on any appreciation or depreciation.

Although many tokens already qualify as actively traded commodities, the Act would explicitly extend the MTM election to actively traded digital assets. While the extension provides helpful clarity, I would have liked to see a MTM election for investors too.

With the tax treatment of liquidity provision and other common DeFi txns still uncertain, many retail investors would welcome a MTM election. The threshold for “trading” is too high to apply to most retail investors, even those with thousands of txns.

Moreover, a MTM election could provide some relief to retail if a wash sale rule goes into effect. (The wash sale rules don’t apply to any property that is marked-to-market.)

CONSTRUCTIVE SALES. Under current law, if you enter an offsetting position on appreciated debt or equity, you are treated as selling the debt or equity. The Act would extend that rule to crypto. While the extension is sensible, it might be very difficult to administer.

PASSIVE STAKING. The IRS takes the view that all staking rewards are ordinary income at acquisition. As we recently explained in a letter to Treasury, under current law, that view is correct for txn fees but not for newly minted tokens.

The Act would codify the IRS’s view but provide “passive stakers” with an election for newly minted tokens. Under the election, newly minted tokens are not taxed until a sale, but if the sale occurs within the current or next 4 years, gain is ordinary.

There are several issues with this proposal. First, as we explained in our letter to Treasury, there is a real constitutional question whether newly minted tokens can be taxed to a staker on acquisition. Thus, even if the Act were passed, one might expect a court challenge.

Second, the election applies only to passive stakers, who are defined as taxpayers with no deductible expenses from staking. That means investment funds that are in a crypto trading business cannot make the election.

Third, even with the election, txn fees continue to be taxed currently. Staking rewards for an electing validator thus will include both zero- and nonzero-basis tokens, creating an administrative burden when it comes time to identify sold lots.

CHARITABLE CONTRIBUTIONS. Under current law, US taxpayers generally need to obtain a “qualified appraisal” to take a tax deduction on a charitable donation of actively traded crypto in excess of $5000, notwithstanding that price quotes are readily available.

The Act would eliminate the requirement for a qualified appraisal for actively traded crypto, and would impose additional substantiation requirements on donations of infrequently traded digital assets.

UBTI EXCLUSION. Under current law, US tax-exempt entities are subject to US tax on income from businesses unrelated to their charitable purpose (so-called unrelated business taxable income). The Act would exclude “passive staking” from UBTI.

Again, this provision is problematic because its application only to “passive staking” creates a negative inference that staking rewards earned through a crypto trading fund are UBTI.

CRYPTO ETPs. Under a safe harbor described in the linked post, ETPs can stake their crypto while remaining nontaxable at the entity level. The Act would codify the safe harbor and extend it by allowing retention of staking rewards (the safe harbor requires distribution).

Last week, Reps Miller & Horsford released a discussion draft of the PARITY Act, which would modify the tax code to address crypto taxation. This thread summarizes the provisions of the Act.

STABLECOIN TREATMENT. Under current law, if you dispose of a stablecoin at a gain or loss, you need to report that gain or loss. The Act would instead treat, as zero, any gain or loss from a stablecoin you bought within 1 penny of the dollar.

This provision might not make a meaningful difference for most stablecoin users. Gain or loss on stablecoin txns can be eliminated if the merchant denominates in USD, effectively agreeing to treat 1 stable as 1 dollar.

It would be more helpful if the Act turned off broker reporting on stablecoin txns, as discussed under "stablecoin reporting" here. Otherwise, every intermediated stablecoin txn results in a 1099 to the IRS and to the taxpayer, notwithstanding the absence of taxable gain or loss.

In addition, no stablecoin de minimis rule is complete unless it also applies to gas fees, as discussed under "de minimis for gas" here. Without that, taxpayers still have gain or loss on stablecoin txns.

TRADING SAFE HARBOR. Very generally, under current law, foreigners can be subject to US income tax if US asset managers are engaged in a crypto trading business on their behalves, unless the crypto is a commodity of a kind regularly traded on an organized commodity exchange.

Most crypto tokens likely satisfy the commodities exemption. However, the Act would create an explicit exemption for certain digital representations of value that are designed and function primarily as a medium of exchange, store of value, or unit of account.

While the provision represents a welcome effort to add clarity, it ultimately muddies the waters. It is often difficult to determine the purpose for which a token was primarily “designed” to function. There’s also an argument that most do not “represent” value.

The Act also provides that “passive staking” through a US agent does not cause foreigners to be subject to US income tax. Passive staking means staking by someone with no deductible expenses from staking.

Unfortunately, the passive staking provision effectively excludes an investment fund that regularly trades crypto—which is exactly the sort of vehicle foreigners would invest in. Thus, the provision might hurt US asset managers by preventing them from staking for foreigners.

LENDING. Under current section 1058 of the tax code, loans of stocks and securities generally are treated as nontaxable dispositions, so long as the lender can call back the stocks or securities within a short period (proposed regs say 5 days).

Many taxpayers have gotten comfortable that a similar rule applies to digital assets, but the Act would explicitly extend 1058 treatment to digital representations of value that are designed and function primarily as a medium of exchange, store of value, or unit of account.

Similar to the trading safe harbor, while the provision represents a welcome effort to add clarity, its definition of digital assets muddies the waters because it is difficult to know the purpose for which a token was primarily designed to function.

WASH SALES. Unfortunately, like other legislative proposals we’ve seen, the Act would extend the tax “wash sale rules” to crypto. Under those rules, losses on a use or sale of crypto are suspended if substantially identical crypto is acquired within 30 days.

So, assume you acquire SOL or jitoSOL and, within 30 days (looking back and forward), you use it in DeFi, to buy NFTs, and/or as gas. The wash sale rules would require you to look at each of those uses and, if SOL has gone down, the loss is suspended (but gains aren’t).

There’s a reason the wash sale rules historically have not applied to commodities: people regularly use commodities in non-tax-motivated transactions. Applying the wash sale rules to crypto assumes that any use of crypto within 30 days of acquiring it is tax-motivated.

MARK-TO-MARKET. Under current law, traders and dealers can elect to mark actively traded commodities to market each year, and pay tax at ordinary rates (or take ordinary losses) on any appreciation or depreciation.

Although many tokens already qualify as actively traded commodities, the Act would explicitly extend the MTM election to actively traded digital assets. While the extension provides helpful clarity, I would have liked to see a MTM election for investors too.

With the tax treatment of liquidity provision and other common DeFi txns still uncertain, many retail investors would welcome a MTM election. The threshold for “trading” is too high to apply to most retail investors, even those with thousands of txns.

Moreover, a MTM election could provide some relief to retail if a wash sale rule goes into effect. (The wash sale rules don’t apply to any property that is marked-to-market.)

CONSTRUCTIVE SALES. Under current law, if you enter an offsetting position on appreciated debt or equity, you are treated as selling the debt or equity. The Act would extend that rule to crypto. While the extension is sensible, it might be very difficult to administer.

PASSIVE STAKING. The IRS takes the view that all staking rewards are ordinary income at acquisition. As we recently explained in a letter to Treasury, under current law, that view is correct for txn fees but not for newly minted tokens.

The Act would codify the IRS’s view but provide “passive stakers” with an election for newly minted tokens. Under the election, newly minted tokens are not taxed until a sale, but if the sale occurs within the current or next 4 years, gain is ordinary.

There are several issues with this proposal. First, as we explained in our letter to Treasury, there is a real constitutional question whether newly minted tokens can be taxed to a staker on acquisition. Thus, even if the Act were passed, one might expect a court challenge.

Second, the election applies only to passive stakers, who are defined as taxpayers with no deductible expenses from staking. That means investment funds that are in a crypto trading business cannot make the election.

Third, even with the election, txn fees continue to be taxed currently. Staking rewards for an electing validator thus will include both zero- and nonzero-basis tokens, creating an administrative burden when it comes time to identify sold lots.

CHARITABLE CONTRIBUTIONS. Under current law, US taxpayers generally need to obtain a “qualified appraisal” to take a tax deduction on a charitable donation of actively traded crypto in excess of $5000, notwithstanding that price quotes are readily available.

The Act would eliminate the requirement for a qualified appraisal for actively traded crypto, and would impose additional substantiation requirements on donations of infrequently traded digital assets.

UBTI EXCLUSION. Under current law, US tax-exempt entities are subject to US tax on income from businesses unrelated to their charitable purpose (so-called unrelated business taxable income). The Act would exclude “passive staking” from UBTI.

Again, this provision is problematic because its application only to “passive staking” creates a negative inference that staking rewards earned through a crypto trading fund are UBTI.

CRYPTO ETPs. Under a safe harbor described in the linked post, ETPs can stake their crypto while remaining nontaxable at the entity level. The Act would codify the safe harbor and extend it by allowing retention of staking rewards (the safe harbor requires distribution).