The Crypto-Tax Chapter
This is a chapter in The Token Handbook.
Table of Contents
Tax codes are very complex and differ from country to country. In this chapter, I’ll highlight a number of cryptocurrency, ICO, trading, payment, and token-related tax issues and point to some resources for further study. This is not legal or tax advice, it’s an opinion piece to raise issues and awareness, mostly for people offering or buying tokens. It also includes an essay (chapter 17) on how I think a better tax system would work and could easily include a universal basic income for all. In total, it’s 7,800 words, broken into the following sections:
2. Tokens are taxed as assets; almost every transfer is a taxable event
3. How Should Systems Charge for Access Tokens
4. Base Currency and Tax Currency
5. ICO income is taxable as ordinary income
6. Start Your Nonprofit Before Your ICO
8. Speculation vs Spending
9. All Tokens Have Value When Allocated
10. Freezing vs Burning Tokens
11. Mining is Taxed as Ordinary Income
12. Paying People in Cryptocurrencies
13. Every Jurisdiction Has its Own Tax Laws
14. The Audit You Will Probably Go Through
15. Forks and Airdrops
16. Token bookkeeping and reporting
17. How a Future Tokenomics Tax System Could Work
18. How Should We Tax Crypto-Assets?
19. Calculating Your Tax Liability
Government regulators are of two minds when it comes to tokens. Securities regulators insist that many tokens are securities. Their message is: “You’d better spend your tokens to show that they are a unit of exchange rather than a store of value.” At the same time, tax authorities give the opposite message: “You’d better hold your tokens because we’re going to tax them like investments; if you spend them, you’ll have unintended tax consequences.” This is the situation we find ourselves in as government officials try to understand what tokens are and how to treat them.
Before we begin, I want to emphasize: ICOs are project finance. The goal of an ICO is to build a system that the funders will use. For the amount of risk involved, the amount of funding is sometimes extreme. The income raised is taxable. The non-profit means there is no “exit strategy” and the tokens are not equity. No company can later acquire a non-profit foundation. If for some reason the project fails, token holders should reasonably expect some kind of refund of unspent funds.
On the other hand, when an investor buys equity in a company, she usually expects the company to pivot and keep pivoting to match market needs, hoping to get enough traction to raise more money at a higher valuation. Since more than 90 percent of funded startups fail, investors are reluctant to overfund at the initial stages until the group gets traction in some market. The income they raise from selling equity is not taxable (even if done via a token sale). They go through several rounds of funding, in which investors have a large amount of input into the strategy and execution of the company, and then the shares are acquired or go public later, providing returns to investors.
The following chapters break down the issues into small chunks. Let’s go.
2. Tokens are Taxed as Assets
Most tax authorities see cryptocurrencies and crypto-tokens as commodities. A token can represent almost any kind of value, different people can purchase the same token for different purposes, and tokens can change their “type” or purpose over time. A crypto-token can represent your gym membership or a ride-sharing credit. Yet most governments tax them as if they were investable assets. I’m not the only person who thinks this is a crazy idea.
Suppose you go to an exchange and want to trade bitcoin for Pillar tokens. This trade breaks down as:
- Sell bitcoin to the exchange, pay blockchain settlement fee in bitcoin (1 taxable transaction)
- Receive Pillar tokens from the exchange. In this case, someone has to pay the gas (blockchain settlement) fee on the Ethereum blockchain (2 taxable transactions)
That trade has three taxable transactions. In each case, the seller has to calculate his net gain/loss on each. When were these tokens purchased and for how much? What was the gain/loss at the time of sale? Which tokens get long-term capital gains treatment and which are short-term gains?
Now suppose you use those Pillar tokens in your Pillar wallet. You want to buy a Pillar t-shirt in the store in the wallet (this should be possible by September). The shirt is priced in ether. You pay a certain amount of ether for the shirt, plus you pay an extra amount in PLR tokens, which are required to use the system. The current fee for an Ethereum blockchain transaction is 40 cents. So here’s your breakdown:
1. Pay the ether for the shirt.
2. Pay the sales or VAT tax, probably in ether.
3. Pay the ether fee to settle the shirt/tax transaction.
4. Pay the PLR to the system.
5. Pay the ether fee to settle the PLR transaction.
In this case, it’s likely that the PLR charge (4) is less than its blockchain settlement fee (5). All five of these transactions are taxable events. This is the nightmare we find ourselves in as we try to reinvent the world of finance. Using dollars or euros, we don’t have any tax consequences, but using blockchain-based tokens, we do. Neither side — those of us designing and using cryptocurrencies/tokens and those charged with collecting tax — is prepared for this unintended battle.
A token can represent almost any kind of value, different people can purchase the same token for different purposes, and tokens can change their “type” or purpose over time.
3. How Should Systems Charge for Access?
There are some things we can do to limit the damage. These tactics apply to groups that have systems that use tokens to “power” the system, as advertised in most white papers.
There should be no transaction tokens. Charging tokens for each transaction incurs a blockchain settlement cost and triggers two separate tax events per transaction. Any system using tokens on a per-transaction basis should switch to one of the following models …
Coupon model: the user pays in advance for a number of internal bookkeeping units that then pay for transactions. For example, she would purchase a “booklet” of ten transaction credits and then spend them as she uses the system. Because they are internal units of account and not blockchain-based assets, purchasing the coupons is a single taxable event but spending them is not.
Subscription model: the user purchases a time-based subscription fee for your system’s services, so she would pay a certain amount every month, and all her fees are covered. There would be a fee to settle the subscription payment, which would produce two taxable events. It may be better to charge people once a quarter than once a month. No one wants extra ethereum fee charges or taxable events.
Staking model: reward users who maintain a certain minimum balance of your tokens with free use of the system. There are economic advantages and incentives for this, but it probably shouldn’t be the only way to charge for access. I think you would want to encourage it but use a subscription model as a back-up.
Things may change. Ethereum fees could come way down. There are some “side channel” attempts, like Raiden Network, Cosmos, and Polka Dot promise to make token transfers much cheaper. Another blockchain could be better suited for token transfers. These solutions may change my recommendations, but probably not for 2018.
4. Base Currency and Tax Currency
I speak a lot about two relatively new terms that I hope will become common among those who are living in a tokenized economy.
The base currency is the currency a user uses as a unit of account. If you live your life in bitcoin, then bitcoin is your base currency. You would trade in and out of bitcoin, and you would want to see things priced in bitcoin. On the other hand, if you have a large portfolio of ERC20 tokens, your base currency could be ether. That way, the tokens are all priced in ether. Having a base currency avoids trading pairs, so it takes a list of n coins and renders a list of n options for trading, whereas the typical trading-pair approach yields n-squared [technically n*(n-1)] pairs.
The tax currency is the fiat currency the user pays tax in. You’ll probably have different users with different tax currencies. Any system that deals in cryptocurrencies or tokens should automatically store the tax currency value of each transaction along with that transaction. This way, the user can easily compute her net gain/loss for the year any time.
It may make sense to help customers watch their holding period. Anyone who holds for over one year may qualify for capital gains. This is also important for staking. Systems that work with tokens may want to help people see how old their tokens are — if someone’s tokens are 50 weeks old, your system could help them retain those tokens for another two weeks for tax purposes. Just transferring tokens from one wallet to another isn’t change of ownership (or taxable), so you have to understand how long they really have been holding them. I hope new tools will help us manage this.
5. ICO Income is Ordinary Taxable Income
When a startup raises capital by selling equity, the income is not taxable. When you sell utility tokens, the tax authorities perceive this as selling a product, so the income from almost all ICOs is taxable.
This is why many ICOs choose to become nonprofit foundations, which also requires them to be open-source. Since many ICOs are open source, they use tokenomics to make money.
Tokenomics has different meanings, but I will use the word to describe a project that raises money initially by selling a majority of its tokens, uses the money to build a system in which the token is necessary, and then relies on the network effect as the system becomes more useful to drive up the price of the tokens. This makes their holdings more valuable — when they are out of money, they should still have plenty of tokens they can cash to pay expenses. This may not go on forever, but in theory it goes on for decades. By holding tokens (and bitcoin), the Ethereum Foundation is not only well funded but at one point in early 2018 was the most valuable nonprofit foundation in the world (on paper).
If you’re not open-source, you should either a) consider raising equity instead or b) pay the tax. There will be income tax on the gain of your ICO, and there is probably some kind of capital gains tax on the appreciation afterward (or a corresponding tax credit if the price has gone down).
In the US, it may be possible to defer recognition of the receipt of cash to the next tax year if the service will take time to develop and deliver:
the IRS does provide certain exceptions for amounts that are due or paid before they are earned (known as advance payments), which may be deferred for tax purposes under Regs. Sec. 1.451–5 for goods and Rev. Proc. 2004–34 for goods, services, use of certain intellectual property, and other eligible payments …
I don’t know if they will recognize software projects, but you can learn more at TheTaxAdvisor.com. For tax purposes, launching your ICO early in the year is probably much better than launching it in Q4.
6. Start Your Nonprofit Before Your ICO
If you are building an open-source system, or you don’t want to pay tax on your ICO income, you should form your nonprofit or tax-exempt entity first, then issue tokens from that. Profit-seeking companies will have to pay taxes on ICO income.
Do not (as we did) form your nonprofit after the token sale. In our case, we thought we would have time to transfer everything into a nonprofit, because we were thinking about the IP assets. We set up a foundation afterward, the expense and hassle were enormous, and we had to make a case that we were not just trying to dodge taxes.
More and more businesses and individuals are accepting cryptocurrencies as payment. They are willing to price goods and services in cryptocurrencies, despite the volatility. Unfortunately, these vendors (and the systems they use) think of cryptocurrencies as money, not property, so they don’t help their customers calculate their tax gains/losses.
Some of us crypto-consultants get paid in cryptocurrency. We have to be clear with our clients what the tax value is of each invoice, so both sides can properly account for their net gains/losses. While moving the money in this case is done using a shared ledger, for tax purposes each party records a (probably different) price on his/her own separate ledger.
Another form of payments is to convert cryptocurrencies to a debit card to spend. If you convert, say, a month’s worth of spending by topping up your card, you’d have a single taxable event, even though you may make a large number of charges. Of course, you get to pay Mastercard or Visa for the privilege of spending your decentralized currency.
8. Speculating vs Spending
I keep saying that the same token can be different things to different people. One person speculates, while the other wants to use the token in the system. David Shakow, in his paper The Tax Treatment of Tokens: What Does It Betoken? provides the key information:
If the purchaser plans to use, in its trade or business, the services or goods that can be obtained by transferring the token to the issuer, the transfer of the token in exchange for the services or goods would have two tax consequences. First, the transfer is a disposition of the token for its fair market value. The gain or loss on this disposition would be capital. Second, the expenditure of the fair market value of the token for the services or goods received would be either a deductible expenditure or a capital expenditure, depending on general tax principles.
Note that gambling and betting have their own tax rules in each jurisdiction. In the UK (but not in the US), gambling income is generally not taxed. This can help people setting up betting markets and other game-based systems offer a tax-free environment to their (UK) customers.
9. Tokens can have Serious Value when allocated
Suppose you have a successful ICO, selling tokens at an average value of ten cents each. From the tax authority’s point of view, you have just raised (amount of all tokens in existence) times (price of each token sold), and the tax office expects to get its share of that. For example, you may have a bounty program, marketing people, advisors, and others who will be rewarded in tokens. These tokens have a value and are considered income to the recipients.
When they are considered income for tax purposes is not exactly clear — to anyone. It’s best if you are clear ahead of time. Let’s look at some scenarios:
Pre-pay — Let’s suppose you create a bunch of tokens that aren’t worth anything yet. You could then give them to select people participating in the project, and they would have no tax liability. As soon as you sell some of those tokens to someone else, those who have received them have unrealized capital gains. You don’t even need to create the tokens, you can allocate them long before the smart contract creates them.
Pay immediately — you send tokens during or shortly after the ICO, and these tokens are unrestricted. Most bounty people get paid in unrestricted tokens (and sell them immediately). In this case, you should be sure to get invoices from these people before you send them tokens. Tokens should be considered the same as cash, at the same price you sold them for.
Pay later — you hold the tokens and plan to send them to advisors and others later. In this case, you should get invoices and written agreements that you are holding tokens on their behalf. They incur the tax liability and “own” the tokens, even though you are holding them back.
Lock-up — you put the tokens into a smart contract and they are “frozen” until some later date. If this is a general pool for later allocation, the company should allocate these tokens before the sale so as not to pay any income tax on them. If the tokens are allocated to specific people and locked up, the best thing is to a) get an invoice for services rendered (resulting in a taxable event for them right after the ICO) and b) get a signed agreement that you will then lock the tokens into a smart contract until a certain date.
Accountants and the government may look at whether you have control over the tokens and have the choice of locking up or not. If an employee does not have control, tax authorities may say that the tax liability comes when the token comes out of the lock-up. This could potentially have disastrous tax consequences for employees. Consult a tax lawyer, but your best bet is probably to incur the taxable event as early as possible.
For tax purposes, launching your ICO early in the year is probably much better than launching it in Q4.
10. Freezing vs Burning tokens
I have said before that rather than burning unsold tokens after an ICO, you can freeze them in a smart contract and figure out what to do with them later. We froze our unsold Pillar tokens for 10 years (I would choose 6 if I could do it again). Because they were unsold, they did have some market value at the time they went into the deep freeze. Because they are locked up for so long, I think you can make the case that they are very risky and should be discounted heavily. You could reasonably come up with a discount schedule that looks something like this:
Tokens locked up for 9 months: 50 percent discount to sale value.
Tokens locked up for 2 years: 75 percent discount.
Tokens locked up for 4 years: 90 percent discount.
Tokens locked up for 6 years: 95 percent discount.
You’ll need to talk with your tax advisor, but I think you could easily argue that the unsold, illiquid tokens have very little value, declare it as income and pay tax, and then lock them up. It could be very important to make this declaration and pay the tax, or they could be counted as ordinary income later when they have value.
Imagine a nonprofit foundation with a large number of tokens locked up for four years. Now suppose that the project is quite successful and the value of the token goes up 20 times. When those locked tokens are unfrozen, they could generate an enormous regular-income tax liability — enough to make the entire foundation insolvent. I think Ripple could be vulnerable to this kind of “IRS attack,” not with frozen tokens but because they have so many tokens in reserve.
For tax reasons, you may just want to burn unsold tokens. If not, you’ll have to justify your tax treatment.
11. Mining is Taxed as Ordinary Income
Mining is earned income. A miner has a fairly normal business model from a tax point of view: investment in equipment, monthly expenses, and monthly profits. The profits, paid in coins, are income the day you earn them. Keep track of their value in your tax currency. I’m guessing few miners do this — it probably pays to understand how aggressive your country’s tax authority is before you decide whether to pay your taxes. Mining can also trigger a self-employment tax if you work for a company at your day job.
12. Paying People in Cryptocurrencies
This can be tricky, and a Forbes article shows several examples, but in the United States the government will treat your cryptocurrency payments like cash AND assets at the same time. So if you pay people in tokens, you’ll have to do all the usual withholding and contributions you do with cash, but when people later sell those tokens, they’ll be taxed as assets. It can also depend whether you use cryptocurrencies for business or personal-investment purposes.
If your token is clearly a security, I would be careful not to pay people more than a small amount in tokens. Although companies do have stock-option plans for employees, they are a nice little add-on, not the bulk of their pay. People receiving those tokens could be forced to pay tax on tokens when they receive them at the peak of the hype cycle, only to watch them go down in price later.
It’s fine to promise people tokens upon the successful outcome of an ICO, but people should understand the risks they are undertaking, and there should be enough potential upside to compensate for those risks. When you allocate those tokens determines their tax value; allocate as early as possible. Be sure to get help from an accountant if you want to pay people for their labor in cryptocurrencies or tokens.
13. Every Jurisdiction Has its Own Tax Laws
I assumed that if tokens are treated as commodities then in most places you have to add up your year’s worth of transactions for each token and compute your net gain/loss for that token for the year. This is how you’d have to do it in the United States. However, in the canton of Zug, Switzerland, they just want you to report the value of all your holdings in all your accounts at the end of December 31. I’m not sure what Swiss federal tax authorities require, but this is what Zug requires of corporations.
Speaking of Switzerland, we get this from the Canton of Geneva: “the utility token would be subject to VAT if it constitutes the prepayment of a service.” Many countries have a Value Added Tax — be sure your token economics take that into account.
On the other hand, Belarus has declared an effective tax holiday on all crypto-assets for the next five years — maybe we should all move to Minsk and buy condos with our bitcoins!
Don’t assume you know the rules — get help from a competent tax advisor.
14. The Audit You Will Probably Go Through
We are forging forward into the 21st century with both feet firmly planted in the 20th century — the first half of the 20th century, to be exact. And for that reason, you should expect an audit from your friendly tax authorities, once they learn that you’ve been messing around with crypto-anything. This is their right; it gives them pleasure. While I note that audits are down significantly in the last few years, you could still have one if the tax authorities don’t understand what you’re doing.
An audit is a full financial rectal exam with gloves snapped tight. It means you need a printed (and often signed) invoice from every party you transferred value to last year. That’s right, every time you sent someone a small amount of ether or tokens, you need to document that transaction, print it, put it into a binder, and carry all your binders into the tax offices to walk them through your entire profit and loss statement for the year. This involves chasing down requests that look like this:
“Hey, David, can you tell me about 20 eth that went to 0xb119D1A57dF103d2158414528BE65315E49C67AD? We need an answer by the end of the day, thanks.”
I don’t know how many emails like that I have received, but it seems like our finance team was staring at rows and rows of these kinds of addresses for many months.
We conducted our own audit voluntarily for two reasons. First, we wanted to be very pro-active with Swiss tax authorities. We wanted to have all the answers ahead of time. Second, because we think our token-holders have a right to see audited financials from us. It adds quite a bit of unnecessary expense, but at this stage of the ICO game, it’s probably worth it to have a very transparent relationship with token holders.
We are forging forward into the 21st century with both feet firmly planted in the 20th century — the first half of the 20th century, to be exact.
Do your token-holders have a right to see your audited financials? Frankly, that probably depends how much you raise and how many token-holders you have. If you raise over $10 million, I would say the answer is probably yes. It is ten times more painful than it should be, but we hope new tools will help us track most of our future transactions and make life much easier. See the tools section for some hopeful possibilities.
15. Forks and Airdrops
It is possible to receive tokens that you may not be aware of and could have market value. In a hard fork, each address participates in two blockchains. As those blockchains go their separate ways, the coins or tokens have two values. In most cases, it’s necessary to go through a splitting process to retrieve the other coins or tokens. The American Bar Association has a summary of recommendation for the tax treatment of hard forks. This summary is worth reprinting here:
On Monday, March 19, 2018, the Section of Taxation (the Section) of the American Bar Association submitted comments in a letter (Letter) to the Internal Revenue Service (IRS) of the U.S. Department of Treasury on the federal income tax treatment virtual currency hard forks. The Letter provides background on hard forks and presents the tax challenges that are created when a hard fork occurs. To address these challenges, the Letter advocates for the creation of a temporary safe harbor in which: (1) taxpayers whose coins were subject to a hard fork in 2017 would be treated as having realized the forked coin in a taxable event; (2) the taxpayer’s basis in the forked coin would be zero as that would be the deemed value of the forked coin at the time of realization; (3) the holding period in the forked coin would begin when the hard fork occurred; (4) taxpayers would be required to disclose that they are choosing the safe harbor treatment on their tax returns; and (5) the IRS would not assert that taxpayers availing themselves of the safe harbor treatment have understated their federal tax liability due to the receipt of a forked coin in a 2017 hard fork.
In an airdrop, many addresses receive free tokens. Those tokens may have value, or they may be worthless. But over time they may become worth something, as others trade them.
In both cases, you don’t have to worry about tax consequences unless you sell the new coins/tokens. As I noted before, there are jurisdictions that will want to know the value of them at the end of the year. As a practical matter, tax authorities are unlikely to be aware of or care about such tokens unless they become worth a lot of money. But if they are worth something, it’s your responsibility to report the gains properly.
16. Token-Based Accounting Systems
Several startups are working on stand-alone accounting systems or plug-ins for popular systems. First and foremost, these systems maintain a database of blended prices back for every day of the past several years. You give them a list of addresses, and they go through the entire blockchain, find every trade, and append a fiat-currency equivalent to every transaction. This results in the “tax history” of each address, in any major tax currency, which is very useful. This tool saves incredible amounts of time chasing down fiat equivalents later.
Other systems have more features, most of them designed to look and feel like familiar accounting systems. Some day, we’ll start to share ledgers between trading partners, and then everything will change. I have written about this elsewhere, but sharing ledgers is a financial game changer.
For 2017, some exchanges offered tax summaries as an added service for added money. I recommend that any system that uses tokens natively offer its users a transaction record in their own tax currency. This way we won’t need some of these external tools and after-the-fact services.
I list the tools at the end.
17. How a Future Tax System Could Work
If part of the reason to adopt tokenomics is to make the world function better and open new opportunities, then we may also want to look at the tax system itself to see whether we could improve that with blockchain technology. It turns out, we can.
[News flash: OpenLaw has released a demo smart-contract automatically calculating and paying income tax automatically witheld — watch it!]
Why are we taxing income in the first place? The United States, which was itself a revolt against British taxation, forbade taxing income until the Civil War. Today, income tax is the standard around the world. We should be mindful of two things: a) governments shouldn’t care how they get their money, as long as the contributions are seen as fair, and b) what you tax you tend to get less of. As the price of cigarettes and alcohol goes up, consumption of cigarettes and alcohol goes down (not much, but it doesn’t go up). Do we really want less income?
Any proper replacement for the current tax system should be revenue neutral. That is, it should raise as much tax as the current system. It’s worth noting that collecting tax in almost any country is an extremely inefficient enterprise. The Tax Justice Network estimates that tax avoidance and evasion fail to bring in $3 trillion (about 5 percent of world GDP) for governments worldwide each year. A similar amount sits in various tax havens. A recent report estimates that the US fails to bring in 30 percent of the amount it is entitled to by law and predicts that number to rise to 35 percent in the next ten years. Americans spend over 8 billion hours (more than $400 billion in lost wages) preparing their taxes and spend over $400 billion in tax consultants.
An excellent paper on taxation sums up the situation:
In addition to putting hours into record keeping and completing their tax returns, most people spend their incomes and assets in ways that would make little economic sense with a simpler tax structure. Complaints about the complexity and inefficiency of the federal tax code explain the support for a simpler, flatter, and broader tax, such as a proportional tax on consumption, or a fixed percentage tax on incomes above a given level. Unlike an income tax, a consumption tax does not double tax savings, while a relatively low flat income or consumption tax rate does not have the same distorting effects on hours worked and other decisions of the marginal income tax rates of 40 percent and higher in the current American tax system.
We should be mindful of two things: a) governments shouldn’t care how they get their money, as long as the contributions are seen as fair, and b) what you tax you tend to get less of. Do we really want less income?
Another approach is to tax spending (consumption) rather than earning. If you think about it, this is a rather good idea. You would keep 100 percent of your pay check, so if you spend less and save more, you would have more to invest. Those who spend more would pay more tax. In this scheme, the incentives are aligned rather than perverse.
Can we make it work? We already do. Most governments have some sort of VAT or sales tax, either at the state or federal level. VATs are complex. State taxes vary, creating tax refugees. It’s entirely possible to shift to a national sales tax, and it’s made much easier using digital currency and smart contracts. The proposal I make here is outlined in The Fair Tax, a movement in the United States that proposes to eliminate the IRS and replace it with a flat federal sales tax on new items, plus a “prebate.” I will explain this approach in terms of smart contracts and blockchain-based assets. I assume that fiat currency is already digital and on a shared ledger, so this is half prescription and half vision. It combines elements of the semantic web, blockchain, and universal income.
Summary of the Fair Tax
I wrote about this in Pull: the Fair Tax is a national sales tax that adds 30 percent to every purchase of a new item and sends it to the government. So if you buy a wedding cake for $100, you would pay $130 at the register. Adding 30 percent to each purchase amounts to a 23 percent tax, since for every $100 spent (tax inclusive), $23 would go to the government.
To prevent it from being unfair, it makes sense to not tax things like milk, eggs, drugs, and other basics. However, there are many good reasons not to categorize spending — that would lead to fierce lobbying to get various products on the no-tax list. Instead, the Fair Tax proposes to send every man, woman, and child a monthly “prebate” check that amounts to around $11,000 per adult and $4,000 per child each year. This means that people living at the poverty level pay no tax at all. This short video sums it up:
My explanation of how it would work using digital currency has three parts:
1. The National Tax Variables
If we’re going to have agile government, we need to think differently. Today, numbers and dates are “baked in” to legislation all over, and after a decade or two those numbers are out of date and it takes a rewrite of the law to change them. This may have worked 150 years ago, but laws are now out of date the moment they are passed.
Another approach is to make the numbers into variables that lawmakers can change fairly easily, without rewriting the laws. This is part of the reg-tech movement. In the case of taxes, we would create a national variable called USTAXRATE and put that onto a secure server. Since we know all servers that hold a lot of value are eventually hacked, we would put this number into a blockchain-based container and make sure that a group of trusted people have the keys in a multisig format. For example, it would take 5 out of 9 people to digitally sign an order to change this number.
Similarly, the government would have two more variables, USTAXPREBATE-ADULT and USTAXPREBATE-CHILD. Now all the software that deals with retail sales can just build these variables in and fetch the numbers from the source in real time, every time. If congress changes these numbers, all systems automatically adjust.
The goal is to generate the revenues the government needs. Not only will it need a lot less without the IRS and missing tax money, blockchain-based services will make governments far more efficient, so it’s easy to adjust these numbers to fit the current situation. We could start with:
USTAXRATE = 23%
USTAXPREBATE-ADULT = $9,200/mo
USTAXPREBATE-CHILD = $300/mo
Whenever these numbers need to change, it’s easy to do so, none of the software needs updating. Changing these numbers could be a direct result of votes cast by whoever is in charge of making the decision. Even better — they could be determined by real financial data that adjusts these values according to the government’s stated budget and the measured low-income level, taking inflation into account.
2. Build The Tax into All Eligible Transactions
Quite a bit of work has gone into planning which transactions would be subject to the FairTax and which wouldn’t. I like much of this thinking, but I also think it needs a bit more refinement. For example, buying a new home carries a hefty sales tax of 30% on top, which is fine, as most home sales are resales anyway. People buying a new home should pay the initial tax and then charge that into their sales price later. But paying rent has no tax associated, which I’m not sure about. The FairTax would tax services as well as goods. I think it makes an excellent start, and the details can be adjusted as we learn how it works.
As we work to eradicate cash, and as we create digital money using shared ledgers, we will be able to use smart contracts to collect tax. It’s simple to describe but takes some work to implement: all transactions that qualify for the national tax should include the government’s smart contracts, which will automatically extract the tax directly, without having to remit. This is an extremely efficient way to tax — your purchase shows both the amount that goes to the seller and the amount that goes to the government.
Now compliance is fairly easy to to check. For private transactions, the government poses as a buyer and spot-checks transactions, handing out fines to people who try to sell goods and services without collecting tax. Since so many transactions will be public, the government can even write software that watches for tax evasion. Watchdog groups can do the same, to make sure the government isn’t overreaching. Much of this ecosystem can be built for a tiny fraction of what we spend today, and I expect the compliance rates will be far higher.
In this way, the government just keeps the servers running and the money flows in via the blockchain. Everything is traceable and verifiable.
3. The Prebate and Basic Income
The prebate variable gives me an immediate idea — we can use that variable to offer a combination of tax prebate and universal basic income. The mechanism is exactly the same, so there is no overhead in distributing more. For example, the government could raise the national sales tax rate by 2 percent and increase everyone’s prebate amount by 2 percent and — voila! — redistribution of wealth. Obviously, there would be different political groups trying to move these numbers both ways, as there are today. This system has the advantage of making it trivially easy to adjust, with no added expense.
I believe inequality is a trend people should take seriously. For the past more than fifty years, all the laws and government programs added together have produced far more inequality than we would have with different governance. Even Sweden has a growing trend of inequality. By keeping these numbers at the “FairTax” values, this scheme simply replaces income tax far more efficiently, and spenders pay for much of it. By increasing just two variables we can do experiments to see how well redistribution works or doesn’t. Using software, governments could even target various regions or groups for redistribution to try to balance out inequality.
The FairTax is a federal tax to fund the federal government. What about local tax? A few new ideas:
In Switzerland, you pay for garbage collection services by purchasing special garbage bags at the store. These bags have the collection fee built in, so it’s a pay-as-you-go system.
Another idea would be to charge anyone in a given city a per-day local tax rate. You would pay a discounted rate for staying longer and a higher rate for just a one-day visit. This has the advantage that it encourages governments to make their city more visitable. It may sound like it doesn’t fund long-term planning, but I think it could.
Of course, many cities also have their own sales tax. This could easily be included in the sales tax scheme I have outlined.
I think a lot about taxation, because if we can go to a pay-as-you-go, consumption-based approach to tax, then the concept of national identity could change. At some point, you could just travel and pay tax for each day and each transaction, and you wouldn’t have to think of yourself as a resident of any particular city or country. This concept goes hand-in-hand with rethinking governance, which blockchain technology is just allowing us to do now.
Compared to other tax schemes I’ve seen, and compared to what we’re doing today, I think the FairTax is on the right track. There are many other tax schemes and proposals. My goal here has been to raise awareness of taxing consumption and show how efficient tax collection could be if we use better ideas and technology we already have today.
If this were an open letter to tax authorities, my message would be: now is a great opportunity to reset the playing field. We should take a hard look at what we’re doing today and use technology to fix it rather than imitate it. Tax is just one area where switched-on government people with vision and an experimental mindset can lead us into the 21st century.
18. How Should We Tax Crypto-Assets?
The default answer to this question has been to simply categorize them as assets or commodities and tax them accordingly. I have argued that the SEC really has no way of knowing which tokens are tickets and which are securities. I have also argued that getting rid of such taxes and switching to a consumption tax will eliminate these conversations entirely.
Perianne Boring, founder of the Chamber of Digital Commerce, has written about digital currencies (not tokens):
Virtual currencies, like their fiat counterparts, may be used for many purposes, including to purchase goods and services, like a cup of coffee. In 2014, the IRS determined that it would treat convertible virtual currency as property, thus subjecting it to capital gain/loss and investment income tax treatment and associated reporting requirements. This treatment hinders the use of virtual currencies as a method of payment, subjecting them to applicable sales tax as well as the calculation and reporting of capital gain/loss on each transaction and hindering the use of virtual currencies to facilitate micro-payments, another promising use case for virtual currencies to reach a wide spectrum of potential participants in the financial system.
The Chamber of Digital Commerce supports policies that treat virtual currencies fairly — as an alternative currency. As such, convertible virtual currencies should not be subject to capital gain or investment income tax, or burdensome tax regulation that would force virtual currency users to calculate and pay gain or loss when transacting with virtual currencies.
The problem here is that there will be a very blurry line between cryptocurrecies and tokens. If cryptocurrencies were money, it would be simple — tax them like money. But they aren’t money. No cryptocurrency meets the definition of money — yet. If they were assets, we could tax them like assets (and some should be, because some tokens represent the ownership of assets). To the degree that tokens look and act like things we know, we should probably expect the corresponding tax treatment. But many tokens are “new things” and shouldn’t be taxed using old frameworks.
I’ve heard talk of a threshold, where authorities say that below a certain amount of value there’s no need to declare or pay taxes. This is probably a good start, though any threshold is still arbitrary, and if you’re anywhere close to the threshold you still have to do the work to figure out whether you’re under or over.
Germany, which has already written a fair amount of legislation on cryptocurrency tax issues, declared in March 2018 that if you purchase something using a cryptocurrency, that’s considered spending money rather than selling an asset, so there won’t be any capital gains. This is almost sure to lead to some very interesting high-ticket, short-term transactions.
France recently reclassified crypto-assets as “moveable property,” lowering the tax rate to 19 percent.
The G20 countries are starting to work together toward coordinated regulations, but I don’t expect unified tax treatment to be a result.
I don’t think Germany has the solution. I don’t think determining tax treatment “on a case by case basis” is the answer. I think almost all systems can and will be gamed. My suggestion is that we look hard at the existing tax systems and ask what we want for the 21st century. The best example we have currently is the Australian scheme, though I think the boundaries between categories are quite blurry.
19. Calculating Your Tax Liability
Assuming you live in a place that treats most cryptocurrencies as an asset, the burden of calculating your year-end tax liability lies with you. Your accountant won’t have any idea how to do it. To do it by hand would be laborious. Fortunately, for every cryptocurrency or token you’ve ever bought or sold, the record of those transactions is sitting on the blockchain right now. Unfortunately, what’s not on the blockchain is the tax-currency equivalent of each transaction. What we want is a tool that will interrogate each blockchain and keep a record of the value of that currency/token for each day of the year, then spit out your values at the end of the year. That software isn’t here yet, but it’s coming. You’ll find a growing list at the end of this page.
My suggestion is that we look hard at the existing tax systems and ask what we want for the 21st century.
There are many issues here; there’s no way I can cover all of them. Neither am I a substitute for professional advice. The first thing we should be mindful of is that the laws haven’t changed, and we will need to deal with them as they are today. It’s likely that tax authorities will let a lot of small amounts through the cracks, simply because they have no way of dealing with them. But it’s up to us to pay our taxes according to the laws that govern us, so we should all do our best to do that.
Some general conclusions:
1. Using ERC20 tokens as a unit of gas is a nonstarter. At the moment, I recommend all ICOs update their terms of service and messaging to exclude this model and switch to an all-you-can-eat subscription model.
2. All ERC20-based systems should record each transaction not only in token and ether but also in the user’s tax currency.
3. All ERC20-based systems should give users a tax summary whenever they ask for it. Tax records should be recorded as they are generated.
4. Tokenomics must consider a wide range of tax consequences for buyers in different jurisdictions and that of the offering organization.
We should work collectively for better tax treatment and an intelligent reset on taxation, rather than trying to cram new assets into old categories. At the very least, Australia’s approach is a sane start.
Very few would deny governments the ability to raise money. But in the 21st century, governments will have to become much more agile and much more lean. Blockchain technology and new ideas will help build a better future for all of us.
I think almost all systems can and will be gamed. My suggestion is that we look hard at the existing tax system and ask what we want for the 21st century.
(Email me any updates to this list: email@example.com)
Summary of US tax treatments of crypto-assets
IRS Notice 2014–21
VAT in a Blockchain World
Deloitte paper “Bridging the Digital Gap”
UK government paper on crypto-capital-gains
Bitcoin Taxation in Germany
American Bar Association Document on Hard Forks
South African Government’s Stance on Crypto-Tax
Perianne Boring on Tax
The Gambling Loophole in the UK
Ernst and Young: Tax Considerations for ICOs
Ernst and Young: Tax Planning for a New Asset Class
Ernst and Young: Accounting for Crypto-Assets
Deloitte: How Tax Fits into Cryptocurrencies
Deloitte: Common Crypto-Tax Misconceptions
The Maddening Task of Calculating Crypto Tax
How Active Crypto Traders Can Save on US Taxes
The Ten Commandments of Crypto Taxes
Understanding the Tax Implications of Cryptocurrency
DAVID SIEGEL is CEO of the Pillar Project, a nonprofit Swiss foundation building the world’s first smart wallet for crypto-assets. He is also the CEO of 20|30, a blockchain innovation company. He is the author of Pull, business strategy in the age of the semantic web, and The Token Handbook, the first book on tokenomics.