Cryptocurrency should be taxed as an investment, not as money

Senators Pat Toomey (R-PA) and Kyrsten Sinema (D-AZ) have proposed exempting cryptocurrency transactions worth $50 or less from capital gains taxes. While it seems like a modest tax change, it could have a profound effect on how crypto is perceived and used. And that would give crypto a tax advantage over other investments.

Like many crypto supporters, Tumi and Sinema seem to want tokens to be treated as both money and property. To some extent, the history of crypto supports this idea. The first cryptocurrency, Bitcoin
was created to allow peer-to-peer financial transactions without the use of a commercial bank or other intermediary.

And some forms of crypto seem to function like currency, at least within their limited ecosystems. But much of crypto’s popularity has been fueled by investor speculation and occasional large valuation increases, rather than its potential as a money substitute.

Since 2014, the IRS has treated crypto as property subject to capital gains taxes when sold. And it is considered a sale when crypto tokens are used to pay for a purchase.

Inconsistent treatment

Toomey and Sinema are just the most recent example of lawmakers looking to give cryptocurrencies special — but different — tax status depending on how they’re used. Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) proposed legislation in June that would allow certain crypto professionals — miners and gamblers — to defer taxes on compensation paid in crypto tokens until they sell those tokens.

In other words, instead of taxing this compensation as cash wages, the IRS would have to treat it more like an asset — the exact opposite of the Toomey-Sinema bill. My TPC colleague John Bull explains this bill here.

For the typical consumer, the tax relief from the Toomey-Sinema bill would be modest. It might be hard to imagine given the recent drop in crypto values, but imagine that $25 you invested in crypto doubled to $50, which you then used to buy dinner. Under current law, your $25 profit will be taxed at 20 percent. Under the new legislation, it will be tax-free. You will save $5.00 in tax.

More than a tax break for consumers

The immediate tax relief would only make sense for power users who do most of their shopping in crypto. And to the industry itself.

Make no mistake, this $50 limit on tax-free transactions is just the beginning. You can be sure that the backers will soon try to raise the limit to $100, and then to $200. Now I can hear them: “Fifty dollars? Hardworking Americans can’t even buy $50 worth of groceries. The Lummis-Gillibrand bill is now capped at $200.

Some cryptocurrencies actually function as currency. When they work as advertised, these stablecoins are pegged to the dollar with little price fluctuation. By design, they would generate little or no capital gain, and in some cases a minimal exemption may make sense if only to avoid worsening record keeping.

Toomey and Sinema would give crypto a significant tax advantage over any other investment. After all, if you’re selling stocks to help pay for living expenses, you owe capital gains tax on the sale. Why should crypto be any different?

And that’s the real problem: the industry wants it both ways. Toomey and Sinema want the IRS to treat crypto like money — at least sometimes. Their argument: You don’t pay tax when you withdraw cash from an ATM to buy that dinner. Why should you pay tax when using crypto?

Well, because most cryptocurrencies are not money. It is an investment, and a highly speculative one at that. Here is a two-year historical price chart for Bitcoin, one of the most stable cryptocurrencies.

Virtual cake

This is not how healthy currencies work. Money is supposed to be a stable medium of exchange, not a speculative investment.

Yet promoters want to have their virtual cake and eat it too. They trade crypto both as an investment and as money. Here’s a typical online ad — in this case from crypto exchange Kraken.

And they want this dual purpose to be reflected in state regulation. When consumers use crypto to make purchases, promoters want the IRS to treat it as money. When the miners and hostages receive it as compensation, they want the IRS to tax it as property. And they want to keep the Securities and Exchange Commission as far away from crypto as possible.

It’s really not hard. Without a doubt, crypto poses enormous regulatory challenges. And one day it may function as an alternative currency.

But for now, it’s largely an investment, not money. That’s how it’s basically sold. And the tax laws should continue to treat it that way.

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