How the U.S. can benefit from effective crypto tax policy
Editor’s note: This op-ed is part of a bigger package of crypto policy views. Find the rest here: “U.S. as the crypto capital: What it would take.”
While a supportive and curious administration presents a welcome change for the crypto industry, developing an effective and comprehensive regulatory framework for decentralized open-source systems remains a challenge, as it requires the effective tailoring of various legislative and policy initiatives within existing laws across the entire U.S. regulatory framework.
Given the complexity of the tax code and innovative organizational structures essential to decentralized systems, it is no surprise that policymakers have struggled to effectively establish clear rules regarding the reporting requirements and tax treatment of digital assets. However, this legislative session provides a historic opportunity to reclaim leadership in a technology that’s reshaping global finance, as well as the future of the internet.
The 2025 expiration of numerous provisions of the Tax Cuts and Jobs Act (TCJA) have set the stage for income tax to be addressed in the first session of the 119th Congress. It is expected that tax legislation will be passed through an expedited process known as reconciliation. While limited to budgetary items like taxes, spending and the debt limit, reconciliation provides Congress the ability to enact legislation with a simple majority vote.
As the most comprehensive tax legislation since the Tax Reform Act of 1986 (TRA), the extension of the TCJA will be a significant undertaking, which will require multiple Congressional committees to each contribute legislation to address their respective reconciliation instructions, further complicated by President Trump’s wide expansion of tariffs and the expected formation of an External Revenue Service.
The Republican majority in both the House and Senate has committed to enacting President Trump’s legislative agenda while prioritizing substantial reductions in spending. Although budgetary scoring is likely to be offset by the expected revenue derived from tariffs and spending cuts, for American citizens to realize tangible benefits, enacted policy changes must result in increased domestic production and economic growth within the United States.
President Trump’s commitment to the rapidly growing crypto industry, along with targeted legislation, can realize these tangible benefits by addressing lingering uncertainties and incentivizing American industry to remain in America. In particular, the U.S. should act to protect decentralized finance (DeFi), provide clarity for domestic projects, and provide a pathway for foreign projects to return to the United States.
Protect decentralized finance (DeFi)
As disappointing as it was predictable, the final Treasury Regulations providing guidance on tax reporting requirements applicable to certain DeFi platforms released on December 27, 2024, far exceeded the provisions of the Infrastructure Investment and Jobst Act (IIJA).
While it is entirely appropriate and expected for the Treasury Secretary to be involved in the crafting of legislation relevant to the application of the Internal Revenue Code, after advocating for amended language, having that language be specifically excluded from the legislation and then proceeding as if no amended language was necessary (in this case an exceedingly broad definition of “broker” beyond any existing or proposed meaning), it is utterly indefensible for the Treasury Department and the IRS to proceed with finalized Treasury Regulations flaunting the intent of Congress.
With an effective enactment of January 1, 2027, it seems likely that even the drafters were aware that the final regulations were unlikely to be enacted, but even so, final Treasury Regulations cannot merely be set aside, and a significant amount of time, money and effort will be spent rectifying this unnecessary impediment. To that end, immediate replacement legislation is being considered, lawsuits have been filed and Senator Ted Cruz and Representative Mike Carey have introduced a joint resolution under the Congressional Review Act (CRA) rules to prevent the final Treasury Regulations from being entered into the Federal Registry.
Limited to just the final regulations pertaining to DeFi, the CRA does not include the final Treasury Regulations providing reporting procedures for more conventional “custodial brokers,” released on June 28, 2024. Far from perfect, the “custodial broker” regulations did at least reflect genuine consideration of the comments received and are serviceable final regulations.
The CRA prevents reissuance of “substantially the same form” which is typically ameliorated by the affected agency focusing on changing the aspects giving rise to the specific objections. Currently, the specific objections have not been fully articulated. However, as the entire final regulations are premised on an interpretation beyond authority granted by Congress, it is unlikely that the specific objections can be addressed through resubmission.
While further study has been recommended on this subject and there are many details to be considered around the upgradeability of smart contracts, enacted legislation should unambiguously state that interaction with smart contract protocols, whether through a front-end or not, should not be considered sufficient intermediation giving rise to tax reporting.
Remove uncertainty for domestic projects
A number of modest legislative considerations can help to remove lingering uncertainties for domestic projects, thereby fostering U.S. innovation. These could be introduced into the expected taxation legislation and provide significant benefits without requiring stand-alone legislation or significant effort to explain their purpose.
While the IRS has provided significant sub-regulatory guidance that is fairly consistent with first principles analysis and existing law, a general lack of cohesion and consistency in how defined terms are utilized creates significant ambiguity in the application of that guidance. Simply including more thorough and consistent definitions of activity pertaining to terms like “digital assets,” “airdrops,” and “smart contract protocols” would provide unambiguous guidance in how to apply existing tax law, which can easily be accomplished in the expected 2025 legislation.
Additionally, given the scope of the provisions under review, legislative developments should be monitored for appropriate additions of items like the electability of mark-to-market method for dealers and traders of digital assets, exclusion of income earned from proof-of-stake delegation to third party validators from unrelated business taxable income and clarification that wrapping tokens to enhance functionality is not a realization event if the custodian has no right to transfer the underlying cryptocurrency and the value of the wrapped token is pegged to that of the original token.
Finally, as Congress considers the particular merits of each provision of the TCJA, a number of broader tax considerations could have a direct impact on the taxation of digital assets and the crypto industry, and any such provision should be monitored to ensure that the provision is inclusive of digital assets and the crypto industry.
For example, provisions like the Domestic Production Activities Deduction (DPAD) and the deductibility of casualty and theft loss were removed from the original TCJA – however, both have been mentioned as possibly being included in the tax legislation around extending the expiring provisions of the TCJA. DPAD is the likely vehicle for President Trump to enact a favorable rate of taxation for domestic production, and it is particularly likely to be at least considered within the upcoming tax legislation. As the purpose of DPAD is to promote domestic production that includes software development, if measures to include DPAD were to be undertaken, any limitations on software development to exclude the crypto industry should be addressed as the legislation evolves.
Provide a pathway for offshore projects to return to the U.S.
The opportunity to finally resolve the confusion surrounding the classification of digital assets under securities laws with market structure legislation will allow the industry to finally move past the specter of former chairman Gary Gensler’s SEC and provide a clear path for new blockchain projects to form in the United States. Unfortunately, legislative solutions are likely necessary to address the tax ramifications for projects wishing to form in the United States that already utilized offshore foundations (a practice involving significant risk and in their typical utilization, necessitated delegation of authority away from decentralized governance mechanisms in favor of centralized boards, counter to crypto’s ethos of decentralization).
While unlikely to be persuasive as a singular issue within President Trump’s commitment to foster domestic production and incentivize operational activity within the United States, the original TCJA provided provisions for repatriation of offshore assets for multinational corporations that could potentially be widened should the domestication of foreign businesses become a legislative priority.
Conclusion
The success of crypto is not dependent on special treatment under the law. The technological and societal benefits of blockchain technology is neither dependent on the outcome of political elections nor on the actions of government to succeed. However, for that success to continue to be an American success, Congress must enact rules that apply fairly to crypto and apply uniformly across all industries.
The 2025 legislative window offers a last chance to align rules with technological reality. Congress must choose: Will America write the playbook for the 21st-century internet, or watch from the sidelines as others reap the rewards?
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David Kerr is the Principal of Cowrie LLC, where he uses 10 years of experience in tax strategy, financial accounting, and risk advisory in the industries of gaming, telecommunications, and technology-driven online sales platforms to assist clients with risk mitigation strategies on developing web3 issues.
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