I was asked to provide a 15 min overview of the current state of play in US crypto taxation at a UChicago symposium.

15 minutes is comically short, so I’ll have to be judicious. Here are my thoughts.

REPORTING. Overbroad reporting requirements are the single biggest threat to the viability of blockchain tech in the US.

In August, the IRS proposed regs that would treat virtually every contributor to the tech stack as a broker and every tokenized asset as reportable.

The proposed regs are predicated on a misconception that the tech stack includes intermediaries who can collect information but choose not to.

They thus treat, eg, websites and wallets as brokers, even though all they do is generate hypothetical call functions.

(For more on the proposed regs, see the comment letter I worked on with @fund_defi - https://www.defieducation fund.org/_files/ugd/e53159_40d4255857d142f2a1744be79f1dab3f.pdf- or listen to our episode on Bankless.)

Meanwhile, section 6050I authorizes the IRS to require anyone who receives >$10k of crypto in a business to report personal info about the payer.

We don’t yet have proposed 6045I regs, but the baseline requirement is incompatible with pseudonymity and pooled onchain capital.

STAKING. In Revenue Ruling 2023-14, the IRS concluded without analysis that staking rewards are income when credited to a staker’s account.

This is the first time the IRS has ever asserted property is income to its first owner. (Farmers are taxed on sale, not on harvest.)

Rev rulings aren’t binding, but the IRS has made its position difficult to challenge for low-resourced taxpayers.

In Jarrett, the taxpayer sued for a refund of tax on staking rewards. The IRS granted the refund then had the suit dismissed as moot, avoiding judicial review.

Even if the IRS is “right,” their approach is disappointing bc it leaves many important questions unanswered:

- Foreigners are subj to 30% withholding tax on US source income. How are staking rwds sourced? Does the answer change for delegated / liquid staking, or staking by hedge funds w US managers?

- Foreigners are subj to US income tax on US biz income. When is staking a US biz?

- Partnerships with > 100 partners default to corps if too much of their income is “active.” Are staking rewards active income?

- Tax-exempts are subject to US income tax on “unrelated business taxable income.” Are staking rewards UBTI?

(For more on staking, see the discussion in another letter I worked on with @fund_defi - https://www.defieducationfund.org/_files/ugd/84ba66_94bb62e0bac1428585c944bc06884bd2.pdf.)

ENTITIES EVERYWHERE. US tax law views a “joint venture or other contractual arrangement” as an entity, even absent a legal entity.

Many DAOs, multisigs, liq pools, and LST protocols could be entities under that definition. The IRS suggested so in the broker regs preamble.

The specter of entity treatment raises lots of hard questions, incl:

- Does the entity owe US income tax?

- Does it have withholding obligations?

- How does decentralized software pay / withhold taxes?

- Could users be liable for the software’s failure to pay/withhold?

- Are US persons subject to the PFIC & CFC regimes if the entity is a foreign corp?

- If the entity is a partnership, US holders are taxed currently on their share of income and foreigners are subj to US income tax if the entity is in a US biz. How is all this determined?

Obviously, there are reasons not to treat onchain relationships as tax entities. Pseudonymity, reliance on software for governance, and wide cross-border distribution suggest there is no “contractual arrangement,” express or implied.

But lack of clarity creates serious risks for anyone involved in DeFi or DAOs, including as a passive investor.

Without answers, US asset managers will have a lot of trouble investing client funds into the crypto ecosystem.

A corollary q is whether some tokens should be looked thru to determine a US person’s tax.

Eg, can staking rewards - which the IRS says are ordinary income as credited - be converted to deferred cap gains thru holding a nonrebasing LST like rETH? Or is rETH looked thru?

(For more on DAOs and smart contracts as tax entities, see the article I wrote for @banklessDAO - https://www.friedfrank.com/uploads/siteFiles/Publications/Decentralized%20Autonomous%20Organizations%20_%20Decentralized%20Law.pdf.)

TRADING. But for a special statutory rule, foreigners are subject to US income tax if they delegate a US manager to trade on their behalf.

The statutory rule exempts trading in stocks, debt securities, and qualifying commodities.

Does crypto satisfy the exemption?

A qualifying commodity is one of a kind ordinarily traded on a regulated commodities exchange.

BTC and ETH should qualify bc they have futures. Everything else is less clear, though, as mentioned above, some tokens, even if not commodities, might be stock in a deemed corp.

Without clarity on this point, US-based investment managers will have trouble trading crypto on behalf of foreign accounts and funds.

(For more on the trading safe harbor, see the Inbound Tax Considerations section in the article I wrote for Tax Notes - https://www.friedfrank.com/uploads/siteFiles/Publications/Schwartz%20%2802-07-2022%29.pdf .)

I think that’s all I have time for. Even all of this is difficult to cover in 15 minutes.

How’d I do? Anything you’d add/remove?

Cheers 🍻