US: IRS issues NFT tax guidance

March 21, 2023

Dive Brief:

• The Internal Revenue Service is seeking comments on the tax treatment of nonfungible tokens as a collectible under the tax law, the agency said in a release Tuesday.
• The request for comment, which defines an NFT as “a unique digital identifier that is recorded using distributed ledger technology and may be used to certify authenticity and ownership of an associated right or asset,” is looking to determine the treatment of NFTs as collectibles, with the IRS also providing guidance for how they will determine whether an NFT counts as a collectible in the meantime.
• Until additional guidance is issued, the IRS will do so via “look-through analysis,” they said. The IRS is relying upon Section 408(m) of the tax code for that analysis and to distinguish which NFTs are collectibles, which “provides that the acquisition by an individual retirement account (IRA) of a collectible shall be treated as a distribution from the IRA equal to the cost to the IRA of the collectible.”

Dive Insight:

Collectibles defined under Section 408(m) include, among other categories, “any work of art, any rug or antique,” and “any metal or gem.” The section also states that “certain coins and bullion are excluded from the definition of collectible.”

For the purposes of present IRS guidance, this means that “an NFT is treated as a collectible if the NFT’s associated right or asset falls under the definition of collectible in the tax code,” they said Tuesday.

“For example, a gem is a collectible under section 408(m); therefore, an NFT that certifies ownership of a gem is a collectible,” they said.

NFTs occupy a unique niche in the digital asset space as both part and apart from the cryptocurrency space, as they typically signal ownershirp of another asset — such as a digital image, digital work of art, digital music, but they can also be tied to physical objects such as paintings. This puts a clear demarcation between NFTs and cryptocurrencies; cryptocurrencies such as bitcoin, are “fungible,” or interchangeable in terms of value, while this is not the case for NFTs, according to a January report by Investopedia.

The dividing line between NFTs and other digital assets on the blockchain like cryptocurrencies could be one of the reasons behind the former’s spike in trading at the start of the year, with total NFT trading volume rising 38% month to month in January, according to a Tuesday report by Entrepreneur.

However, the agencies’ call for comment and updated guidance on NFTs follows a series of actions taken by regulators and lawmakers to address risk and uncertainty in the wider cryptocurrency market, which follow the large-scale collapse of crypto exchange FTX and other ensuing hiccups in the space.

Regulatory scrutiny of the cryptocurrency industry — including how it should be regulated and what status certain assets in the industry should have under the tax code, such as stablecoins — had increased even before the exchange’s failure, with U.S. regulators playing tug-of-war with crypto standards and jurisdiction.

U.S. Securities and Exchange Commission Chair Gary Gensler noted in September 2022 — three months before FTX’s collapse that November — during prepared remarks that the “vast majority” of crypto tokens meet the definition of a security and are thus, both covered by securities law and subject to the SEC’s authority. Following the FTX crisis, the SEC reupped its focus on crypto, calling for companies to fully disclose their crypto asset risks and causing the agency to cast a deeper spotlight on the risks faced by public companies dealing with the industry as they and other regulators came under fire from lawmakers.

The closer scrutiny of cryptocurrency standards has already led to further rumblings within the industry. Paxos Trust, the issuer of Binance-backed stablecoin BUSD, recently received a notice from the New York State Department of Financial Services directing it to end its relationship with Binance, as well as a Wells Notice from the SEC alleging they were “considering recommending an action alleging that BUSD is a security,” CFO Dive previously reported. A Wells Notice is a formal notice from the SEC which tells the recipient of the agency’s intent to take enforcement action against them, according to Investopedia.

The cryptocurrency world has also faced large-scale layoffs since spring of 2022, with more than 26,000 jobs in the market having been lost by the end of the year and 2023’s tally reaching 1,900 by late January.

The uncertainty surrounding crypto and the market turbulence make it all the more important for there to be regulatory clarity and cohesion. Jeremy Fox-Geen, CFO of stablecoin issuer Circle, noted that his company has always favored “a robust dialogue” with regulators, he said in a previous interview.

“We have always taken the view that constructive relationships with regulators are critical and the events of the last year have demonstrated exactly why that is true,” he previously told CFO Dive.

[CFO Dive]