TaxDAO Writes to the U.S. Senate Finance Committee Addressing the 9 Key Issues of Digital Asset Taxation

TaxDAO Writes to U.S. Senate Finance Committee on Digital Asset Taxation

Author | TaxDAO

On July 11, 2023, the U.S. Senate Finance Committee issued a letter seeking comments from the digital asset community and other stakeholders on how to properly handle transactions and income from digital assets under federal tax law. The letter raised a series of questions, including whether digital assets should be valued at fair market value and how digital asset lending should be taxed. Based on the principle that tax policies should be lenient and flexible, TaxDAO has provided corresponding responses to these questions and submitted a response document to the Finance Committee on September 5. We will continue to follow up on the progress of this important issue and look forward to close cooperation with all parties. We welcome everyone’s attention, communication, and discussion!

Below is the full response from TaxDAO:

TaxDAO’s Response to the U.S. Senate Finance Committee’s Questions on Taxation of Digital Assets

September 5, 2023

To the Finance Committee:

TaxDAO is pleased to have the opportunity to respond to the key issues raised by the Finance Committee regarding the intersection of digital assets and tax law. TaxDAO was founded by the former tax director and CFO of a blockchain industry unicorn, and has handled hundreds of financial and tax cases in the Web3 industry, with a cumulative amount of billions of dollars. It is a rare institution that is extremely professional in both Web3 and tax. TaxDAO hopes to help the community better address tax compliance issues, bridge the gap between tax regulation and the industry, and conduct basic research and construction in the early stage of tax regulation in the industry to help the industry’s future compliance development.

We believe that in the current booming digital asset industry, lenient and flexible tax policies will benefit the industry’s growth. Therefore, while regulating digital asset transactions for tax purposes, it is necessary to consider the simplicity and convenience of tax operations. At the same time, we also suggest unifying the definition of digital assets to facilitate regulation and tax operations. Based on this principle, we respond as follows.

We look forward to working with the Finance Committee and supporting the positive changes in digital asset taxation, promoting sustainable economic development.

Sincerely,

Leslie TaxDAO Senior Tax Analyst

Calix TaxDAO Founder

Anita TaxDAO Head of Content

Jack TaxDAO Head of Operation

1. Traders and Dealers Valuing at Fair Market Value (IRC Section 475)

a) Should traders of digital assets be allowed to value at fair market value? Why?

b) Should dealers of digital assets be allowed or required to value at fair market value? Why?

c) Should the answers to the above two questions depend on the type of digital asset? How is it determined that a digital asset is actively traded (under IRC section 475(e)(2)(A))?

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

First, the characteristic of actively traded crypto assets is that their prices fluctuate greatly, so the tax consequence of valuing at fair market value would increase the taxpayer’s burden.

In the case of valuation at market price, if a taxpayer is unable to exchange cryptocurrency before the end of the tax year, it may result in the disposal price of the cryptocurrency being lower than the tax liability. (For example, a trader purchases 1 bitcoin on September 1, 2023, at a market price of $10,000. On December 31, 2023, the market price of bitcoin is $20,000. The trader sells the bitcoin on January 31, 2024, at a market price of $15,000. At this time, the trader only realizes a profit of $5,000 but recognizes a taxable profit of $10,000.)

However, if after recognizing the taxable profit, the trader incurs a loss on the same digital asset, the loss can be offset against the recognized taxable profit, also using the market price method. However, this accounting method will increase tax operations and is not conducive to promoting transactions. Therefore, we do not recommend traders or exchanges of digital assets to use the market price method.

Second, it is difficult to determine the (average) fair market value of cryptocurrency. Active-traded cryptocurrencies are often traded on multiple platforms, such as Bitcoin being traded on Binance, OKEX, Bitfinex, and other platforms. Unlike securities trading, which usually only has one securities exchange, the prices of cryptocurrencies vary on different trading platforms, making it difficult for us to determine the fair value of cryptocurrencies through a “hypothetical sale.” In addition, inactive-traded cryptocurrencies do not have a fair market value, so they are also not suitable for valuation at market price.

Finally, in an emerging industry, tax policies are often simple and stable to encourage industry development. The cryptocurrency industry is an emerging industry that needs encouragement and support. The tax treatment based on market price undoubtedly increases administrative costs for traders and exchanges, which is not conducive to the growth of the industry. Therefore, we do not recommend adopting this tax policy.

We recommend continuing to use the cost basis method for taxing traders and exchanges of cryptocurrency. This method has the advantages of simplicity and policy stability and is suitable for the current cryptocurrency market. At the same time, we believe that since the cost basis method is used for taxation, it is not necessary to consider whether the cryptocurrency is an active-traded asset (according to IRC Section 475(e)(2)(A)).

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

a) Under what circumstances should the policy behind the safe harbor for trading (to encourage foreign investment in US investment assets) apply to digital assets? If these policies should apply to (at least some) digital assets, should digital assets fall within the scope of IRC Section 864(b)(2)(A) (safe harbor for securities trading) or IRC Section 864(b)(2)(B) (safe harbor for commodity trading)? Or should it depend on the regulatory status of specific digital assets? Why?

b) If a new, separate safe harbor for trading can be applied to digital assets, should additional restrictions apply to commodities that meet the safe harbor conditions? Why? If additional restrictions should apply to commodities in this new safe harbor, how should terms such as “organized commodity exchange” and “habitually completed transactions” be interpreted in different types of digital asset exchanges? (As stated in IRC Section 864(b)(2)(B)(iii))

The Transaction Safe Harbor rules do not apply to digital assets, but this is not because digital assets should not enjoy tax benefits, but rather due to the nature of digital assets. One important attribute of digital assets is their borderless nature, which means that it is difficult to determine the location of a large number of digital asset traders. Therefore, it is difficult to determine whether a digital asset transaction belongs to the “trading in the United States” as mentioned in the Transaction Safe Harbor provisions.

We believe that the tax treatment of digital asset transactions can be based on the status of the resident taxpayer. If the trader is a resident taxpayer of the United States, they will be taxed according to the rules for resident taxpayers. If the trader is not a resident taxpayer of the United States, there is no tax issue in the United States, and therefore the Transaction Safe Harbor rules do not need to be considered. This tax treatment avoids the administrative cost of determining the location of the transaction, making it simpler and more conducive to the development of the cryptocurrency industry.

3. Treatment of digital asset lending (IRC Section 1058)

a) Please describe the different types of digital asset lending.

b) If IRC Section 1058 specifically applies to digital assets, would companies that allow customers to lend out digital assets establish standard lending agreements to comply with the requirements of this provision? What challenges would compliance with this provision bring?

c) Should IRC Section 1058 include all digital assets or only a subset of digital assets, and why?

d) If digital assets are lent to a third party and a hard fork, protocol change, or airdrop occurs during the lending period, is it more appropriate for the borrower to recognize income in such transactions, or for the lender to recognize income upon the return of the asset? Please explain.

e) Are there other transactions similar to hard forks, protocol changes, or airdrops that could occur during the loan period? If so, please explain whether it is more appropriate for the borrower or the lender to recognize income in such transactions.

  • Digital asset lending

The operation of digital asset lending is that one user provides their own cryptocurrency to another user and charges a certain fee. The exact way of managing loans varies depending on the platform. Users can find cryptocurrency lending services on centralized and decentralized platforms, and the core principles of both remain the same. Digital asset lending can be divided into the following types based on their nature:

Collateralized loans: This requires the borrower to provide a certain amount of cryptocurrency as collateral to obtain a loan of another cryptocurrency or fiat currency. Collateralized loans generally need to go through centralized cryptocurrency trading platforms.

Flash loans: This is a new type of lending method that has emerged in the decentralized finance (DeFi) field. It allows borrowers to borrow a certain amount of cryptocurrency from smart contracts without providing any collateral and repay it in the same transaction. “Flash loans” utilize smart contract technology and have “atomicity”, which means that the steps of “borrowing-trading-repaying” are either all successful or all failed. If the borrower fails to repay the funds at the end of the transaction, the entire transaction is reversed and the smart contract automatically returns the funds to the lender, ensuring the safety of the funds.

Similar provisions to IRC 1058 should apply to all digital assets. The purpose of IRC 1058 is to ensure that taxpayers who issue securities loans maintain similar economic and tax conditions as when they do not issue loans. Similar regulations are also needed in digital asset lending to ensure the stability of traders’ financial conditions. The latest consultation draft on DeFi in the UK, “General Principles,” states: “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 disposal principle is consistent with the disposal principle of IRC 1058.

We can make a corresponding provision for digital asset lending similar to the existing IRC 1058 (b). As long as a digital asset lending transaction meets the following four conditions, there is no need to recognize income or loss:

① The agreement must stipulate that the transferor will receive the same digital assets as the transferred digital assets when the agreement expires;

② The agreement must require the transferee to pay the transferor all interest and other income equivalent to what the owner of the digital assets is entitled to during the term of the agreement;

③ The agreement must not reduce the transferor’s risk or profit opportunities in the transferred digital assets;

④ The agreement must comply with other requirements stipulated by the Minister of Finance through regulations.

It should be noted that applying similar regulations to digital assets as IRC 1058 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.

After applying regulations similar to IRC 1058 to digital assets, centralized lending platforms can draft corresponding lending agreements for traders according to the regulations. As for decentralized lending platforms, they can meet the corresponding regulations by adjusting the implementation of smart contracts. Therefore, the application of this clause will not have a significant economic impact.

  • Recognition of Income

If a digital asset undergoes a hard fork, protocol change, or airdrop during the lending period, it is more appropriate for the borrower to recognize income in such transactions, for the following reasons:

Firstly, according to trading practices, the income generated from forks, protocol changes, and airdrops belongs to the borrower, which is in line with the actual situation and contract terms of the digital asset lending market. Generally, the digital asset lending market is a highly competitive and free market, where lenders and borrowers can choose suitable lending platforms and conditions based on their interests and risk preferences. Many digital asset lending platforms explicitly state in their terms of service that any new digital assets generated from hard forks, protocol changes, or airdrops during the loan period belong to the borrower. This can avoid disputes and protect the rights and interests of both parties.

Secondly, US tax law stipulates that when a taxpayer receives new digital assets due to a hard fork or airdrop, the fair market value of the assets should be included in taxable income. This means that when borrowers receive new digital assets due to hard forks or airdrops, they need to recognize income when they gain control and recognize gains or losses when selling or exchanging. Lenders do not receive new digital assets, so they have no taxable income or gains or losses.

Third, protocol changes can cause changes in the functionality or attributes of digital assets, thereby affecting their value or tradability. For example, protocol changes can increase or decrease the supply, security, privacy, speed, fees, etc. of digital assets. These changes may have different effects on borrowers and lenders. Generally speaking, borrowers have more control and risk exposure to digital assets during the loan period, so they should enjoy the benefits or losses brought by protocol changes. Lenders can only regain control and risk exposure to digital assets when the loan matures, so they should recognize the benefits or losses based on the value at the time of repayment.

In summary, if digital assets are lent to a third party and there is a hard fork, protocol change, or airdrop during the loan period, it is more appropriate for the borrower to recognize the income in such transactions.

4. Wash Sales (IRC Section 1091)

a) Under what circumstances would a taxpayer consider the economic substance doctrine (IRC Section 7701(o)) applicable to wash sales of digital assets?

b) Are there best practices for reporting wash sales of digital assets that are economically equivalent to transactions?

c) Should IRC Section 1091 apply to digital assets? Why?

d) Does IRC Section 1091 apply to assets other than digital assets? If so, what types of assets?

For this set of questions, we believe that IRC Section 1091 does not apply to digital assets, and our reasons are as follows: First, the liquidity and diversity of digital assets make it difficult to trace corresponding transactions. Unlike stocks or securities, digital assets can be traded on multiple platforms and there are many types and variations. 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. Additionally, due to price differences and arbitrage opportunities between digital assets, taxpayers may frequently transfer and exchange their digital assets between different platforms, which also increases the difficulty of enforcing wash sale rules.

Second, it is difficult to determine the boundaries of concepts such as “same” or “very similar” for specific types of digital assets. For example, non-fungible tokens (NFTs) are considered unique digital assets. Consider the following scenario: a taxpayer sells an NFT and then buys a similarly named NFT from the market. Whether these two NFTs are considered the same or very similar digital assets is legally ambiguous. Therefore, to avoid such issues, IRC Section 1091 may not apply to digital assets.

Finally, the fact that IRC Section 1091 does not apply to digital assets does not create significant tax issues. On one hand, the cryptocurrency market is characterized by rapid value fluctuations and frequent conversions in a short period of time, resulting in investors holding cryptocurrencies for less “extremely long-term” periods. On the other hand, the prices of mainstream cryptocurrencies in the cryptocurrency market tend to rise and fall together. Therefore, the application of wash sale rules to cryptocurrencies is not meaningful, as cryptocurrencies sold at low prices will inevitably recognize income and pay taxes when sold at high prices.

The following html code is shown in English:

The chart below shows the price trends of the top 10 cryptocurrencies by market cap on September 4, 2023. It can be observed that, except for stablecoins, the price trends of other cryptocurrencies are often similar. This means that the possibility for investors to evade taxes through wash sales is unlikely.

In conclusion, we believe that digital assets not subject to IRC 1091 will not pose significant tax issues.

5. Constructive Sales (IRC Section 1259)

a) Under what circumstances would a taxpayer consider the economic substance doctrine (IRC Section 7701(o)) applicable to constructive sales related to digital assets?

b) Are there best practices for digital asset transactions that are economically equivalent to constructive sales?

c) Should IRC Section 1259 apply to digital assets? Why?

d) Should IRC Section 1259 apply to assets other than digital assets? If so, which assets should it apply to? Why?

Regarding this group of questions, we believe that IRC Section 1259 should not apply to digital assets. The reasons are similar to our answers to the previous group of questions.

Firstly, similar to the previous question, it is still difficult to determine the boundaries of “identical” or “substantially identical” digital assets. For example, in an NFT transaction, if an investor holds 1 NFT and sets up a bearish option against that type of NFT, the implementation of IRC Section 1259 would face difficulties as it is hard to confirm if the NFTs in these two transactions are “identical”.

Similarly, the non-application of IRC Section 1259 to digital assets does not pose significant tax issues. The cryptocurrency market is characterized by the rapid transition between bull and bear markets, and bull and bear markets can change multiple times in a short period of time. Therefore, investors hold cryptocurrencies for a relatively shorter period of time. Thus, the adoption of Constructive Sales rules for cryptocurrencies is not significant as the determined transaction time will come quickly.

6. Timing and Sources of Income from Mining and Staking

a) Please describe the various types of rewards provided by mining and staking.

b) How should the returns and rewards obtained from validation (mining, staking, etc.) be treated for tax purposes? Why? Should different validation mechanisms have different treatment methods? Why?

c) Should the nature and timing of income from mining and staking be the same? Why?

d) What are the most important factors in determining when an individual participates in the mining industry or mining activities?

e) What are the most important factors in determining when an individual participates in the staking industry or staking activities?

f) Please provide an example of the arrangement of individuals participating in a staking pool protocol.

g) Please describe the appropriate treatment of various types of income and rewards obtained by individuals staking for others or in a pool.

h) What is the correct source of staking rewards? Why?

i) Please provide feedback on the proposal put forward by the Biden administration to impose consumption tax on mining.

  • Mining Rewards and Staking Rewards

Mining rewards mainly include block rewards and transaction fees.

Block rewards: Block rewards refer to the newly issued digital assets that miners receive when a new block is generated. The quantity and rules of block rewards depend on different blockchain networks. For example, the block reward for Bitcoin is halved every four years, from the initial 50 bitcoins to the current 6.25 bitcoins.

Transaction fees: Transaction fees are the fees paid by transactions included in each block and are also allocated to miners. The quantity and rules of transaction fees also depend on different blockchain networks. For example, the transaction fee for Bitcoin is set by the transaction sender and varies based on transaction size and network congestion.

Staking rewards refer to the process in which stakers support the consensus mechanism on the blockchain network and earn rewards. Base rewards: Base rewards are digital assets allocated to stakers based on the quantity and duration of their staking, according to a fixed or floating ratio.

Additional rewards: Additional rewards are digital assets allocated to stakers based on their performance and contributions in the network, such as block validation, voting decisions, and providing liquidity. The types and quantities of additional rewards depend on different blockchain networks, but can generally be categorized as follows:

· Dividend rewards: Dividend rewards refer to stakers receiving a certain percentage of profits or income generated by participating in certain projects or platforms. For example, stakers can receive dividends from the transaction fees of decentralized exchanges (DEX) on Binance Smart Chain.

· Governance rewards: Governance rewards refer to stakers receiving governance tokens or other rewards by participating in the governance voting of certain projects or platforms. For example, stakers can receive ETH 2.0 by participating in Ethereum’s validation nodes.

· Liquidity rewards: Liquidity rewards refer to stakers receiving liquidity tokens or other rewards by providing liquidity to certain projects or platforms. For example, stakers can receive DOT by providing cross-chain asset conversion services (XCMP) on Polkadot.

Mining and staking rewards have the same nature. Both mining and staking obtain corresponding token income through verification on the blockchain. The difference is that mining requires hardware device computing power, while staking requires virtual currency. However, they have the same on-chain verification mechanism. Therefore, the difference between mining and staking is only a difference in form. We believe that for entities, the income obtained from mining and staking should be treated as operating income; for individuals, it can be treated as investment income.

Since the rewards for mining and staking have the same nature, the time for confirming the income should be the same. The income from mining and staking should be declared and taxed by taxpayers when they obtain the right to control the reward digital assets. This usually refers to the time when taxpayers are free to sell, exchange, use, or transfer the reward digital assets.

  • Industry Activities

We believe that the question of “determining when an individual participates in the mining/staking industry or mining/staking activities” is equivalent to determining whether a person is engaged in mining/staking as a business, which may subject them to self-employment taxes. Specifically, whether a person is engaged in mining/staking as a business can be determined based on the following criteria:

Purpose and intent of mining: Individuals engage in mining/staking with the purpose of generating income or profit and have ongoing and systematic mining activities.

Scale and frequency of mining: Individuals use a large amount of computing resources and electricity and engage in mining frequently or regularly.

Results and impact of mining: Individuals generate significant income or profit through mining and make important contributions or impacts on the blockchain network.

  • Staking Pool Protocol

A staking pool protocol generally includes the following parts:

Creation and management of the staking pool: The staking pool protocol is usually created and managed by one or more staking pool operators, who are responsible for operating and maintaining the staking nodes, as well as handling the registration, deposit, withdrawal, allocation, and other transactions of the staking pool. Staking pool operators usually charge a certain percentage of fees or commissions as their service compensation.

Participation and withdrawal from the staking pool: The staking pool protocol usually allows anyone to participate in or withdraw from the 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 staking pool by sending digital assets to the staking pool address or smart contract, or they can withdraw from the staking pool by requesting a withdrawal or redemption. Participants usually receive a token representing their share or stake in the staking pool, such as rETH, BETH, etc.

Earnings distribution of the staking pool: The staking pool protocol usually calculates and distributes the earnings of the staking pool periodically or in real-time based on the performance of the staking nodes and the reward mechanism of the network. Earnings usually include newly issued digital assets, transaction fees, dividends, governance tokens, etc. Earnings are typically distributed based on the participants’ share or stake in the staking pool, after deducting the fees or commissions of the operators, and are sent to the participants’ addresses or smart contracts.

  • Response to Consumption Tax

The Biden administration imposes a 30% consumption tax on the mining industry. We believe that this tax rate is too harsh during a bear market. The comprehensive income of the mining industry in both bear and bull markets should be calculated, and a reasonable tax rate should be confirmed separately. This tax rate should not be excessively higher than that of cloud services or cloud computing businesses.

The following table shows the gross profit margins of major mining industry companies listed on the Nasdaq during a bear market (2022) and a bull market. In 2022, the average gross profit margin was 37.92%, but in 2021, the average gross profit margin was 65.42%. Because consumption tax is different from income tax, it is levied directly on mining income, which directly affects the company’s operating conditions. In a bear market, a 30% consumption tax is a major blow to mining companies.

Another major reason for imposing consumption tax on the mining industry is that mining consumes a large amount of electricity and therefore needs to be punished. However, we believe that mining industry’s use of electricity does not necessarily cause environmental pollution, as it may use clean energy. It is unfair to impose the same consumption tax on all mining companies. The government can regulate electricity prices to meet the environmental requirements of mining companies.

7. Non-functional Currency (IRC Section 988(e))
a) Should the microcancellation rules similar to those in IRC Section 988(e) apply to digital assets? Why? What is an appropriate threshold and why?

b) If the cancellation rules apply, can the existing best practices prevent taxpayers from evading tax obligations? What reporting system helps taxpayers comply with the regulations?

The microcancellation rules in IRC 988(e) should apply to digital assets. Similar to securities investments, digital asset transactions typically involve foreign exchange, so verifying foreign exchange losses for each digital asset transaction would create a significant administrative burden. We believe that the threshold specified in IRC 988(e) is appropriate.

The application of microcancellation rules in digital assets may lead to taxpayers evading tax obligations. In this regard, we recommend referring to relevant national tax laws and voluntarily declaring each transaction without verifying foreign exchange losses. However, at the end of the tax year, a random sample of transactions should be checked to verify whether foreign exchange losses have been accurately reported. If a trader fails to report foreign exchange losses accurately, they will face corresponding penalties. This system design will help taxpayers comply with tax reporting requirements.

8. FATCA and FBAR Reporting (IRC Sections 6038D, 1471-1474, 6050I, and 31 U.S.C. Section 5311 et seq.)
a) When should taxpayers report digital assets or digital asset transactions on FATCA forms (e.g., Form 8938), FBAR FinCEN Form 114, and/or Form 8300? If a taxpayer reports certain categories and not others, please explain and specify the reported and unreported categories of digital assets on these forms.

b) Should the reporting requirements of FATCA, FBAR, and/or Form 8300 be clarified to eliminate ambiguity regarding whether they apply to all or certain categories of digital assets? Why?

c) Considering the policies behind FBAR and FATCA, should digital assets be more included in these reporting systems? Are there any obstacles to doing so? What are the obstacles?

d) How should wallet custody be considered by stakeholders in determining compliance with FATCA, FBAR, and Form 8300 requirements? Please provide examples of wallet custody arrangements and indicate which types of arrangements should or should not be subject to FATCA, FBAR, and/or Form 8300 reporting requirements.

  • Response to Reporting Rules

Overall, we recommend designing a new form for reporting all digital assets. This would contribute to the development of the digital asset industry, as reporting digital assets in existing forms can be slightly cumbersome and may hinder trading activity.

However, if reporting needs to be done within existing forms, we suggest the following reporting approaches:

For FATCA forms (e.g., Form 8938), taxpayers should report any form of digital assets held or controlled outside the United States, regardless of whether they are associated with the US dollar or other fiat currencies. This includes but is not limited to cryptocurrencies, stablecoins, tokenized assets, non-fungible tokens (NFTs), decentralized finance (DeFi) protocols, etc. Taxpayers should convert their overseas digital assets to US dollars based on the year-end exchange rate and determine whether they need to file Form 8938 based on the reporting threshold.

For FBAR FinCEN Form 114, taxpayers should report offshore wallets that can be considered as financial accounts, whether custodial or non-custodial, if the total value of these accounts exceeds $10,000 at any time. Taxpayers should convert their overseas digital assets to US dollars based on the year-end exchange rate and provide relevant account information on Form 114.

For Form 8300, taxpayers should report receiving cash or cash equivalents, including cryptocurrencies, totaling over $10,000 from the same buyer or agent. Taxpayers should convert the received cryptocurrencies to US dollars based on the exchange rate on the day of the transaction and provide relevant transaction information on Form 8300.

  • Response to Wallet Custody

Regarding the issue of wallet custody, our views are as follows:

A cryptocurrency wallet is a tool used for storing and managing digital assets, which can be divided into custodial wallets and non-custodial wallets. The following are the definitions and differences between these two types of wallets:

A custodial wallet refers to entrusting the cryptographic keys to a third-party service provider, such as an exchange, bank, or professional digital asset custody institution, who is responsible for storing and managing them.

A non-custodial wallet refers to controlling one’s own cryptographic keys, such as using software wallets, hardware wallets, or paper wallets, etc.

We believe that regardless of the type of wallet used, taxpayers should report their holdings of digital assets on Form 8938 or Form 8300 according to existing regulations. However, in order for taxpayers to report digital assets on FBAR FinCEN Form 114, it must be clarified whether a cryptocurrency wallet constitutes an offshore financial account. We believe that custodial wallets provided by overseas service providers can be recognized as offshore financial accounts, while non-custodial wallets require further discussion.

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

On the other hand, some non-custodial wallets may be considered as foreign financial accounts because they involve the services or functions of a third party. For example, if a software wallet is used and it can connect to a foreign exchange or platform, or provides cross-border transfer or exchange functions, they can be considered as foreign financial accounts.

However, whether it is a custodial or non-custodial wallet, as long as the wallet is associated with a foreign financial account, such as conducting cross-border transfers or exchanges through the wallet, it may need to be reported on the FBAR form because it involves a foreign financial account.

9. Valuation and Substantiation (IRC Section 170)

a) Digital assets currently do not meet the exception provisions of IRC Section 170(f)(11) for assets with readily determinable values. Should the substantiation rules be modified to consider digital assets? If so, in what manner and for which types of digital assets? Specifically, should different measures be taken for publicly traded digital assets?

b) What characteristics should exchanges and digital assets have in order to appropriately apply this exception, and why?

We believe that the relevant provisions of IRC Section 170 should be modified to include the donation of digital assets. However, only common and publicly traded digital assets should be eligible for tax deductions, not all digital assets. Digital assets like NFTs that have difficulty obtaining fair market value should not qualify for the exception provisions of IRC Section 170(f)(11) because their transactions can be artificially controlled. Moreover, digital assets like NFTs that are difficult to liquidate and obtain funds will increase additional costs for the recipients of the donations. Policy should encourage donors to donate easily liquidable cryptocurrencies.

In particular, we believe that digital asset donations that can determine fair market value in accordance with the spirit of Notice 2014-21 and related documents can qualify for the exception provisions of IRC Section 170(f)(11), such as virtual currencies that are “traded on at least one platform with real currency or other virtual currencies and have a published price index or value data source.”

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