President Biden proposed a $3.3 trillion ten-year tax increase on the 2020 campaign trail. Among other things, the tax proposals would have increased the top income tax rate to 39.6% and raised the corporate tax rate to 28%. While most of these didn't make it into the Inflation Reduction Act, advocates continue to push for changes in future legislation.
Let's look at President Biden's proposed tax changes and how they might impact the crypto industry if signed into law.
Income & Investment Taxes
The Biden campaign initially sought to raise the top income tax rate to 39.6% for those earning over $400,000 and impose a 12.4% Social Security payroll tax on income over $400,000. While the 2021 Build Back Better Act included a few of these provisions, no income tax increases made it into the 2022 Inflation Reduction Act.
In addition to income tax proposals, President Biden proposed raising the long-term capital gains and dividend tax rate to 39.6% for income over $1 million. It also hoped to eliminate the step-up in basis for inherited assets, raising the estate tax rate to 45% and lowering the exemption to $3.5 million per estate – but nothing made it into the 2022 IRA.
The IRA did include a 15% minimum corporate tax rate on book profits of more than $1 billion, with exemptions for accelerated depreciation and other items. In addition, the legislation tacked on a 1% excise tax to net stock buybacks and extended pass-through loss limitation through 2028 for S-Corp businesses and entrepreneurs.
While Biden's income and investment tax proposals didn't make it into the IRA, they could reappear in future legislation over the next couple of years. Many Democrats are also keen on raising the corporate income tax rate to 28% and introducing surtaxes on offshore activity, which could impact many crypto businesses and miners in the future.
In addition to these income and investment tax considerations, the Biden administration has already introduced new efforts to curb illicit finance via executive order. Earlier this year, he directed regulatory agencies to protect against systemic risk, curb illicit finance, and explore the idea of a U.S. central bank digital currency.
IRS Enforcement Funding
The most significant impact of the Inflation Reduction Act on the crypto industry may be the $80 billion in new funding earmarked for IRS enforcement activities. To put the number in context, the $80 billion is six times the current IRS budget of $12.6 billion, and more than half of the funding ($45.6 billion) will go toward hiring some 87,000 new agents.
While the IRS didn't dedicate a fixed amount toward crypto enforcement, the agency did say they'd pursue "digital asset monitoring and compliance activity." IRS Commissioner Charles Rettig believes that the growing popularity of cryptocurrencies has been a significant factor behind the $1 trillion annual tax gap (e.g., uncollected taxes due).
The IRS has taken several steps in recent years to pave the way for more crypto tax enforcement. For instance, the 2021 Form 1040 asks taxpayers if they participated in cryptocurrency transactions. In 2022's Form 1040, the agency casts an even wider net by asking if taxpayers received crypto as a gift, award, reward, or compensation.
Taxpayers can avoid problems with the IRS by using crypto tax software to ensure accurate returns. For instance, ZenLedger automatically aggregates transactions across wallets and exchanges and computes your capital gain or loss. You can even use the platform to auto-generate the IRS forms you need each year for your accountant.
Crypto Tax Challenges Remain
The collapse of FTX (and other factors) could put more pressure on legislators and regulators to address compliance gaps in the crypto ecosystem. These pieces of legislation could significantly impact traders and investors by, for example, preventing tax-loss harvesting or forcing exchanges to document capital gains.
Some of the biggest challenges include:
- Tax-loss Harvesting – Cryptocurrencies aren't subject to the tax-loss harvesting rule yet since the IRS considers them property. However, Biden's ill-fated Build Back Better plan attempted to amend the rule, and the effort could revive.
- Income Classification – Proof-of-stake blockchains enable token holders to stake their crypto on a network and validate transactions in exchange for rewards. However, it's unclear if reward tokens are taxable as income or only when sold.
- Business Entities – Decentralized Autonomous Organizations (DAOs) have become widely popular in crypto circles, but they don't fit cleanly into an IRS tax entity. So, it's uncertain how the IRS should tax their activities.
- Decentralized Finance – A growing number of DeFi protocols aim to cut out intermediaries to reduce costs. But, at the same time, these intermediaries would usually report transactions to the IRS, creating new compliance challenges for the agency.
Meanwhile, the crypto industry will also struggle to implement existing rules coming into effect next year. Namely, 2021 legislation requires crypto exchanges or platforms to report transactions to the IRS and investors on a Form 1099-B or 1099-DA. But, of course, these requirements will be challenging to enforce due to how crypto works.
In addition to these tax rules, legislators are keen on closing money laundering loopholes with restrictions on privacy coins and related projects. For example, the Treasury Department recently sanctioned Tornado Cash for its role in laundering more than $7 billion in virtual currency since its launch in 2019.
The Bottom Line
Biden's proposed $3.3 trillion 10-year tax increase never made it into law, but that doesn't mean future legislation isn't on the way. At the same time, the Inflation Reduction Act will significantly expand funding to the IRS for enforcement-related activities. And various IRS changes could pave the way for crypto holders to become a key target.
If you buy, sell, or trade crypto assets, ZenLedger can help you organize everything for tax time and avoid aggravations. You can also use the platform to identify tax-loss harvesting opportunities and see all your crypto assets in one place.