Letter to the U.S. Senate Finance Committee: Responding to 9 Major Questions on Digital Asset Taxation

Written by: TaxDAO

On July 11, 2023, the U.S. Senate Finance Committee released a request for comments to the digital asset community and other stakeholders to understand how to appropriately handle transactions and income related to digital assets under federal tax law. The open letter posed a series of questions, including whether digital assets should be valued at market price and how digital asset lending should be taxed.

Based on the principle that tax policy should be lenient and flexible, TaxDAO has responded to these questions and submitted a response document to the Finance Committee on September 5. We will continue to follow the progress of this important issue and look forward to maintaining close cooperation with all parties involved.

Here is the full response from TaxDAO:

TaxDAO's Response to the U.S. Senate Finance Committee on Digital Asset Taxation Issues

September 5, 2023

To the Finance Committee:

TaxDAO is pleased to have the opportunity to respond to the key issues at the intersection of digital assets and tax law raised by the Finance Committee. TaxDAO was founded by former tax directors and financial directors from blockchain industry unicorns, having handled hundreds of tax cases in the Web3 industry with a total amount in the hundreds of billions. It is a rare institution that is extremely professional in both Web3 and tax matters. TaxDAO aims to help the community better address tax compliance issues, bridge the gap between tax regulation and the industry, and conduct foundational research and construction to assist the future compliance development of the industry at this relatively early stage of tax regulation.

We believe that in the current burgeoning landscape of digital assets, a lenient and flexible tax policy will benefit the growth of the industry. Therefore, while regulating the taxation of digital asset transactions, it is necessary to also consider the simplicity and convenience of tax operations. At the same time, we recommend standardizing the conceptual definitions of digital assets to facilitate regulation and tax operations. Based on this principle, we provide the following responses.

We look forward to cooperating with the Finance Committee and supporting it in bringing about positive changes in digital asset taxation to promote sustainable economic development.

Sincerely,

Leslie TaxDAO Senior Tax Analyst

Calix TaxDAO Founder

Anita TaxDAO Head of Content

Jack TaxDAO Head of Operation

1. Traders and Dealers Valuing at Market Price (IRC Section 475)

a) Should traders of digital assets be allowed to value at market price? Why?

b) Should dealers of digital assets be allowed or required to value at market price? Why?

c) Should the answers to the above two questions depend on the type of digital asset? How is it determined whether a digital asset is actively traded (according to IRC Section 475(e)(2)(A))?

Overall, we do not recommend that traders or dealers of digital assets value at market price. Our reasoning is as follows:

First, the characteristic of actively traded crypto assets is that their prices are highly volatile, thus, the tax implications of valuing at market price would increase the burden on taxpayers.

In a scenario where assets are valued at market price, if a taxpayer cannot timely exchange their crypto assets before the end of the tax year, it may lead to the disposal price of the crypto asset being lower than the tax liability. (For example, if a trader buys 1 Bitcoin on September 1, 2023, at a market price of $10,000; the market price of Bitcoin on December 31, 2023, is $20,000; and the trader sells the Bitcoin on January 31, 2024, at a market price of $15,000. At this point, the trader only realizes a gain of $5,000 but recognizes a taxable gain of $10,000.)

However, if after recognizing taxable gains, losses related to the same digital asset can offset the already recognized taxable gains, then valuing at market price could be adopted. Nevertheless, this accounting method would complicate tax operations and hinder trading. Therefore, we do not recommend that traders or dealers of digital assets value at market price.

Second, the (average) fair market value of crypto assets is difficult to determine. Actively traded crypto assets are often traded on multiple platforms; for instance, Bitcoin can be traded on Binance, OKEx, Bitfinex, etc. Unlike securities trading, which has a single market, the prices of crypto assets vary across different trading platforms, making it difficult to determine the fair value of crypto assets through "virtual sales." Additionally, non-actively traded crypto assets do not have a fair market value, thus they are also unsuitable for valuation at market price.

Finally, in an emerging industry, tax policies are often simple and stable to encourage industry development. The crypto industry is indeed an emerging sector that needs encouragement and support. Valuing at market price for tax treatment would undoubtedly increase the administrative costs for traders and dealers, which is detrimental to the growth of the industry. Therefore, we do not recommend adopting this tax policy.

We suggest continuing to use the cost basis method for taxing traders and dealers of crypto assets, as this method is simple to operate and provides policy stability, making it suitable for the current crypto asset market. At the same time, we believe that since the cost basis method is used for taxation, there is no need to consider whether the crypto asset is actively traded (according to IRC Section 475(e)(2)(A)).

2. Trading Safe Harbor (IRC Section 864(b)(2))

a) Under what circumstances should the policy behind the trading safe harbor (encouraging foreign investment in U.S. investment assets) apply to digital assets? If these policies should apply to (at least some) digital assets, should digital assets fall under the trading safe harbor for securities in IRC Section 864(b)(2)(A) or the trading safe harbor for commodities in IRC Section 864(b)(2)(B)? Or should it depend on the regulatory status of specific digital assets? Why?

b) If a brand new, separate trading safe harbor could apply to digital assets, should there be additional restrictions for commodities that meet the trading safe harbor conditions? Why? If additional restrictions should apply to commodities in this new trading safe harbor, how should terms like "organized commodity exchange" and "customarily completed transactions" be interpreted among different types of digital asset exchanges? (as in IRC Section 864(b)(2)(B)(iii))

The trading safe harbor rules do not apply to digital assets, but this is not because digital assets should not enjoy tax benefits; rather, it is due to the nature of digital assets themselves. A significant attribute of digital assets is their borderless nature, which means that the domicile of many digital asset traders is difficult to determine. Therefore, it is challenging to ascertain whether a particular digital asset transaction falls under the "traded in the U.S." provisions of the trading safe harbor.

We believe that the tax treatment of digital asset transactions can start from the perspective of resident taxpayers. If the trader is a U.S. resident taxpayer, they should be taxed according to the rules for resident taxpayers; if the trader is not a U.S. resident taxpayer, there are no tax issues in the U.S., and thus the trading safe harbor rules do not need to be considered. This tax treatment avoids the administrative costs of determining the trading location, making it simpler and more conducive to the development of the crypto industry.

3. Treatment of Digital Asset Lending (IRC Section 1058)

a) Please describe the different types of digital asset lending.

b) If IRC Section 1058 explicitly applies to digital assets, will companies allowing customers to lend digital assets establish standard lending agreements to comply with the requirements of that section? What challenges would compliance with that section present?

c) Should IRC Section 1058 include all digital assets or only a portion of them, and why?

d) If digital assets are lent to a third party and a hard fork, protocol change, or airdrop occurs during the lending period, is it more appropriate for the borrower to recognize income from such transactions, or for the lender to subsequently recognize income upon the return of the assets? Please explain.

e) During the lending period, could other transactions similar to hard forks, protocol changes, or airdrops occur? If so, please explain whether it is more appropriate for the borrower or the lender to recognize income from such transactions.

(1) Digital Asset Lending

The operation of digital asset lending involves a user providing their cryptocurrency to another user in exchange for a fee. The exact management of the loan varies by platform. Users can find cryptocurrency lending services on both centralized and decentralized platforms, with the core principle remaining unchanged. Digital asset lending can be categorized into the following types based on its nature:

Collateralized Loans: These require the borrower to provide a certain amount of cryptocurrency as collateral to obtain a loan in another cryptocurrency or fiat currency. Collateralized loans generally need to go through a centralized cryptocurrency exchange.

Flash Loans: This is a new type of lending that has emerged in the decentralized finance (DeFi) space, allowing borrowers to borrow a certain amount of cryptocurrency from a smart contract without providing any collateral, and to repay it within the same transaction. "Flash loans" utilize smart contract technology, which has "atomicity," meaning that the steps of "borrowing - trading - repaying" either all succeed or all fail. If the borrower cannot repay the funds by the end of the transaction, the entire transaction will be reversed, and the smart contract will automatically return the funds to the lender, ensuring the safety of the funds.

Similar provisions to IRC Section 1058 should apply to all digital assets. The purpose of IRC Section 1058 is to ensure that taxpayers issuing securities loans maintain a similar economic and tax status as when they do not issue loans. Similar provisions are also needed in digital asset lending to ensure the stability of traders' financial situations. The latest consultation draft from the UK regarding DeFi states: "The staking or lending of liquidity tokens or of other tokens representative of rights in staked or lent tokens will not be seen as a disposal." This principle of disposal aligns with the disposal principle of IRC Section 1058.

We can analogize the current IRC Section 1058(b) to make corresponding provisions for digital asset lending. As long as a digital asset lending transaction meets the following four conditions, there is no need to recognize income or loss:

① The agreement must stipulate that the transferor will receive back the exact same digital asset at the end of the agreement;

② The agreement must require the transferee to pay the transferor all interest and other income that the digital asset owner is entitled to during the agreement period;

③ The agreement cannot reduce the transferor's risk or opportunity for gain in the transferred digital asset;

④ The agreement must comply with other requirements prescribed by the Secretary of the Treasury through regulations.

It should be noted that applying provisions similar to IRC Section 1058 to digital assets does not mean that digital assets should be treated as securities, nor does it mean that digital assets follow the same tax treatment as securities.

After applying provisions similar to IRC Section 1058 to digital assets, centralized lending platforms can draft corresponding lending agreements for traders to use according to the regulations. For decentralized lending platforms, they can meet the corresponding regulations by adjusting the implementation of smart contracts. Therefore, the applicability of this provision will not have a significant economic impact.

(2) Recognition of Income

If a hard fork, protocol change, or airdrop occurs during the lending period of digital assets, it is more appropriate for the borrower to recognize income from such transactions for the following reasons:

First, according to trading practices, the benefits arising from forks, protocol changes, and airdrops belong to the borrower, which aligns with the actual situation of the digital asset lending market and the contract terms. Generally speaking, the digital asset lending market is a highly competitive and free market, where lenders and borrowers can choose suitable lending platforms and conditions based on their interests and risk preferences. Many digital asset lending platforms explicitly state in their service terms that any new digital assets generated from hard forks, protocol changes, or airdrops during the lending period belong to the borrower. This approach can avoid disputes and protect the rights of both parties.

Second, U.S. tax law stipulates that when a taxpayer receives new digital assets due to a hard fork or airdrop, they need to include their fair market value in taxable income. This means that when the borrower receives new digital assets due to a hard fork or airdrop, they need to recognize income when they gain control over them and recognize gains or losses when they sell or exchange them. The lender, on the other hand, does not receive new digital assets and therefore has no taxable income or gains or losses.

Third, protocol changes may alter the functions or attributes of digital assets, thereby affecting their value or tradability. For example, protocol changes may increase or decrease the supply, security, privacy, speed, or fees of digital assets. These changes may have different impacts on the borrower and the lender. Generally, the borrower has more control and risk exposure to the digital assets during the lending period, and thus they should enjoy the gains or losses arising from protocol changes. The lender, however, only regains control and risk exposure to the digital assets at the end of the loan term, and therefore they should recognize gains or losses based on the value at the time of return.

In summary, if digital assets are lent to a third party and a hard fork, protocol change, or airdrop occurs during the lending period, it is more appropriate for the borrower to recognize income from such transactions.

4. Wash Sales (IRC Section 1091)

a) Under what circumstances would a taxpayer consider the economic substance rule (IRC Section 7701(o)) applicable to wash sales of digital assets?

b) Are there best practices for reporting transactions that are economically equivalent to wash sales of digital assets?

c) Should IRC Section 1091 apply to digital assets? Why?

d) Should IRC Section 1091 apply to assets other than digital assets? If so, to what types of assets?

For this set of questions, we believe that IRC Section 1091 does not apply to digital assets for the following reasons: First, the liquidity and diversity of digital assets make it difficult to track corresponding transactions. Unlike stocks or securities, digital assets can be traded on multiple platforms and come in many varieties and types. This makes it challenging for taxpayers to track and record whether they purchased the same or very similar digital assets within 30 days. Additionally, due to price differences and arbitrage opportunities among digital assets, taxpayers may frequently transfer and exchange their digital assets across different platforms, which also increases the difficulty of enforcing wash sale rules.

Second, for specific types of digital assets, it is difficult to determine the boundaries of concepts like "same" or "similar." For example, digital collectibles (NFTs) are considered unique digital assets. Consider the following scenario: after selling an NFT, a taxpayer purchases a similarly named NFT from the market. At this point, whether the two NFTs are recognized as the same or very similar digital assets is legally ambiguous. Therefore, to avoid such issues, IRC Section 1091 may not apply to digital assets.

Finally, the non-application of IRC Section 1091 to digital assets will not lead to serious tax issues. On one hand, the characteristic of the cryptocurrency market is that value fluctuates rapidly, with frequent conversions occurring in a short period, leading to investors rarely holding cryptocurrencies "very long-term." On the other hand, the mainstream currencies in the cryptocurrency market often experience "rising and falling together." Therefore, applying wash sale rules to cryptocurrencies is of little significance, as cryptocurrencies sold at low prices will inevitably recognize income and incur tax when sold at high prices.

The chart below shows the price trends of the top 10 cryptocurrencies by market capitalization on September 4, 2023. It can be observed that, except for stablecoins, the price trends of other cryptocurrencies are often similar, indicating that the possibility for investors to indefinitely evade taxes through wash sales is minimal.

In summary, we believe that the non-application of IRC Section 1091 to digital assets will not lead to serious tax issues.

5. Constructive Sales (IRC Section 1259)

a) Under what circumstances would a taxpayer consider the economic substance rule (IRC Section 7701(o)) applicable to constructive sales related to digital assets?

b) Are there best practices for transactions that are economically equivalent to constructive sales of digital assets?

c) Should IRC Section 1259 apply to digital assets? Why?

d) Should IRC Section 1259 apply to assets other than digital assets? If so, to what types of assets? Why?

For this set of questions, we believe that digital assets should not be subject to IRC Section 1259 for reasons similar to those we provided for the previous set of questions.

First, similar to the previous question, it remains difficult to determine the boundaries of "same" or "extremely similar" digital assets. For example, in NFT trading, if an investor holds one NFT and sets up a put option for that type of NFT, the implementation of IRC Section 1259 would face challenges, as it would be difficult to confirm whether the NFTs in these two transactions are "the same."

Similarly, the non-application of IRC Section 1259 to digital assets will not lead to serious tax issues. The cryptocurrency market is characterized by rapid transitions between bull and bear markets, with frequent shifts occurring in a short time, leading to investors rarely holding cryptocurrencies "very long-term." Therefore, applying constructive sales rules to cryptocurrencies is of little significance, as the determined transaction time will soon arrive.

6. Timing and Source of Income from Mining and Staking

a) Please describe the various types of rewards provided by mining and staking.

b) How should the returns and rewards obtained from validation (mining, staking, etc.) be treated for tax purposes? Why? Should different validation mechanisms have different treatment methods? Why?

c) Should the nature and timing of income from mining and staking be the same? Why?

d) What factors are most important in determining when an individual participates in the mining industry or mining activities?

e) What factors are most important in determining when an individual participates in the staking industry or staking activities?

f) Please describe examples of arrangements for participants in staking pool agreements.

g) Please describe the appropriate treatment of various types of income and rewards obtained by individuals staking for others or in a pool.

h) What is the correct source of staking rewards? Why?

i) Please provide feedback on the Biden administration's proposal to impose a consumption tax on mining.

(1) Mining Rewards and Staking Rewards

Mining rewards mainly include block rewards and transaction fees.

Block Rewards: Block rewards refer to the amount of newly issued digital assets that miners receive for generating a new block. The quantity and rules of block rewards depend on different blockchain networks; for example, Bitcoin's block reward halves every four years, from an initial 50 Bitcoins to the current 6.25 Bitcoins.

Transaction Fees: Transaction fees refer to the fees paid by transactions included in each block, which are also distributed to miners. The quantity and rules of transaction fees also depend on different blockchain networks; for example, Bitcoin's transaction fees are set by the transaction sender and vary based on transaction size and network congestion.

Staking rewards refer to the process by which stakers support the consensus mechanism on the blockchain network and earn returns. Base Returns: Base returns refer to the digital assets distributed to stakers based on the amount and duration of their staking, according to a fixed or floating ratio.

Additional Returns: Additional returns refer to the digital assets distributed to stakers based on their performance and contributions in the network, such as validating blocks, voting decisions, providing liquidity, etc. The types and quantities of additional returns depend on different blockchain networks but can generally be categorized into the following:

· Dividend Returns: Dividend returns refer to the proportion of profits or income generated by participating in certain projects or platforms that stakers receive. For example, stakers can earn dividends from trading fees by participating in decentralized exchanges (DEX) on the Binance Smart Chain.

· Governance Returns: Governance returns refer to the governance tokens or other rewards that stakers receive by participating in governance voting for certain projects or platforms. For example, stakers can earn ETH 2.0 by participating in Ethereum's validation nodes.

· Liquidity Returns: Liquidity returns refer to the liquidity tokens or other rewards that stakers receive by providing liquidity for certain projects or platforms. For example, stakers can earn DOT by providing cross-chain asset conversion services (XCMP) on Polkadot.

The nature of rewards obtained from mining and staking is the same. Both mining and staking acquire corresponding token income through validation on the blockchain. The difference lies in that mining involves hardware computational power, while staking involves virtual currency; however, they share the same on-chain validation mechanism. Therefore, the distinction between mining and staking is merely a difference in form. We believe that for entities, income obtained from mining and staking should be treated as business income; for individuals, it can be treated as investment income.

Since the rewards from mining and staking have the same nature, the timing of income recognition should also be the same. Income from mining and staking should be reported and taxed when the taxpayer gains control over the rewarded digital assets. This typically refers to the point at which the taxpayer can freely sell, exchange, use, or transfer the rewarded digital assets.

(2) Industry Activities

We believe that the question "determining when an individual participates in the mining/staking industry or mining/staking activities" is equivalent to judging whether a person is engaged in mining/staking as a business, which may subject them to self-employment tax. Specifically, whether a person is engaged in mining/staking as a business can be assessed based on the following criteria:

Purpose and Intent of Mining: The individual is engaged in mining with the intent to earn income or profit, and there is a continuous and systematic mining activity.

Scale and Frequency of Mining: The individual uses a significant amount of computational resources and electricity and engages in mining frequently or regularly.

Results and Impact of Mining: The individual earns considerable income or profit from mining and makes significant contributions or impacts on the blockchain network.

(3) Staking Pool Agreements

A staking pool agreement generally includes the following components:

Creation and Management of the Staking Pool: Staking pool agreements are typically created and managed by one or more pool operators, who are responsible for running and maintaining staking nodes, as well as handling registration, deposits, withdrawals, and distribution for the staking pool. Pool operators usually charge a certain percentage as a fee or commission for their services.

Participation and Exit from the Staking Pool: Staking pool agreements typically allow anyone to participate or exit the staking pool with any amount of digital assets, as long as they comply with the rules and requirements of the staking pool. Participants can join the staking pool by sending digital assets to the pool's address or smart contract, and they can exit the pool by requesting withdrawals or redemptions. Participants usually receive a token representing their share or interest in the staking pool, such as rETH, BETH, etc.

Distribution of Staking Pool Rewards: Staking pool agreements typically calculate and distribute the rewards of the staking pool periodically or in real-time based on the performance of the staking nodes and the network's reward mechanism. Rewards usually include newly issued digital assets, transaction fees, dividends, governance tokens, etc. Rewards are typically distributed based on participants' shares or interests in the staking pool, after deducting the operator's fees or commissions, and are sent to participants' addresses or smart contracts.

(4) Response to Consumption Tax

The Biden administration's proposal to impose a 30% consumption tax on the mining industry is considered excessively harsh during a bear market. The comprehensive revenue of the mining industry in both bear and bull markets should be calculated to determine a reasonable tax rate, which should not be excessively higher than that for cloud services or cloud computing businesses.

The table below shows the gross profit margins of major Nasdaq-listed companies in the mining industry during the bear market (2022) and bull market (2021). In 2022, the average gross profit margin was 37.92%; however, in 2021, the average gross profit margin was 65.42%. Since consumption tax is different from income tax and is levied directly on mining income, it will directly affect the operating conditions of companies. In a bear market, a 30% consumption tax is a significant blow to mining enterprises.

Another major reason for imposing a consumption tax on the mining industry is that mining consumes a large amount of electricity, thus necessitating a penalty. However, we believe that the mining industry’s use of electricity does not necessarily cause environmental pollution, as it may utilize clean energy. If the same consumption tax is levied on all mining companies, it would be unfair to those using clean energy. The government can regulate electricity prices to ensure that mining enterprises meet environmental protection requirements.

7. Non-Functional Currency (IRC Section 988(e))

a) Should the de minimis non-recognition rule similar to IRC Section 988(e) apply to digital assets? Why? What threshold is appropriate, and why?

b) If the non-recognition rule applies, can existing best practices prevent taxpayers from evading tax obligations? What reporting system would help taxpayers comply with regulations?

The de minimis non-recognition rule in IRC 988(e) should apply to digital assets. Similar to securities investments, digital asset transactions often involve foreign exchange conversions; therefore, if every digital asset transaction requires verification of foreign exchange losses, it would impose a significant administrative burden. We believe that the limits set by IRC 988(e) are appropriate.

Applying the de minimis non-recognition regulation to digital assets may lead to taxpayers evading tax obligations. In this regard, we recommend referencing relevant national tax laws, allowing taxpayers to report each transaction without verifying foreign exchange losses, but conducting random checks at the end of the tax year to verify whether a portion of the reported foreign exchange losses has been accurately declared. If a trader fails to accurately report foreign exchange losses, they would face corresponding penalties. This system design would help taxpayers comply with reporting regulations.

8. FATCA and FBAR Reporting (IRC Sections 6038D, 1471-1474, 6050I, and 31 U.S.C. Section 5311 et seq.)

a) When should taxpayers report digital assets or digital asset transactions on FATCA forms (e.g., Form 8938), FBAR FinCEN Form 114, and/or Form 8300? If taxpayers report certain categories but not others, please explain and specify the categories of digital assets reported and not reported on these forms.

b) Should the reporting requirements for FATCA, FBAR, and/or Form 8300 be clarified to eliminate ambiguities regarding whether they apply to all or some categories of digital assets? Why?

c) Given the policies behind FBAR and FATCA, should digital assets be more included in these reporting systems? Are there any obstacles to doing so? What kind of obstacles?

d) How should stakeholders consider wallet custody when determining compliance with FATCA, FBAR, and Form 8300 requirements? Please provide examples of wallet custody arrangements and indicate which types of arrangements should or should not be subject to FATCA, FBAR, and/or Form 8300 reporting requirements.

(1) Response to Reporting Rules

Overall, we recommend designing a new form for reporting all digital assets. This would facilitate the development of the digital asset industry, as reporting digital assets on existing forms is somewhat cumbersome and may suppress trading activity.

However, if reporting must occur within existing forms, we suggest the following reporting methods:

For FATCA forms (e.g., Form 8938), taxpayers should report any form of digital assets they hold or control offshore, regardless of whether they are related to U.S. dollars or other fiat currencies. This includes but is not limited to cryptocurrencies, stablecoins, tokenized assets, non-fungible tokens (NFTs), decentralized finance (DeFi) protocols, etc. Taxpayers should convert their offshore digital assets into U.S. dollars based on the year-end exchange rate and determine whether they need to file Form 8938 based on the reporting threshold.

For FBAR FinCEN Form 114, taxpayers should report their offshore digital asset wallets, whether custodial or non-custodial, that can be considered financial accounts if the total value of these accounts exceeds $10,000 at any time. Taxpayers should convert their offshore digital assets into U.S. dollars based on the year-end exchange rate and provide relevant account information on Form 114.

For Form 8300, taxpayers should report cash or cash equivalents received from the same buyer or agent exceeding $10,000, including cryptocurrencies. Taxpayers should convert the received cryptocurrencies into U.S. dollars based on the exchange rate on the transaction date and provide relevant transaction information on Form 8300.

(2) Response to Wallet Custody

Regarding wallet custody issues, our views are as follows:

Cryptocurrency wallets are tools used to store and manage digital assets, which can be divided into custodial wallets and non-custodial wallets. Below are the definitions and distinctions of these two types of wallets:

Custodial Wallets: These refer to wallets where the encryption keys are entrusted to third-party service providers, such as exchanges, banks, or specialized digital asset custodians, who are responsible for storage and management.

Non-Custodial Wallets: These refer to wallets where individuals control their own encryption keys, such as using software wallets, hardware wallets, or paper wallets.

We believe that regardless of the type of wallet used, taxpayers should report their held digital assets on Form 8938 or Form 8300 according to existing regulations. However, for taxpayers to report digital assets on FBAR FinCEN Form 114, it must be clarified whether cryptocurrency wallets constitute foreign financial accounts. We believe that custodial wallets provided by service providers offshore can be recognized as foreign financial accounts; non-custodial wallets require further discussion.

On one hand, some non-custodial wallets may not be considered foreign financial accounts because they do not involve third-party participation or control. For example, if a user uses a hardware wallet or paper wallet and fully controls their private keys and digital assets, they may not need to report these wallets on the FBAR form, as they are merely personal property and not foreign financial accounts.

On the other hand, some non-custodial wallets may be considered foreign financial accounts because they involve third-party services or functions. For example, if a software wallet can connect to an offshore exchange or platform or provides cross-border transfer or exchange functions, it may be considered a foreign financial account.

However, whether custodial or non-custodial, if a wallet is associated with a foreign financial account, such as through cross-border transfers or exchanges conducted via that wallet, it may need to be reported on the FBAR form, as it involves a foreign financial account.

9. Valuation and Proof (IRC Section 170)

a) Digital assets currently do not meet the exception provisions for easily obtainable valuations in IRC Section 170(f)(11). Should the proof rules be amended to consider digital assets? If so, in what way, and for which types of digital assets? More specifically, for publicly traded digital assets, should different measures be taken?

b) What characteristics should exchanges and digital assets possess to appropriately apply this exception, and why?

We believe that the relevant provisions of IRC 170 should be amended to include digital asset donations. However, deductible digital assets should be limited to common, publicly traded digital assets, rather than all digital assets. Digital assets like NFTs, which are difficult to obtain fair market value for, should not be subject to the exception provisions of IRC 170(f)(11), as their transactions may be subject to artificial control. Moreover, digital assets like NFTs that are difficult to obtain fair value may be challenging to liquidate for funds, increasing the additional costs for the donee. Policies should encourage donors to donate easily liquidated cryptocurrencies.

Specifically, we believe that digital asset donations that can determine fair market value according to the spirit of Notice 2014-21 and related documents should be eligible for the exception provisions of IRC 170(f)(11), such as "virtual currencies that are traded on at least one platform with real currency or other virtual currencies and have a published price index or value data source."