More taxes may cause short-term volatility, “but long term, you may see more demand for DeFi applications and other collateralized use cases.”
There are often multiple causes for an asset’s sharp decline, but Bitcoin’s (BTC) 10% “nosedive,” which took place on April 22, may be blamed on the Biden Administration’s reported plan to tax capital gains at double the current rate on America’s wealthiest.
Bitcoin is habitually volatile, so one probably shouldn’t read too much into a double-digit swoon in any given week, but this might be as good a place as any to reflect upon the possible impact of the United States capital gains taxes, and taxes in general, upon the future growth of cryptocurrencies and blockchain technology.
Could it hinder long-term adoption? If so, in what ways? Will the Biden plan even reach fruition, given the vagaries of U.S. politics? How, too, does one explain the mini-market eruption in the face of the mere possibility of more taxes in a single nation? What sorts of misperceptions might we be harboring with regard to crypto taxation generally?
“The price drop can probably be attributed to a number of factors and rumors — chiefly, the month-end expiration of future positions, which resulted in a liquidation of positions that triggered a slide,” Markus Veith, a partner in the audit practice at Grant Thornton LLP and leader of the firm’s digital assets practice, told Cointelegraph.
There were also reports, generally thought to be false, that Treasury Secretary Janet Yellen was spearheading an effort to impose an 80% capital gains tax rate on cryptocurrencies, “as well as rumors that the U.S. Treasury was investigating financial institutions for illicit use of cryptocurrencies, which the DoJ would do, not the Treasury,” added Veith, continuing: “Then, there were also comments about a drop in Chinese mining capacity.”
A lot was happening that week
David Trainer, CEO of investment research firm New Constructs, downplayed the BTC price gyrations, stating: “10% volatility is nothing new for BTC and crypto in general.” Meanwhile, Tyler Menzer, a CPA and doctoral student in accounting at the University of Iowa, noted: “While the tax news does coincide with the drop, it may only be one of many contributing factors.”
But taxes do matter. “The [Biden] proposal would put the effective tax rate at above 50% in certain states and would be detrimental to job creation,” Carlos Betancourt, co-founder of BKCoin Capital in Miami, told Newsweek, adding, “and would continue to accelerate the move from states like California and New York to more tax-friendly states like Florida and Texas that have no state income tax.”
This is still an early stage in a new administration, of course, and there is some question whether a doubling of the capital gains on the wealthiest to 39.6% — as proposed — will even make it through Congress intact, or if that rate will eventually be reduced.
“Someone needs to pay for all the stimulus, deficits, and national debt, so very likely you would see a tax increase in the near future — whether on capital gains or something else is still to be decided,” Mazhar Wani, a PricewaterhouseCoopers tax partner in San Francisco, told Cointelegraph.
However, Omri Marian, professor of law at the University of California, Irvine School of Law, said that the proposal will unlikely be accepted in its current form. “The Democratic majority in Congress is just too narrow for this,” Marian informed Cointelegraph. Chris Weston, head of research at the Pepperstone Group — a forex broker — said: “The numbers being proposed at this juncture will unlikely pass the Senate in its current form, and centrist Democrats will not back the touted numbers.”
But casting rumors aside, if a doubling of the capital gains tax does pass through Congress intact, would it necessarily mean stormy weather for cryptocurrencies and blockchain technology?
Maybe not. Nathan Goldman, assistant professor of accounting at North Carolina State University, told Cointelegraph — after consulting with his co-author on BTC taxation matters, Christina Lewellen — that the new capital gains taxes are geared to the wealthiest — those with more than $1 million in annual income — and they would be paid only upon the sale of the digital asset:
“As a result, it is not clear whether the proposed changes would significantly affect most cryptocurrency holders.”
Still, “taxes likely do have an effect on Bitcoin prices,” said Menzer, continuing, “as we have a lot of prior research on a wide variety of outcomes and aspects of life that are affected by tax rates, especially in the financial sector.”
Moreover, they could push crypto and blockchain technology in some interesting directions. Wani, for example, would expect to see more “short-term volatility due to certain investors cashing out at the lower rates, but long term, you may see more demand for DeFi applications and other collateralized use cases to create liquidity and avoid triggering gains.”
What about murmurs surrounding Yellen’s so-called 80% capital gains tax — which would be “punitive and unprecedented”? Goldman told Cointelegraph, “I do not believe there is strong merit to the rumors of an 80% capital gains tax on cryptocurrency” — a position echoed elsewhere. But some still believe that Yellen hasn’t really warmed to crypto.
“My own view is Yellen fundamentally doesn’t get Bitcoin,” Weston said, continuing, “and to go after digital assets to protect against criminal activity in an asset that leaves a record is odd” particularly because cash is usually favored in such transactions, given its untraceability. Meanwhile, Trainer added:
“I think Janet Yellen was looking to minimize the speculation in crypto. She believes that rampant speculation, like what we see in crypto, is not healthy for investors or the underlying asset over time.”
With regard to the capital gains issue in general, Menzner commented: “To the extent that higher taxes make it more expensive to use cryptocurrency or adopt it for new uses, it will be a setback.” However, he added: “It could also accelerate the use of stablecoins for certain cryptocurrency projects, as they are designed to minimize price fluctuations and thus minimize any gain or loss from a tax perspective.”
“We don’t often see tax as the controlling decision of whether to exit a position, but it may drive when an exit occurs; for example, if any corresponding losses should be harvested, when long-term/short-term holding periods are met, etc.,” Paul Beecy, tax services partner at Grant Thornton LLP, told Cointelegraph.
Does U.S. tax policy matter globally?
To what extent, though, is this all just a U.S. issue? Does it really even matter in Singapore or France what happens in the U.S. with regard to tax policy — especially for a globally purchased and held asset like Bitcoin?
“Competitive advantage is key here,” according to Wani, who added: “It matters if other countries follow similar policies for taxation.” Also, he believes other countries may try to become more competitive by offering “more incentives — i.e., less taxation — to attract more talent and businesses from this growing industry to their jurisdictions.”
“The only thing I can definitively say on how much U.S. tax policy affects crypto is that we don’t know,” added Menzer, but “U.S. policy can cause real changes in crypto-exchange economics.” Many global exchanges do not allow U.S. residents and citizens to trade, for example, thanks to U.S. policy, “thus effectively separating non-U.S. traders from U.S. traders, which slightly breaks down the idea that Bitcoin or other cryptocurrencies are uniformly global.”
It matters, said Marian, because “if you are a U.S. taxpayer, you owe U.S. taxes on your crypto trades no matter how you make them. It may be more difficult for the IRS to enforce if you hold your assets with a foreign custodian. But if you cheat on purpose, you wouldn’t care very much about a change in tax rates.”
What does seem clear is the lack of clarity with regard to taxes and cryptocurrencies, starting with the common misperception that you do not need to pay taxes on crypto. According to Goldman:
“You still need to pay taxes on the appreciation of your cryptocurrency assets. For example, if you bought a single Bitcoin on Jan. 1, 2016, for $434 and used that Bitcoin to buy a Tesla on April 1, 2021 — value $58,726 — you owe capital gains taxes on the difference.”
No hard and fast rules
More problematic still, there is no standard tax treatment for all cryptocurrency uses. As Beecy told Cointelegraph: “When digital currency is held [in the U.S.] by individual retail investors as a capital asset, the tax rules on buying and selling it are reasonably understood, and the capital gains tax that applies ought to impact digital currency transactions in a manner very similar to other financial capital assets.”
But when, by contrast, digital currency is structured as part of more complex transactions “and mimics other and more esoteric financial instruments — like derivatives, NFTs [nonfungible tokens], and certain security tokens — then the tax rules on those digital currency transactions are not really clear,” said Beecy.
All in all, last week’s BTC’s price gyrations might have been an over-reaction to some preliminary tax plans, but this response was probably predictable, given that “regulation is obviously a major grey cloud” that begets anxiety, as Weston noted, “but as we’ve seen many times of late, the market sells first, thinks about it, and calmer heads generally prevail.”
Taxation, of course, is a serious business, and even if doubling of the capital gains tax only directly impacts the wealthiest, history teaches that taxes can have a leveraged impact on long-term growth — so, one needs to pay attention.
Taxation is a form of regulation, and the mere fact that discussions like this are taking place in crypto’s only 12th year of existence may provide some confidence, arguably, that the U.S. is not going to ban or attempt to “shut down” cryptocurrencies. Indeed, the net effect could be an “increase [in] adoption as people feel more confident,” submitted Menzer.
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Author: Andrew Singer