Author: TaxDAO

On July 11, 2023, the U.S. Senate Committee on Finance released a letter seeking answers from the digital asset community and other interested parties on appropriate treatment under federal tax law. The open letter raises a number of questions, including whether digital assets should be permitted to mark to market and treatment of loans of digital assets, etc. Based on the principle that tax policies should be loose and flexible, TaxDAO has responded to these questions accordingly and has submitted the response to the Committee on Finance on September 5th. We will continue to follow up on this important topic and also look forward to maintaining close cooperation with all parties. We welcome your attention, communication and discussions!

Below is the full text of TaxDAO’s response:

TaxDAO’s Response to Committee on Finance on the Taxation of Digital Assets September 5, 2023

To Committee on Finance:

TaxDAO welcomes the opportunity to response to key questions that lie at the intersection of digital assets and tax law raised by Committee on Finance.

Founded by the former Tax Director and CFO of a blockchain industry unicorn, TaxDAO has handled hundreds of Web3 financial and tax cases, amounting to tens of billions of dollars, and is a rare institution with extreme expertise in both Web3 and taxation. TaxDAO hopes to help the community better deal with tax compliance issues, bridge the gap between tax regulation and the industry, and carry out basic research and construction at the relatively early stage of tax regulation, so as to help the future compliance of the industry.

We believe that a loose and flexible tax policy will be conducive to the growth of the industry at a time when digital assets are in the ascendant, and therefore the tax regulation of digital asset transactions should be balanced with the simplicity and convenience of tax operations. Meanwhile, we also suggest that the conceptual definition of digital assets be unified to facilitate regulation and tax operations. The following responses are made based on this principle.

We look forward to working with and supporting the Committee on Finance to bring positive changes to the taxation of digital assets and promote sustainable economic development.

Sincerely,

Leslie Senior Tax Analyst TaxDAO

Calix Founder TaxDAO

Anita Head of Content TaxDAO

Jack Head of Operations TaxDAO

1. Marking-to-Market for Traders and Dealers (IRC Section 475)

· Should traders of digital assets be permitted to mark to market? Why?

· Should dealers of digital assets be permitted or required to mark to market? Why?

· Should the answer depend on the type of digital asset? How should digital assets be determined to be actively traded (under IRC Section 475(e)(2)(A))?

Our response:

In general, we do not recommend traders or dealers of digital assets to mark-to-market. Our reasons are as follows:

First, actively traded crypto assets are characterized by high volatility in asset prices, and therefore, mark-to-market tax results will increase the burden on taxpayers.

In a mark-to-market scenario, a taxpayer’s failure to redeem a crypto asset in time for the end of the tax year could result in the crypto asset being disposed of at a lower price than the tax. (For example, a trader purchases 1 bitcoin on September 1, 2023, at a market price of $10,000; the market price of bitcoin on December 31, 2023, is $20,000; and the trader sells the bitcoin on January 31, 2024, at a market price of $15,000.) At this point, the trader receives only $5,000 in gain but recognizes $10,000 in taxable gain.)

Meanwhile, if a trader recognizes a taxable gain, then a loss on the same digital asset can be offset against the recognized taxable gain, they can use mark-to-market. However, this accounting method will increase tax operations and is not conducive to facilitating trading. Therefore, we do not recommend mark-to-market for traders or dealers of digital assets.

Second, the (average) fair market value of crypto assets is difficult to determine. Crypto assets that are actively traded are often traded on multiple trading platforms, such as Bitcoin, which can be traded on Coin, Ouyee, Bitfinex, and so on. Unlike securities, which are traded on a single stock exchange, crypto assets are traded at different prices on different trading platforms, making it difficult to determine the fair value of crypto assets through a “virtual sale”. In addition, inactively traded crypto-assets do not have a fair market value and therefore are not suitable for mark-to- market valuation.

Last, in an emerging industry, tax policies tend to be simple and stable in order to encourage the growth of the industry. The crypto industry is exactly the kind of emerging industry that needs to be encouraged and supported. The mark-to-market tax treatment will undoubtedly increase the administrative costs for traders and dealers, which is not conducive to the growth of the industry. Therefore, we do not recommend this tax policy.

We recommend that traders and dealers in crypto assets still be taxed using the cost basis method, which has the advantages of operational simplicity and policy stability and is suitable for the current crypto asset market. At the same time, we believe that because of the cost basis method of taxation， there is no need to consider whether the crypto asset is actively traded (under Resection 475(e)(2)(A)).

2. Trading Safe Harbor (IRC Section 864(b)(2))

· When should the policies behind the trading safe harbor (of encouraging foreign investment in U.S. investment assets) apply to digital assets? If those policies should apply to (at least some) digital assets, should digital assets fall under IRC Section 864(b)(2)(A) (trading safe harbor for securities), IRC Section 864(b)(2)(B) (trading safe harbor for commodities), or should the answer depend on the regulatory status of the specific digital asset? Why?

· Another possibility is that a new, separate trading safe harbor could apply to digital assets. In that case, should the additional limitation on commodities eligible for the trading safe harbor apply? Why?

· To the extent that the additional limitation on commodities for the trading safe harbor applies, how should the terms “an organized commodity exchange” and “transactions of a kind customarily consummated” (in IRC Section 864(b)(2)(B)(iii)) be interpreted in the context of different kinds of digital asset exchanges?

Our response:

The safe harbor rules do not apply to digital assets, but this is not because digital assets should not enjoy tax benefits, but rather because of the nature of digital assets themselves. One of the key attributes of digital assets is that they are borderless, which means that it is difficult to determine where a large number of digital asset dealers are located. As a result, it is difficult to determine whether a transaction in digital assets is “transacted in the United States” for purposes of the transaction safe harbor.

We believe that the tax treatment of digital asset transactions can focus on resident taxpayer status. If the trader is a U.S. resident taxpayer, he is taxed under the resident taxpayer rules; if the trader is not a U.S. resident taxpayer, there are no tax issues in the U.S. and there is no need to consider the transaction safe harbor rules. This tax treatment avoids the administrative costs of determining the location of the transaction and is therefore simpler and beneficial to the crypto industry.

3. Treatment of Loans of Digital Assets (IRC Section 1058)

· Please describe the different types of digital asset loans.

· If IRC Section 1058 expressly applied to digital assets, would companies allowing customers to lend digital assets institute a standard loan agreement to comply with the requirements of that section? What challenges would compliance present?

· Should IRC Section 1058 include all digital assets or only a subset of digital assets? Why?

· If a digital asset is lent to a third party and the digital asset incurs a hard fork, protocol change, or air drop during the term of the loan, is it more appropriate for there to be a recognition of income for the borrower upon such transaction or subsequently by the lender when the asset is returned? Please explain.

· Are there any other transactions similar to a hard fork, protocol change, or air drop that may occur during the term of a loan? If so, please explain whether it is more appropriate for the borrower or the lender to recognize income upon such transaction.

Our response:

（1） Description of Digital Asset Lending

Cryptocurrency lending works on the principle that one user takes out their cryptocurrency and offers it to another user for a fee. The exact way in which lending is managed varies from platform to platform. Users can find cryptocurrency lending services on both centralized and decentralized

platforms, with the core principle remaining the same for both. Digital asset lending can be categorized into the following types depending on their nature:

(i) Collateral Loan: It requires the borrower to provide a certain amount of cryptocurrency as collateral for a loan in another cryptocurrency or fiat currency. Collateral lending generally requires going through a centralized cryptocurrency trading platform.

(ii) Flash lending: a new type of lending in the decentralized finance (DeFi) space that allows borrowers to lend a certain amount of cryptocurrency from a smart contract and return it in the same transaction without providing any collateral. Flash lending utilizes smart contract technology, which is “atomic” in nature, meaning that the “borrow-transaction-return” steps are either all successful or all unsuccessful. If the borrower is unable to return the funds at the end of the transaction, the entire transaction is cancelled and the smart contract automatically returns the funds to the lender, thus ensuring the safety of the funds.

Provisions similar to IRC Section 1058 should apply to all digital assets. The purpose of IRC 1058 is to ensure that taxpayers who make securities loans remain in a similar financial and tax position as they would have been had the loans not been made. Similar provisions are needed in digital asset lending to ensure the stability of a trader’s financial position. The UK’s latest exposure draft for DeFi states in its general principles that “The staking or lending of liquidity tokens or of other tokens representative of the staking or lending of liquidity tokens or of other tokens representative of rights in staked or lent tokens will not be seen as a disposal.” This principle of disposal is compatible with the disposal principle in IRC 1058.

We can analogize the current IRC 1058(b) to provide for digital asset lending accordingly. As long as a digital asset lending or borrowing transaction meets the following four conditions, no revenue or loss need be recognized:

(i) The agreement must provide for the transferor to recover, at the end of the term of the agreement, digital assets that are identical to the transferred digital assets;

(ii) The agreement must require the transferee to pay the transferor all interest and other income during the term of the agreement equal to that due to the owner of the digital asset;

(iii) The agreement cannot reduce the transferor’s risk or opportunity for gain in the transfer of the digital asset;

(iv) The agreement must meet such other requirements as the Secretary of the Treasury may prescribe by regulation.

It is important to note that applying provisions similar to IRC 1058 to digital assets does not mean that digital assets should be treated as securities, nor does it mean that digital assets follow the same tax treatment as securities.

By applying provisions similar to IRC 1058 to digital assets, centralized lending platforms can develop lending agreements for use by traders. As for decentralized lending platforms, they can adjust the implementation of smart contracts to meet the corresponding provisions. Therefore, the application of this provision will not have a significant economic impact.

（2） Revenue recognition for digital asset lending and borrowing

If hard forks, protocol change, or airdrop of digital assets occur during the borrowing or lending period, then it is the borrower who is more appropriately recognizing revenue on such transactions for the following reasons:

First, according to trading habits, the proceeds from forks, protocol changes, and airdrops are attributed to the borrower, which is in line with the actual situation and contractual terms of the digital asset loan market. Generally speaking, the digital asset lending market is a highly competitive and free market, where lenders and borrowers can choose appropriate lending platforms and terms based on their interests and risk preferences. Many digital asset lending platforms will specify in their terms of service that any new digital assets generated by hard forks, protocol changes or airdrops that occur during the loan period belong to the borrower. Doing so avoids disputes and controversies and protects the rights and interests of both parties.

Second, U.S. tax law requires that when a taxpayer acquires a new digital asset as a result of a hard fork or airdrop, they need to include its fair market value in taxable income. This means that when a lender acquires new digital assets as a result of a hard fork or airdrop, they need to recognize income when they gain control and recognize a gain or loss when they sell or exchange them.

Lenders, on the other hand, do not acquire new digital assets and therefore have no taxable income or gain or loss.

Third, a protocol change may result in a change in the functionality or attributes of a digital asset that affects its value or tradability. For example, protocol changes may increase or decrease the availability, security, privacy, speed, fees, etc. of digital assets. These changes may affect borrowers and lenders differently. Generally, borrowers have more control and risk-taking over the digital assets for the duration of the loan, so they should be entitled to the gains or losses resulting from a change in the agreement. Lenders, on the other hand, will only regain control and risk taking over the digital assets when the loan matures, so they should recognize gains or losses at the value at the time of return.

In summary, if a digital asset is lent to a third party and that digital asset undergoes a hard fork, protocol change, or airdrop during the lending period, it is the borrower who is more appropriately recognizing revenue on such transactions.

4. Wash Sales (IRC Section 1091)

· In what situations do taxpayers take the position that economic substance (IRC Section 7701(o)) applies to wash sales with regards to digital assets?

· Are there existing best practices for reporting transactions in digital assets that are economically equivalent to wash sales?

· Should IRC Section 1091 apply to digital assets? Why or why not?

· Should IRC Section 1091 apply to other assets beyond digital assets? If so, what assets and why or why not?

Our response:

With respect to this set of questions, we believe that IRC 1091 does not apply to digital assets, and our reasoning is as follows:

First, the liquidity and diversity of digital assets make the corresponding transactions difficult to track. Unlike stocks or securities, digital assets can be traded on multiple platforms and exist in many varieties and types. This makes it difficult for taxpayers to track and record whether they have purchased the same or very similar digital assets within a 30-day period. In addition, because of the price differences and arbitrage opportunities between digital assets, taxpayers may frequently transfer and exchange their digital assets between platforms, which makes enforcement of the wash sale rule more difficult.

Second, it is difficult to define the boundaries of concepts such as “identical” or “similar” for specific types of digital assets. For example, digital treasures (NFTs) are considered to be unique digital assets. Consider a situation where a taxpayer sells an NFT and then buys a similarly named NFT from the market, where the legal definition of whether the two NFTs are considered the same or very similar digital assets is ambiguous. Therefore, to avoid such problems, IRC 1091 may not apply to digital assets.

Finally, the non-application of IRC 1091 to digital assets does not pose serious tax problems. On the one hand, the cryptocurrency market is characterized by rapid fluctuations in value and a high number of conversions in a short period of time, so that investors are less likely to hold cryptocurrencies “for the very long term”; on the other hand, the prevailing cryptocurrencies in the cryptocurrency market tend to trade at a price that is “both good and bad”. On the other hand. Therefore, there is little point in applying a wash sale rule to cryptocurrencies, as cryptocurrencies sold at a low transaction price will inevitably be recognized as income and subject to tax when sold at a high price.

The chart below lists the top 10 cryptocurrencies by market capitalization as of September 4, 2023 in terms of traded price action. It can be noticed that cryptocurrencies other than stablecoins tend to have similar traded price movements, which means that it is unlikely that investors will be able to evade taxes indefinitely by shuffling their sales.

In summary, we do not believe that the non-application of IRC 1091 to digital assets poses a serious tax problem.

5. Constructive Sales (IRC Section 1259)

· In what situations do taxpayers take the position that economic substance (IRC Section 7701(o)) applies to constructive sales with regards to digital assets?

· Are there existing best practices for reporting transactions in digital assets that are economically equivalent to constructive sales?

· Should IRC Section 1259 apply to digital assets? Why?

· Should IRC Section 1259 apply to other assets beyond digital assets? If so, what assets and why?

Our response:

In response to that set of questions, we believe that digital assets should not be subject to IRC 1259. The reasons are similar to those we gave in response to the previous set of questions. First, similar to the previous issue, it remains difficult to determine the boundaries of “identical” or “very similar” digital assets. For example, in the case of an NFT transaction where an investor holds one NFT and sets up a call option on that NFT, the application of IRC 1259 would be difficult because it would be difficult to ascertain whether the NFTs in the two transactions are “identical”.

Similarly, the non-application of IRC 1259 to digital assets does not pose a serious tax problem. The cryptocurrency market is characterized by rapid shifts between bull and bear markets, which can occur several times in a short period of time, and as a result, investors are less likely to hold cryptocurrencies for the “very long term”. Therefore, it makes little sense to apply the Constructive Sales rule to cryptocurrencies, as their definitive trading hours are fast approaching.

6. Timing and Source of Income Earned from Staking and Mining

· Please describe the various types of rewards provided for mining and staking.

· How should returns and rewards received for validating (mining, staking, etc) be treated for tax purposes? Why? Should different validation mechanisms be treated differently? Why?

· Should the character and timing of income from mining and staking be the same? Why or why not?

· What factors should be most important when determining when an individual is participating in mining in the trade or business of mining?

· What factors should be most important when determining when an individual is participating in staking in the trade or business of staking?

· Please describe examples of the arrangements for those participating in staking pool protocols.

· Please describe the appropriate treatment for the various types of income and rewards individuals staking for others or in a pool receive.

· What is the proper source of staking rewards? Why?

· Please provide feedback on the Biden Administration’s proposal to impose an excise tax on mining.

Our response:

（1） Description of mining and staking rewards

Mining rewards mainly consist of block rewards and transaction fees.

Block Reward is a certain amount of newly issued digital assets that miners receive for each new block generated. The amount of block rewards and the rules depend on the different blockchain networks, for example, Bitcoin’s block rewards are halved every four years, from an initial 50 Bitcoins to the current 6.25 Bitcoins.

Transaction Fee is the fee paid by the exchange included in each block, which is also distributed to miners. The amount and rules of transaction fees also depend on different blockchain networks, for example, Bitcoin’s transaction fees are set by the sender of the transaction and vary according to the size of the transaction and network congestion.

Staking Reward is the process by which pledgers are rewarded for their support of the consensus mechanism on the blockchain network and receive revenue.

Base Returns: Base Returns are digital assets that are distributed to the stakers at a fixed or variable rate, depending on the amount and timing of the staking.

Extra proceeds: Extra Proceeds are digital assets that are allocated to the stakers based on the stakers’s performance and contribution in the network, such as validating blocks, voting decisions, providing liquidity, and so on. The type and amount of extra revenue depends on different blockchain networks, but can generally be categorized as follows:

· Dividend Income: Dividend income refers to the fact that pledgers receive a certain percentage of the profits or income generated by certain projects or platforms through participation in them. For example, a stakers can receive a dividend on its transaction fees by participating in the decentralized exchange (DEX) on CoinAn’s smart chain.

· Governance Gains: Governance Gains are governance tokens or other rewards issued by certain programs or platforms that the Pledgor receives by participating in their governance voting. For example, a Pledgor may receive ETH 2.0 issued by Ether 2.03 by participating in its verification node.

· Liquidity Gain: Liquidity Gain is when a Pledgor receives liquidity tokens or other rewards issued by certain programs or platforms by providing them with liquidity. For

example, a stakers may receive DOTs issued by it by providing the Cross-Chain Asset Conversion Service (XCMP) on Boka.

The nature of the rewards obtained from mining and staking is the same. Both mining and staking get the corresponding token income by means of verification on the blockchain. The difference is that mining invests in hardware equipment arithmetic power, while staking invests in virtual currency; but they have the same on-chain verification mechanism. Therefore, the difference between mining and staking is only a difference in form. In our view, for entities, income from mining and staking should be treated as business income; for individuals, it can be treated as investment income.

Since the nature of the rewards from mining and staking is the same, they should be recognized as income at the same time. Income from both mining and staking should be reported and taxed at the point at which the taxpayer gains dominion over the rewarded digital asset. This is usually the point in time when the taxpayer is free to sell, exchange, use or transfer the rewarded digital asset.

（2） Determining when an individual is involved in the dredging/staking industry or dredging/staking activities

We believe that the question, “Determining when an individual is involved in the mining/staking industry or mining/staking activities,” is equivalent to determining whether an individual is engaged in mining/staking as a business, and thus potentially subject to the self-employment tax. Specifically, the following criteria can be used to determine whether an individual is engaged in mining/staking as a business:

Purpose and intent of mining: Individuals are mining for the purpose of earning income or profit and there is continuous and systematic mining activity.

Scale and frequency of mining: Individuals use large amounts of computing resources and electricity and mine frequently or regularly.

Mining results and impact: Individuals earn a significant income or profit from mining and has a significant contribution or impact on the blockchain network.

（3） Staking pool contract

A staking pool contract typically contains the following sections:

(i) Creation and Management of Staking Pools: Staking pool contracts are typically created and managed by one or more pool operators, who are responsible for operating and maintaining the staking nodes, as well as handling the registration, deposits, withdrawals, and distributions of the staking pool. Staking pool operators typically receive a percentage of fees or commissions as compensation for their services.

(ii) Staking Pool Participation and Withdrawal: Staking pool contract typically allow anyone to participate in or withdraw from a staking pool with any amount of digital assets, as long as they comply with the rules and requirements of the staking pool. Participants can join the pool by sending digital assets to the pool’s address or a smart contract, or they can exit the pool by requesting a withdrawal or redemption. Participants are usually given a token that represents their share or interest in the staking pool, such as rETH, BETH, etc.

(iii) Staking Pool Revenue Distribution: The staking pool contract usually calculates and distributes the revenue of the staking pool on a regular or real-time basis, based on the performance of the pledged nodes and the network’s reward mechanism. Revenues typically include newly issued digital assets, transaction fees, dividends, governance tokens, etc. The proceeds are usually distributed according to the participant’s share or interest in the staking pool, less the operator’s fees or commissions, to the participant’s address or smart contract.

（4） Excise tax on the mining industry

The Biden administration has imposed a 30% excise tax on the mining industry, and we believe that this tax level is too harsh in a bear market. The combined returns of the mining industry in the bear and bull markets should be calculated to separately confirm a reasonable tax level, which should not be too much higher than cloud services or cloud computing business.

The table below shows the gross margins of major NASDAQ-listed companies in the mining industry in the bear market (2022), and bull market (2021). In 2022, the average gross margin is 37.92%; however, in 2021, the average gross margin is 65.42%. Because excise tax, unlike income tax, is levied directly on the proceeds of mining, it has a direct impact on the company’s operations. In a bear market, a 30% excise tax is a major blow to mining companies.

Another major argument for imposing an excise tax on the mining industry is that mining consumes large amounts of electricity and therefore needs to be penalized. However, we believe that the mining industry’s use of electricity does not necessarily cause environmental pollution, as it may use clean energy. If the same excise tax is imposed on all mining companies, it would not be fair to companies using clean energy. The government can make mining companies meet environmental needs by regulating electricity prices.

7. Nonfunctional Currency (IRC Section 988(e))

· Should a de minimis nonrecognition rule like the rule in IRC Section 988(e) apply to digital assets? Why?

· What threshold is appropriate and why?

· Are there existing best practices that would prevent taxpayers from avoiding tax obligations if a nonrecognition rule were to apply? What reporting regime would help taxpayers comply?

Our response:

The de minimis nonrecognition rule in IRC 988(e) should apply to digital assets. Similar to investments in securities, foreign currency exchanges are often involved in digital asset transactions, and therefore it would be extremely administratively burdensome to require verification of foreign currency losses for every digital asset transaction. We believe that the limits set forth in IRC 988(e) are appropriate.

The application of the de minimis non-recognition rule in digital assets may lead to taxpayers evading their tax obligations, in this regard, we suggest that reference be made to the tax laws of the relevant countries, where active declaration of each transaction is not required to verify the foreign exchange loss, but at the end of the tax year, random checks are conducted to verify that the foreign exchange loss of a portion of the transaction has been truthfully declared. If traders fail to declare foreign exchange losses truthfully, they face appropriate penalties. This system design will help taxpayers to comply with the tax reporting requirements.

8. FATCA and FBAR Reporting (IRC Sections 6038D, 1471–1474, 6050I, and 31 U.S.C. Section 5311 et seq.)

· When do taxpayers report digital assets or digital asset transactions on FATCA forms (e.g. Form 8938), FBAR FinCEN Form 114, and/or Form 8300? If taxpayers report some categories and not others, please explain and identify which categories of digital assets are reported and not reported with respect to each of these forms.

· Should FATCA, FBAR, and/or 8300 reporting requirements be clarified to eliminate ambiguity about whether they apply to all, and/or some categories of, digital assets? Why?

· Given the policies behind FBAR and FATCA, should digital assets be more integrated into those reporting regimes? Are there barriers to doing so? What are they?

· How do stakeholders consider wallet custody when determining compliance requirements with FATCA, FBAR, and Form 8300? Please provide examples of wallet custody arrangements and identify which types of arrangements FATCA, FBAR, and/or Form 8300 reporting requirements should or should not apply to.

Our response:

(1) Form

Overall, we propose to design a new form for the declaration of all digital assets. This will help the development of the digital assets industry, as declaring digital assets on the current form is slightly cumbersome and may inhibit active trading.

However, if a filing needs to be made within an existing form, we recommend that the filing be made as follows:

For FATCA forms (e.g., Form 8938), taxpayers should report any form of digital assets held or controlled outside of their home country, whether or not they are associated with the U.S. dollar or other fiat currency. This includes, but is not limited to, cryptocurrencies, stablecoins, tokenized assets, non-homogenized tokens (NFTs), decentralized finance (DeFi) protocols, etc. Taxpayers should convert their offshore digital assets to U.S. dollars based on year-end exchange rates and determine whether they need to file Form 8938 based on the reporting thresholds.

For the FBAR FinCEN Form 114, taxpayers should report their offshore, custodial or non-custodial digital asset wallets that can be considered financial accounts if the aggregate value of those accounts exceeds $10,000 at any time. Taxpayers should convert their offshore digital assets to U.S. dollars based on year-end exchange rates and provide the relevant account information on the Form 114.

For Form 8300, taxpayers should report cash or cash equivalents, including cryptocurrencies, that they receive in excess of $10,000 from the same buyer or agent. Taxpayers should convert the cryptocurrencies they receive to U.S. dollars based on the exchange rate on the day of the transaction and provide the relevant transaction information on the Form 8300.

(2) Cryptocurrency wallet

In response to the issue of wallet retention, our views are as follows:

A cryptocurrency wallet is a tool used to store and manage digital assets, which can be categorized into custodial and non-custodial wallets. Here are the definitions and differences between these two types of wallets:

· Escrowed wallets involve entrusting cryptographic keys to a third-party service provider, such as an exchange, bank, or specialized digital asset custodian, who is responsible for storing and managing them.

· Uncustodial wallets are those that control their own encryption keys, for example by using a software wallet, hardware wallet or paper wallet.

We believe that regardless of the type of wallet used, under the current regime, taxpayers should report their digital asset holdings on Form 8938 or Form 8300. However, for taxpayers to report digital assets on FBAR FinCEN Form 114, it must be clarified whether cryptocurrency wallets constitute offshore financial accounts. In our view: a custodial wallet provided by a service provider located outside of the country could be recognized as an offshore financial account; a non- custodial wallet would require further discussion.

On the one hand, some non-custodial wallets may not be considered offshore financial accounts because they do not involve the involvement or control of a third party. For example, if a hardware wallet or paper wallet is used and the user has full control over his or her private keys and digital assets, the user may not be required to report these wallets on the FBAR form because they are simply personal property and not offshore financial accounts.

On the other hand, some non-custodial wallets may be considered offshore financial accounts because they involve third-party services or functions. For example, if software wallets are used and the wallet can be connected to an offshore exchange or platform, or provides some functionality such as cross-border transfers or exchange, they may be considered offshore financial accounts.

However, both custodial and non-custodial wallets may need to be reported on Form FBAR as it relates to an offshore financial account, as long as the wallet is associated with an offshore financial account, such as through which cross-border transfers or exchanges are made.

9. Valuation and Substantiation (IRC Section 170)

· Digital assets do not currently qualify for the IRC Section 170(f)(11) exception for assets that have a readily available valuation on an exchange. Should the substantiation rules be modified to account for digital assets? If so, in what ways and for which types of digital assets? More specifically, would something different need to be done for those publicly traded digital assets?

· What are the characteristics of an exchange and the digital asset for which this exemption would appropriately apply and why?

Our response:

We believe the relevant provisions of IRC 170 should be amended to include donations of digital assets. However, tax-deductible digital assets are limited to common, publicly traded digital assets, not all digital assets, and digital assets such as NFTs that are difficult to obtain fair market value should not be subject to the IRC 170(f)(11) exception because of the possibility that their transactions may be artificially controlled. Moreover, digital assets such as NFTs that are difficult to obtain fair value are more difficult to liquidate for funding, adding additional costs to the recipient donor. Policies should encourage donors to contribute cryptocurrencies that can be easily liquidated.

Specifically, we believe that donations of digital assets for which fair market value can be determined in accordance with the spirit of Notice 2014–21 and related documents may be subject to the IRC 170(f)(11) exception, such as donations of virtual currencies that are “traded on at least one platform with real or other virtual currencies and have a published price index or value data source” for virtual currencies.

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