The Crypto-Tax Chapter
By: David Siegel
Tags: Taxes, Token Sale, Finance, Cryptocurrency, Blockchain

16. Token-Based Accounting Systems

Several startups are working on stand-alone accounting systems or plug-ins for popular systems. First and foremost, these systems maintain a database of blended prices back for every day of the past several years. You give them a list of addresses, and they go through the entire blockchain, find every trade, and append a fiat-currency equivalent to every transaction. This results in the “tax history” of each address, in any major tax currency, which is very useful. This tool saves incredible amounts of time chasing down fiat equivalents later.

Other systems have more features, most of them designed to look and feel like familiar accounting systems. Some day, we’ll start to share ledgers between trading partners, and then everything will change. I have written about this elsewhere, but sharing ledgers is a financial game changer.

For 2017, some exchanges offered tax summaries as an added service for added money. I recommend that any system that uses tokens natively offer its users a transaction record in their own tax currency. This way we won’t need some of these external tools and after-the-fact services.

I list the tools at the end.

17. How a Future Tax System Could Work

If part of the reason to adopt tokenomics is to make the world function better and open new opportunities, then we may also want to look at the tax system itself to see whether we could improve that with blockchain technology. It turns out, we can.

[News flash: OpenLaw has released a demo smart-contract automatically calculating and paying income tax automatically witheld — watch it!]

Why are we taxing income in the first place? The United States, which was itself a revolt against British taxation, forbade taxing income until the Civil War. Today, income tax is the standard around the world. We should be mindful of two things: a) governments shouldn’t care how they get their money, as long as the contributions are seen as fair, and b) what you tax you tend to get less of. As the price of cigarettes and alcohol goes up, consumption of cigarettes and alcohol goes down (not much, but it doesn’t go up). Do we really want less income?

Any proper replacement for the current tax system should be revenue neutral. That is, it should raise as much tax as the current system. It’s worth noting that collecting tax in almost any country is an extremely inefficient enterprise. The Tax Justice Network estimates that tax avoidance and evasion fail to bring in $3 trillion (about 5 percent of world GDP) for governments worldwide each year. A similar amount sits in various tax havens. A recent report estimates that the US fails to bring in 30 percent of the amount it is entitled to by law and predicts that number to rise to 35 percent in the next ten years. Americans spend over 8 billion hours (more than $400 billion in lost wages) preparing their taxes and spend over $400 billion in tax consultants.

An excellent paper on taxation sums up the situation:

In addition to putting hours into record keeping and completing their tax returns, most people spend their incomes and assets in ways that would make little economic sense with a simpler tax structure. Complaints about the complexity and inefficiency of the federal tax code explain the support for a simpler, flatter, and broader tax, such as a proportional tax on consumption, or a fixed percentage tax on incomes above a given level. Unlike an income tax, a consumption tax does not double tax savings, while a relatively low flat income or consumption tax rate does not have the same distorting effects on hours worked and other decisions of the marginal income tax rates of 40 percent and higher in the current American tax system.

We should be mindful of two things: a) governments shouldn’t care how they get their money, as long as the contributions are seen as fair, and b) what you tax you tend to get less of. Do we really want less income?

Taxing Consumption

Another approach is to tax spending (consumption) rather than earning. If you think about it, this is a rather good idea. You would keep 100 percent of your pay check, so if you spend less and save more, you would have more to invest. Those who spend more would pay more tax. In this scheme, the incentives are aligned rather than perverse.

Can we make it work? We already do. Most governments have some sort of VAT or sales tax, either at the state or federal level. VATs are complex. State taxes vary, creating tax refugees. It’s entirely possible to shift to a national sales tax, and it’s made much easier using digital currency and smart contracts. The proposal I make here is outlined in The Fair Tax, a movement in the United States that proposes to eliminate the IRS and replace it with a flat federal sales tax on new items, plus a “prebate.” I will explain this approach in terms of smart contracts and blockchain-based assets. I assume that fiat currency is already digital and on a shared ledger, so this is half prescription and half vision. It combines elements of the semantic web, blockchain, and universal income.

Summary of the Fair Tax

I wrote about this in Pull: the Fair Tax is a national sales tax that adds 30 percent to every purchase of a new item and sends it to the government. So if you buy a wedding cake for $100, you would pay $130 at the register. Adding 30 percent to each purchase amounts to a 23 percent tax, since for every $100 spent (tax inclusive), $23 would go to the government.

To prevent it from being unfair, it makes sense to not tax things like milk, eggs, drugs, and other basics. However, there are many good reasons not to categorize spending — that would lead to fierce lobbying to get various products on the no-tax list. Instead, the Fair Tax proposes to send every man, woman, and child a monthly “prebate” check that amounts to around $11,000 per adult and $4,000 per child each year. This means that people living at the poverty level pay no tax at all. This short video sums it up:

My explanation of how it would work using digital currency has three parts:

1. The National Tax Variables

If we’re going to have agile government, we need to think differently. Today, numbers and dates are “baked in” to legislation all over, and after a decade or two those numbers are out of date and it takes a rewrite of the law to change them. This may have worked 150 years ago, but laws are now out of date the moment they are passed.

Another approach is to make the numbers into variables that lawmakers can change fairly easily, without rewriting the laws. This is part of the reg-tech movement. In the case of taxes, we would create a national variable called USTAXRATE and put that onto a secure server. Since we know all servers that hold a lot of value are eventually hacked, we would put this number into a blockchain-based container and make sure that a group of trusted people have the keys in a multisig format. For example, it would take 5 out of 9 people to digitally sign an order to change this number.

Similarly, the government would have two more variables, USTAXPREBATE-ADULT and USTAXPREBATE-CHILD. Now all the software that deals with retail sales can just build these variables in and fetch the numbers from the source in real time, every time. If congress changes these numbers, all systems automatically adjust.

The goal is to generate the revenues the government needs. Not only will it need a lot less without the IRS and missing tax money, blockchain-based services will make governments far more efficient, so it’s easy to adjust these numbers to fit the current situation. We could start with:

USTAXRATE = 23%

USTAXPREBATE-ADULT = $9,200/mo

USTAXPREBATE-CHILD = $300/mo

Whenever these numbers need to change, it’s easy to do so, none of the software needs updating. Changing these numbers could be a direct result of votes cast by whoever is in charge of making the decision. Even better — they could be determined by real financial data that adjusts these values according to the government’s stated budget and the measured low-income level, taking inflation into account.

2. Build The Tax into All Eligible Transactions

Quite a bit of work has gone into planning which transactions would be subject to the FairTax and which wouldn’t. I like much of this thinking, but I also think it needs a bit more refinement. For example, buying a new home carries a hefty sales tax of 30% on top, which is fine, as most home sales are resales anyway. People buying a new home should pay the initial tax and then charge that into their sales price later. But paying rent has no tax associated, which I’m not sure about. The FairTax would tax services as well as goods. I think it makes an excellent start, and the details can be adjusted as we learn how it works.

As we work to eradicate cash, and as we create digital money using shared ledgers, we will be able to use smart contracts to collect tax. It’s simple to describe but takes some work to implement: all transactions that qualify for the national tax should include the government’s smart contracts, which will automatically extract the tax directly, without having to remit. This is an extremely efficient way to tax — your purchase shows both the amount that goes to the seller and the amount that goes to the government.

Now compliance is fairly easy to to check. For private transactions, the government poses as a buyer and spot-checks transactions, handing out fines to people who try to sell goods and services without collecting tax. Since so many transactions will be public, the government can even write software that watches for tax evasion. Watchdog groups can do the same, to make sure the government isn’t overreaching. Much of this ecosystem can be built for a tiny fraction of what we spend today, and I expect the compliance rates will be far higher.

In this way, the government just keeps the servers running and the money flows in via the blockchain. Everything is traceable and verifiable.

3. The Prebate and Basic Income

The prebate variable gives me an immediate idea — we can use that variable to offer a combination of tax prebate and universal basic income. The mechanism is exactly the same, so there is no overhead in distributing more. For example, the government could raise the national sales tax rate by 2 percent and increase everyone’s prebate amount by 2 percent and — voila! — redistribution of wealth. Obviously, there would be different political groups trying to move these numbers both ways, as there are today. This system has the advantage of making it trivially easy to adjust, with no added expense.

I believe inequality is a trend people should take seriously. For the past more than fifty years, all the laws and government programs added together have produced far more inequality than we would have with different governance. Even Sweden has a growing trend of inequality. By keeping these numbers at the “FairTax” values, this scheme simply replaces income tax far more efficiently, and spenders pay for much of it. By increasing just two variables we can do experiments to see how well redistribution works or doesn’t. Using software, governments could even target various regions or groups for redistribution to try to balance out inequality.

Local Taxes

The FairTax is a federal tax to fund the federal government. What about local tax? A few new ideas:

Switzerland charges you for garbage collection per-bag.

In Switzerland, you pay for garbage collection services by purchasing special garbage bags at the store. These bags have the collection fee built in, so it’s a pay-as-you-go system.

Another idea would be to charge anyone in a given city a per-day local tax rate. You would pay a discounted rate for staying longer and a higher rate for just a one-day visit. This has the advantage that it encourages governments to make their city more visitable. It may sound like it doesn’t fund long-term planning, but I think it could.

Of course, many cities also have their own sales tax. This could easily be included in the sales tax scheme I have outlined.

I think a lot about taxation, because if we can go to a pay-as-you-go, consumption-based approach to tax, then the concept of national identity could change. At some point, you could just travel and pay tax for each day and each transaction, and you wouldn’t have to think of yourself as a resident of any particular city or country. This concept goes hand-in-hand with rethinking governance, which blockchain technology is just allowing us to do now.

Summary

Compared to other tax schemes I’ve seen, and compared to what we’re doing today, I think the FairTax is on the right track. There are many other tax schemes and proposals. My goal here has been to raise awareness of taxing consumption and show how efficient tax collection could be if we use better ideas and technology we already have today.

If this were an open letter to tax authorities, my message would be: now is a great opportunity to reset the playing field. We should take a hard look at what we’re doing today and use technology to fix it rather than imitate it. Tax is just one area where switched-on government people with vision and an experimental mindset can lead us into the 21st century.

18. How Should We Tax Crypto-Assets?

The default answer to this question has been to simply categorize them as assets or commodities and tax them accordingly. I have argued that the SEC really has no way of knowing which tokens are tickets and which are securities. I have also argued that getting rid of such taxes and switching to a consumption tax will eliminate these conversations entirely.

Perianne Boring, founder of the Chamber of Digital Commerce, has written about digital currencies (not tokens):

Virtual currencies, like their fiat counterparts, may be used for many purposes, including to purchase goods and services, like a cup of coffee. In 2014, the IRS determined that it would treat convertible virtual currency as property, thus subjecting it to capital gain/loss and investment income tax treatment and associated reporting requirements. This treatment hinders the use of virtual currencies as a method of payment, subjecting them to applicable sales tax as well as the calculation and reporting of capital gain/loss on each transaction and hindering the use of virtual currencies to facilitate micro-payments, another promising use case for virtual currencies to reach a wide spectrum of potential participants in the financial system.

She concludes:

The Chamber of Digital Commerce supports policies that treat virtual currencies fairly — as an alternative currency. As such, convertible virtual currencies should not be subject to capital gain or investment income tax, or burdensome tax regulation that would force virtual currency users to calculate and pay gain or loss when transacting with virtual currencies.

The problem here is that there will be a very blurry line between cryptocurrecies and tokens. If cryptocurrencies were money, it would be simple — tax them like money. But they aren’t money. No cryptocurrency meets the definition of money — yet. If they were assets, we could tax them like assets (and some should be, because some tokens represent the ownership of assets). To the degree that tokens look and act like things we know, we should probably expect the corresponding tax treatment. But many tokens are “new things” and shouldn’t be taxed using old frameworks.

I’ve heard talk of a threshold, where authorities say that below a certain amount of value there’s no need to declare or pay taxes. This is probably a good start, though any threshold is still arbitrary, and if you’re anywhere close to the threshold you still have to do the work to figure out whether you’re under or over.

Germany, which has already written a fair amount of legislation on cryptocurrency tax issues, declared in March 2018 that if you purchase something using a cryptocurrency, that’s considered spending money rather than selling an asset, so there won’t be any capital gains. This is almost sure to lead to some very interesting high-ticket, short-term transactions.

France recently reclassified crypto-assets as “moveable property,” lowering the tax rate to 19 percent.

The G20 countries are starting to work together toward coordinated regulations, but I don’t expect unified tax treatment to be a result.

I don’t think Germany has the solution. I don’t think determining tax treatment “on a case by case basis” is the answer. I think almost all systems can and will be gamed. My suggestion is that we look hard at the existing tax systems and ask what we want for the 21st century. The best example we have currently is the Australian scheme, though I think the boundaries between categories are quite blurry.

19. Calculating Your Tax Liability

Assuming you live in a place that treats most cryptocurrencies as an asset, the burden of calculating your year-end tax liability lies with you. Your accountant won’t have any idea how to do it. To do it by hand would be laborious. Fortunately, for every cryptocurrency or token you’ve ever bought or sold, the record of those transactions is sitting on the blockchain right now. Unfortunately, what’s not on the blockchain is the tax-currency equivalent of each transaction. What we want is a tool that will interrogate each blockchain and keep a record of the value of that currency/token for each day of the year, then spit out your values at the end of the year. That software isn’t here yet, but it’s coming. You’ll find a growing list at the end of this page.

My suggestion is that we look hard at the existing tax systems and ask what we want for the 21st century.

20. Summary

There are many issues here; there’s no way I can cover all of them. Neither am I a substitute for professional advice. The first thing we should be mindful of is that the laws haven’t changed, and we will need to deal with them as they are today. It’s likely that tax authorities will let a lot of small amounts through the cracks, simply because they have no way of dealing with them. But it’s up to us to pay our taxes according to the laws that govern us, so we should all do our best to do that.

Some general conclusions:

1. Using ERC20 tokens as a unit of gas is a nonstarter. At the moment, I recommend all ICOs update their terms of service and messaging to exclude this model and switch to an all-you-can-eat subscription model.

2. All ERC20-based systems should record each transaction not only in token and ether but also in the user’s tax currency.

3. All ERC20-based systems should give users a tax summary whenever they ask for it. Tax records should be recorded as they are generated.

4. Tokenomics must consider a wide range of tax consequences for buyers in different jurisdictions and that of the offering organization.

We should work collectively for better tax treatment and an intelligent reset on taxation, rather than trying to cram new assets into old categories. At the very least, Australia’s approach is a sane start.

Very few would deny governments the ability to raise money. But in the 21st century, governments will have to become much more agile and much more lean. Blockchain technology and new ideas will help build a better future for all of us.

I think almost all systems can and will be gamed. My suggestion is that we look hard at the existing tax system and ask what we want for the 21st century.

21. Resources

(Email me any updates to this list: david@2030.io)

Documents

Summary of US tax treatments of crypto-assets

IRS Notice 2014–21

VAT in a Blockchain World

Deloitte paper “Bridging the Digital Gap”

UK government paper on crypto-capital-gains

Bitcoin Taxation in Germany

American Bar Association Document on Hard Forks

South African Government’s Stance on Crypto-Tax

Perianne Boring on Tax

TheTaxAdvisor.com

The Gambling Loophole in the UK

Ernst and Young: Tax Considerations for ICOs

Ernst and Young: Tax Planning for a New Asset Class

Ernst and Young: Accounting for Crypto-Assets

Deloitte: How Tax Fits into Cryptocurrencies

Deloitte: Common Crypto-Tax Misconceptions

The Maddening Task of Calculating Crypto Tax

How Active Crypto Traders Can Save on US Taxes

The Ten Commandments of Crypto Taxes

Understanding the Tax Implications of Cryptocurrency

Software

Balanc3, by Consensys

LibraTax, Libra Platform

CoinTracking

YaxReturns

Services

Chainalysis

Coinfirm

Cryptotax

Advisors

TheTaxAdvisor.com

Bitcoin Tax Solutions

CryptoTaxLegal

DAVID SIEGEL is CEO of the Pillar Project, a nonprofit Swiss foundation building the world’s first smart wallet for crypto-assets. He is also the CEO of 20|30, a blockchain innovation company. He is the author of Pull, business strategy in the age of the semantic web, and The Token Handbook, the first book on tokenomics.