"Cryptocurrency" by The Focal Project is licensed under CC BY-NC 2.0

Democrats in Congress and the executive branch are broadening their approach to taxing digital assets, such as cryptocurrencies and stablecoins. 

Buried in the Democrats’ misnamed Inflation Reduction Act is a provision that directs the Internal Revenue Service to investigate and enforce tax collection on digital assets. The bill appropriates over $45.6 billion for tax enforcement activities. In addition to tax collection and a litany of other uses to nickel-and-dime Americans, the exorbitant funds will be used for “digital asset monitoring and compliance activities.” 

The fact that the bill specifically mentions digital assets suggests that Democrats desire to target transactions on cryptographically secured distributed ledgers to heighten scrutinization of household sources of income and capital gains. 

A large percentage of lower-income individuals use digital assets to invest and make transactions. According to a paper published by the Federal Reserve, 29 percent of adults using cryptocurrency solely for investment purposes “had an income under $50,000.” Moreover, the paper found that “Nearly 6 in 10 adults who used cryptocurrencies for transactions had an income of less than $50,000.” 

The new funds used by the IRS to compel tax collections and compliance will be used on these individuals that transact and invest in digital assets. The Transactional Records Access Clearinghouse at Syracuse University found that “low-income wage earners with less than $25,000 in total gross receipts [are] being audited at a rate five times higher than for everyone else.” 

Crypto investors and transactors are likely to see an increase in audits from the IRS if the Inflation Reduction Act is signed into law. 

The Biden administration has also introduced new methods of taxing digital assets. In March, the Treasury Department released its General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals. The Green Book offers numerous proposals to add digital assets to the tax code:

Applies nonrecognition treatment of securities lending to digital assets

  • Adding certain digital assets to this provision will exempt transactions from recognition of gains or losses, provided there is a predetermined agreement. However, this assumes that digital assets will be regulated as securities, which is still a large debate among industry, the Securities and Exchange Commission, the Commodity Futures Trading Commission, and Congress. 

Requires brokers, such as U.S. digital asset exchanges, to report to the IRS the gross proceeds of digital assets held by partnerships and trusts owned by foreign entities

  • “Broker” as redefined in the Infrastructure Investment and Jobs Act of 2021, erroneously encapsulates software developers, validators, wallet providers, and crypto miners. Fortunately, there are laudable efforts by both the House and the Senate to fix this error and narrow the definition so that certain individuals in the crypto industry are not forced to report to the IRS. 

Mandates taxpayers who hold digital assets with foreign digital asset service providers or exchanges to report to the IRS or be subject to strict penalties

  • The Treasury Department states in the Green Book that this reporting subject to strict penalties is “critical” to squeezing revenue out of crypto investors. This provision limits what individuals can do with their investments. 

Amends the mark-to-market rules for dealers and traders to include digital assets

  • Treasury Secretary Janet Yellen has previously stated she is open to the idea of taxing unrealized capital gains. Applying mark-to-market accounting to actively traded digital assets, while bringing it to parity with how other financial products are accounted for, will also make it easier for the Treasury Department to value unrealized digital assets and tax them. 

Democrats are laser-focused on raking in revenue from every investment and transaction involving digital assets. Instead of helping the Biden administration accomplish their goal, lawmakers should rein in this egregious expansion of government power and vote against empowering the IRS’ scrutinization of digital assets.