On January 3, Musk posted on his social media platform: 'The client bought cumrocket worth $7,000 and staked it for three months to earn a 6900% return. Then they sold and extracted profits to invest in NFTitties, but the developers rug pulled the project, and they only managed to liquidate 10% of the funds. Can the client deduct the gas fees for minting tokens to balance the short-term capital gains tax?'
To truly understand what Musk is mocking and why he has repeatedly criticized the IRS, BlockBeats consulted professional tax advisors from TaxDAO, who have been providing professional crypto asset financial management software and crypto tax consulting services in the Web3 field since 2023. They have recently developed a professional crypto asset tax management software, FinTax, aimed at both B2B and B2C markets, leveraging AI agents to help users address their crypto financial and tax-related needs in a one-stop manner.
Through their explanation of U.S. tax law, using the numbers provided in the image as a case study, we can further elucidate the current situation and future of U.S. crypto taxation.
Graphic Interpretation: An Unreasonable Tax Story
First, let’s interpret what sad story the image is telling:
This is an example of calculating taxes on cryptocurrency investments, where the tax calculation can be broken down into three stages. The first stage is staking income, taxed as ordinary income under personal income tax, with a progressive tax rate ranging from 10% to 37%. The second stage is the investor using the earned staking income to mint NFTs, which falls under investment behavior and should incur capital gains tax. The third stage is investment failure, where the project rug pulls, leading to a 90% loss. In 2023, the IRS issued tax guidance memos regarding worthless or abandoned crypto assets, stating that if a taxpayer has lost control over their crypto assets (the investor in the image has already sold the depreciated crypto assets), the loss can be used to offset taxes before calculating but can only offset capital gains tax, and depending on marital status, can offset up to $3,000 of ordinary income.
Based on the situation in the image, let’s first assume that the client is a single person, the staking income is paid out in a lump sum at the end of a three-month period, and upon receiving the staking income, the client sells it all and invests in an NFT project, with no other income. The tax implications of this series of transactions can be calculated as follows:
(1) The client purchased $7,000 worth of Cumrocket and staked it for 3 months, earning an interest of 6900%. Therefore, the income is 7000 * 6900% = $483,000. According to IRS regulations, this income is classified as ordinary income rather than capital gains.
(2) After that, the amount invested in NFTs is $7,000 * 7000% = $490,000.
(3) After investing the profits from crypto assets into the NFT project, due to the rug pull, they could only liquidate 10% of the funds, resulting in a loss of 90%, which translates to a loss of $441,000 (490,000 * 90%). Since the funds have been liquidated, this loss is realized and meets the criteria for deductible capital losses.
Capital losses will first be used to offset capital gains of the same type. In this case, there are no capital gains from price increases, so the $441,000 capital loss cannot offset any capital gains. Assuming the client is single, according to IRS regulations, this portion of capital loss can offset a maximum of $3,000 of ordinary income in that year. Additionally, the exemption amount for ordinary income tax for single individuals is $13,850, therefore the client's taxable ordinary income = 483,000 - 3,000 - 13,850 = $466,150. According to the graduated ordinary income tax rate table, they need to pay $11,000 × 10% + $33,725 × 12% + $50,650 × 22% + $86,725 × 24% + $49,150 × 32% + (466,150 - 231,250) × 35% = $1,100 + $4,047 + $11,143 + $20,814 + $15,728 + $82,215 = $135,047.
Thus, from the calculations above, we can see that the investor ultimately only made a profit of $50,000 (which includes the $7,000 principal), but still had to pay up to $130,000 in taxes that year. This example sharply critiques the irrationality of U.S. crypto tax laws, and it is no wonder Musk has repeatedly criticized the IRS’s legislation.
Crypto Tax Disputes: Inextricably Entangled
Why has Musk held a long-standing dissatisfaction with U.S. crypto taxes? FinTax tax advisors analyze two main reasons:
1. U.S. taxation is complex, with each region having its own regulations, and compliance costs are high, nearly reaching 10 times that of China;
2. Starting in 2023, the U.S. has introduced targeted tax legislation for the crypto sector, but it has not taken into account the characteristics of the crypto industry and still approaches it from a traditional industry perspective, which may be unreasonable in legal terms; even if the legal principles themselves are reasonable, the government’s complete reliance on traditional tax collection methods to manage crypto enterprises makes it difficult for companies to truly implement compliance.
The case illustrated in the image is a typical problem: the taxpayer has some businesses that are profitable and others that are loss-making, but these profitable and loss-making businesses cannot offset each other under specific tax scenarios, leading to a situation where ultimately no profit is made, yet they still owe significant taxes. Similar disputes also exist between the Jarrett couple and the IRS regarding whether taxes should be paid on staked assets.
Related Reading:
(U.S. Crypto Broker Rules: A Bitter Pill or a Deadly Poison?)
(IRS Maintains Its Stance on Taxing Crypto Asset Staking: Interpreting Jarrett v. United States).
On the other hand, due to the decentralized and anonymous nature of cryptocurrencies, they have also become tools for some individuals to evade taxes. Such cases have become the most common disputes in the crypto field.
Taking the famous 'Bitcoin Jesus' case as an example, the protagonist Roger Ver was born in Silicon Valley, USA, in 1979, and started investing in Bitcoin in 2011. Due to his active promotion of Bitcoin's applications and value, he played a significant role in its early popularization, accumulating substantial influence in the crypto asset field, which earned him the title 'Bitcoin Jesus' from media and the crypto community.
In 2014, Roger Ver obtained citizenship in the Federation of St. Kitts and Nevis and soon after renounced his U.S. citizenship. According to U.S. tax law, individuals who renounce their citizenship must fully report the capital gains of their global assets, including their holdings of Bitcoin and fair market value. The IRS believes Roger Ver concealed and undervalued his personal asset value before renouncing citizenship and subsequently obtained and sold about 70,000 Bitcoins from his controlled U.S. company, earning nearly $240 million in revenue, thereby evading at least $48 million in taxes owed.
In this regard, the IRS primarily raised two charges: first, Roger Ver did not comply with exit tax regulations; second, Roger Ver violated tax obligations as a non-U.S. tax resident.
Roger Ver's case win rate may be influenced by multiple factors. On the favorable side, his legal team argues that the tax law's provisions on taxing crypto assets are unclear, which adds arguments about loopholes in the tax system to the defense. They also accuse the prosecution of selective enforcement; if sufficient evidence can be provided, it may weaken the legitimacy of the IRS's prosecution. Notably, the Trump administration intended to end the harsh regulation of crypto assets, which could bring a turning point for the case. However, the unfavorable factor is that the prosecution has a wealth of concrete evidence, including $48 million in unpaid taxes and a series of records of tax evasion, which likely meet the statutory requirements for tax evasion.
The Bitcoin Jesus case has sounded the alarm for tax compliance in the crypto industry, especially for individual investors in crypto assets. Strengthening international cooperation and technological advancements are continuously narrowing the space for investors to evade taxes. For investors in the crypto industry, tax compliance has become an unavoidable key issue.
Related Reading: (IRS vs. Bitcoin Jesus: Compliance Risks Behind $48 Million in Taxes)
Wealth Tax: The Sword of Damocles Over the Crypto Industry
In addition, the series of 'corporate taxes' and 'wealth taxes' introduced during Biden's initial period in power has indeed caused significant financial strain for Musk.
After Biden took office in 2020, he initiated multiple rounds of large-scale infrastructure plans to achieve political ambitions. Behind high expenditures must be high tax revenues, with American corporations and the wealthy first in line to pay high taxes to fund this plan, and Musk is undoubtedly targeted by Biden. When announcing the 2023 budget, Biden proposed a new tax scheme targeting the wealthy, imposing a minimum income tax of 25% on citizens with a net worth of over $100 million, which includes standard tax liabilities and annual gains from the total value of 'tradable assets' (including stocks, bonds, mutual funds, and other securities). According to a report released by ProPublica in 2021, Biden's wealth tax would compel tech giants like Musk to pay $35 billion to $50 billion in taxes. That year, news that 'Musk will pay an $11 billion tax bill' became a hot topic, marking the highest single tax payment in U.S. history.
Under the new regulations, U.S. capital gains tax will reach a historic high, as depicted by the U.S. Treasury.
After raising the fiscal year 2025 budget to $7.3 trillion, Biden proposed a new proposal to tax unrealized gains and plans to tax unrealized gains of trusts, corporations, and other non-corporate entities that have not had recognition events in the past 90 years. Taxing unrealized gains means that even if individuals or companies (with net assets exceeding $100 million) hold stocks, bonds, and other tradable assets without selling them, they still need to pay taxes at a minimum income tax rate of 25% when their value increases.
This bill is akin to declaring war for the venture capital circles that prioritize valuation growth as their foundational logic. Bill Ackman commented on the tax plan, stating that the Democratic Party should not implement a tax policy that 'will destroy the U.S. economy.' 'If someone invests $1 billion into your startup at a valuation, and you own 50% of the company, you will immediately incur $100 million in tax liabilities... All American startups will go bankrupt, and no one will want to start a business in America anymore.' In the latest podcast episode, two founding partners of A16Z expressed similar views. This bill hangs like a precarious Sword of Damocles over startups, where huge taxes could deal a fatal blow at any moment, limiting the development of entrepreneurship and investment.
David Sacks stated at the early-year tech conference that this tax could stifle the startup industry's ability to offer stock options to founders and employees, and called it 'a significant reason Silicon Valley is seriously considering who to vote for.' The investment community believes this tax policy will greatly distort the investment behavior of U.S. investors, especially regarding small-cap stocks and startups. These companies are often the engines of economic growth and innovation, relying on investors willing to take risks for future returns. However, when unrealized gains are also taxed, investors will be less inclined to invest in growth-oriented companies, as their valuations tend to be more volatile compared to larger, more mature companies.
Read more: (Silicon Valley Turns Right: Peter Thiel, A16Z, and the Political Ambitions of Cryptocurrency)
What is the future of crypto tax law?
Since the birth of the cryptocurrency market, the tax issues surrounding its transactions have been a focal point of debate. The core contradiction lies in the differing positions of the government and investors: the government seeks to increase fiscal revenue through taxation, while investors worry that excessive tax burdens will reduce investment returns.
Even with a high enthusiasm for trading cryptocurrencies like in South Korea, the authorities have consistently attempted to regulate the crypto field through high taxes. This involves not only a game of chess between regulatory agencies and the market but also a struggle for discourse power between the Democratic Party and the People Power Party.
The Korean Democratic Party planned to impose a 20% tax on cryptocurrency profits (22% for local taxes) as early as 2022, but due to strong opposition from investors and the industry, the plan has been postponed twice to January 1, 2025. After the December 1, 2024 press conference, the tax collection was postponed again to 2027. The ruling People Power Party has also proposed pushing the implementation date to 2028.
Overall, South Korea has taken a relatively cautious approach to crypto taxation issues and has not imposed stringent regulations on the market. On one hand, this provides the market with time and space for natural development; on the other hand, it offers South Korea a valuable window to observe the effects of policy implementation in other countries and global regulatory trends, allowing them to build a more comprehensive tax system based on the lessons learned from others.
The U.S. attitude towards the crypto market has been favorable since Trump's administration. From the SEC chairman to the Treasury Secretary, and the 'crypto czar' coordinating the overall strategy, Trump's 'crypto team' not only represents significant policy adjustments but also signals a potential major turning point for the U.S. cryptocurrency industry. However, regarding government attitudes toward taxation, FinTax tax advisors hold a conservative view, believing that although many favorable policies for the crypto industry were promised before Trump took office and will continue to be rolled out, tax measures will only become stricter. This is because Trump's initial support for the crypto industry stemmed from recognizing its important role in the U.S. financial system and technological development, believing it could bring new growth to the fintech sector, which must be reflected in tax measures. Therefore, in the future, crypto taxes will become clearer, and tax collection will become stricter.
A satirical image from Musk sparked a frenzy for one cryptocurrency, leaving new imaginations for the crypto field. In the U.S. Treasury's announcement of the 2025 crypto tax system, rules related to DeFi and non-custodial wallets have been temporarily shelved, indicating the U.S. government's cautious attitude towards formulating crypto tax policies. In the future, whether in terms of the adaptability of tax policies or the regulation of tax evasion, U.S. tax law still has a long way to go. We hope that as the crypto industry gallops forward like a runaway wild horse, there will also be a strong rein guiding it in the right direction.
References:
Overview of the U.S. crypto tax system;
The IRS stipulates that staking income must be taxed as ordinary income;
Ordinary income tax rates and capital gains tax rates;
For single individuals, capital losses exceeding capital gains can offset a maximum of $3,000 of ordinary income in that year;
Income from crypto assets classified as ordinary income;
Crypto asset transactions subject to capital gains tax;
(How should crypto companies respond to inquiries from the U.S. SEC: Compliance Insights from Bitdeer)
(How Web3 companies can use tax mediation systems to resolve tax disputes: Examples from FTX and MicroStrategy)
