Crypto Trading Earnings of 40,000 Are Taxed 130,000, That's the U.S. Tax Law Musk Was Mocking

On January 3rd, Musk posted on his social media: "A customer bought $7000 worth of cumrocket and staked it for 3 months to earn 6900% APY. They then sold it, took profits, and invested in NFTitties, but the developer rugged the project, and they only managed to liquidate 10% of the funds. Can the customer deduct the coin's gas fee to balance short-term capital gains tax?"

To truly understand what Musk was sarcastically referring to and why he repeatedly dissed the IRS, BlockBeats reached out to professional tax experts from TaxDAO. They have been providing professional cryptocurrency financial management software and crypto tax advisory services in the Web3 space since 23 years ago. Recently, they developed a professional cryptocurrency financial tax management software, FinTax, that caters to both B2B and B2C clients, using an AI Agent to help users address all cryptocurrency financial and tax-related needs in one place.

Through their explanation of US tax law and calculations based on the provided numbers in the image, we were able to further elucidate the current and future state of cryptocurrency taxation in the US.

Image Interpretation: An Unreasonable Tax Story

First, let's interpret what the image is really telling us about a tragic story:

This is an example of calculating taxes on cryptocurrency investments. The tax calculation in the example can be broken down into three stages. The first stage is staking income, taxed as ordinary income in individual income tax, which is a progressive tax rate ranging from 10% to 37%. The second stage is where the investor mints NFTs with the staking rewards earned, which falls under investment activity and should be subject to capital gains tax. The third stage is the investment failure, rug pull in the project, with a 90% loss. In 2023, the IRS issued a memo on tax treatment of worthless or abandoned cryptocurrency assets, stating that if a taxpayer has lost control of cryptocurrency assets (as the investor in the image sold the devalued cryptocurrency), the resulting loss can be used to offset pre-tax income. However, since this is an investment activity, it can only offset capital gains tax, with provisions allowing a maximum offset of $3000 of ordinary income based on marital status.

Based on the scenario in the image, let's assume the customer is a single individual, the staking income was paid out in a lump sum after three months, and upon receiving the staking rewards, the customer immediately sold them all and invested in the NFT project with no other income. We can then calculate the tax implications of this series of transactions as follows:

（1）The customer purchased $7,000 worth of Cumrocket and staked it for 3 months, earning a 6,900% interest rate. Therefore, the earnings were $7,000 * 6,900% = $483,000. According to IRS regulations, this income is considered ordinary income rather than capital gains.

（2）The subsequent investment in NFT amounted to $7,000 * 7,000% = $490,000.

（3）After investing the crypto asset profits into an NFT project, due to a Rug Pull, only 10% of the funds could be salvaged, resulting in a loss of 90% of the funds, which amounts to a loss of $490,000 * 90% = $441,000. As this amount has been realized through liquidation, it qualifies as a deductible capital loss.

Capital losses are first used to offset similar capital gains. In this case, there are no capital gains resulting from a coin price increase, so the $441,000 capital loss cannot offset any capital gains. Assuming the customer is single, according to IRS regulations, this capital loss can offset up to $3,000 of ordinary income for the year. Additionally, the standard deduction for a single individual is $13,850. Therefore, the customer's taxable ordinary income = $483,000 - $3,000 - $13,850 = $466,150. Based on the progressive tax rate table for ordinary income, they would 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.

Therefore, as seen from the above calculation, after a series of financial activities, the investor ends up with only a $50,000 surplus (including the initial $7,000 principal). Yet, they are required to pay as much as $130,000 in taxes for the year, highlighting the absurdity of the U.S. cryptocurrency tax laws, which is why Musk has repeatedly criticized the IRS regulations.

Cryptocurrency Tax Disputes: Unraveling Complexity

Why has Musk been consistently dissatisfied with U.S. crypto tax laws? FinTax tax experts analyze the following two reasons:

1. The U.S. tax system itself is complex, with each jurisdiction having its own regulations and high compliance costs, almost 10 times that of China.

2. Since 2023, the U.S. has specifically enacted tax laws for the cryptocurrency sector, but they have not been tailored to the characteristics of the industry, still approaching it from a traditional sector perspective. There may be some inherent legal flaws; even if the legal basis is sound, as the government solely uses traditional tax administration methods to regulate crypto companies, it is challenging for companies to achieve real compliance.

The case in the illustration is a very typical problem. Some taxpayers have businesses that make money, while others have businesses that lose money. However, these two profitable and unprofitable businesses cannot offset each other in a specific tax scenario. Therefore, it is possible to end up not making any money but still having to pay a significant amount of tax, leading to an awkward situation. A similar case is the dispute between the Jarretts and the IRS regarding whether taxed should be paid on pledged assets.

Related Readings:

《U.S. Cryptocurrency Broker Rules: Bitter Medicine or Lethal Poison?》

《IRS Maintains Position on Taxing Cryptocurrency Staking: Analyzing the Jarrett v. U.S. Case》.

On the other hand, due to its decentralized and anonymous nature, cryptocurrency has also become a tool for some individuals to evade taxes. This type of case has become one of the most common disputes in the cryptocurrency field.

Taking the famous "Bitcoin Jesus" case as an example, the main character of the case, Roger Ver, was born in Silicon Valley, USA, in 1979. He started investing in Bitcoin in 2011 and actively promoted the application and value of Bitcoin, driving its early adoption and accumulating significant influence in the cryptocurrency field. Therefore, he was dubbed the "Bitcoin Jesus" by the media and the cryptocurrency community.

In 2014, Roger Ver obtained citizenship in the Federation of Saint Kitts and Nevis and shortly afterwards renounced his U.S. citizenship. According to U.S. tax law, individuals who renounce their citizenship must fully declare the capital gains on their global assets, including the amount of Bitcoin held and its fair market value. The IRS believed that Roger Ver concealed or underreported the value of his personal assets before renouncing his citizenship. After renouncing his citizenship, he obtained and sold about 70,000 Bitcoins from a U.S.-based company under his control, earning nearly $240 million in income, thereby evading at least $48 million in taxes.

In response, the IRS mainly made two accusations: first, that Roger Ver did not comply with the expatriation tax rules, and second, that he violated his tax obligations as a non-U.S. taxpayer.

Roger Ver's case's success rate may be influenced by various factors. On the favorable side, his legal team argued that the tax law's provisions regarding cryptocurrency assets are unclear, providing arguments for the defense based on the existence of loopholes in the tax system. They also accused the prosecution of selective enforcement, which, if proven with sufficient evidence, could weaken the legitimacy of the IRS's prosecution. It is also worth noting that the Trump administration intended to end harsh regulations on cryptocurrency assets, which may bring a turning point to the case. However, on the unfavorable side, the prosecution has substantial specific evidence, including the $48 million in unpaid taxes and a series of tax evasion records, all of which likely meet the statutory requirements for tax evasion charges.

The Bitcoin Jesus Case has sounded the alarm for tax compliance in the cryptocurrency industry, especially serving as a significant cautionary tale for individual cryptocurrency investors. The strengthening of international cooperation and advancements in technology are continuously narrowing the space for investors to evade taxes. For investors in the cryptocurrency industry, tax compliance has become a crucial issue that cannot be avoided.

Related Reading: "IRS vs. Bitcoin Jesus: The Compliance Risk Behind a $48 Million Tax Bill"

Wealth Tax: The Sword of Damocles for the Cryptocurrency Industry

In addition, a series of "corporate tax" and "wealth tax" measures introduced during the early days of the Biden administration have certainly made Elon Musk bleed.

After Biden took office in 2020, to fulfill his political ambitions, he initiated multiple large-scale infrastructure plans. However, high expenditures must be supported by high tax revenues. The burden fell on American corporations and the wealthy to foot the bill for this plan, with Musk undoubtedly becoming a target of Biden's strategies. When Biden unveiled the 2023 budget, he proposed a new tax plan targeting the wealthy, imposing a minimum income tax of 25% on individuals with a net worth exceeding $1 billion, including both standard taxable income and the annual returns of "tradable assets" (such as stocks, bonds, mutual funds, and other securities). According to a 2021 report by ProPublica, Biden's billionaire tax plan would have tech giants like Musk paying between $35 billion and $50 billion in taxes. In that year, the news of "Musk facing an $11 billion tax bill" became a hot topic, marking the highest individual tax payment in U.S. history.

Under the new regulations, the U.S. capital gains tax will reach a historic high, image source from the U.S. Department of the Treasury

After raising the fiscal year 2025 budget to $7.3 trillion, Biden once again proposed a tax on unrealized gains and plans to tax the unrealized gains of trusts, enterprises, and other non-corporate entities that have not experienced a recognition event in the past 90 years. Taxing unrealized gains means that even if individuals or businesses (with a net worth over $1 billion) hold tradable assets such as stocks and bonds that have not been sold, they still need to pay a 25% minimum income tax on the increased value.

This legislation is akin to a declaration of war against the venture capital sector, which considers valuation growth as its underlying logic. When discussing this tax plan, Bill Ackman stated that the Democratic Party should not pursue tax policies that would "destroy the U.S. economy," mentioning scenarios where if someone invests $1 billion in your startup at a $10 billion valuation and you own a 50% stake, you would immediately incur a $1 billion tax bill... "All U.S. startups would go bankrupt as a result, and no one would want to start a business in the U.S." In a recent podcast episode, two founding partners of A16Z also expressed similar sentiments. This legislation is like holding a precarious Sword of Damocles over the heads of startups, where a massive tax burden could deliver a fatal blow at any time, constraining the development of entrepreneurship and investment.

David Sacks warned at a tech conference earlier this year that such taxation could stifle the practice of startup companies offering stock options to founders and employees, stating that "this is a key reason why Silicon Valley takes seriously who it votes for." The investment community believes that this tax policy will greatly distort the investment behavior of American investors, especially when it comes to small-cap stocks and startups. These companies are often the engines of economic growth and innovation, but they rely on investors willing to take risks for future returns. However, when unrealized gains are also included in the tax base, investors will no longer favor growth-oriented companies because these companies' valuations often fluctuate more than larger, more mature companies.

Read more: "Silicon Valley Turns Right: Peter Thiel, A16Z, and the Political Ambitions of Cryptocurrency"

The Future of Crypto Taxation

Since the birth of the cryptocurrency market, the issue of taxation on its transactions has been a focal point of debate. The core contradiction lies in the differing positions of the government and investors: the government aims to increase fiscal revenue through taxation, while investors are concerned that high taxes will reduce investment returns.

Even in countries where cryptocurrency trading fervor is high, such as South Korea, authorities have continuously attempted to regulate the crypto field through heavy taxation. This has involved not only a game of regulation between government agencies and the market but also a struggle for discourse power between the Democratic Party and the People Power Party.

The South Korean Democratic Party had long planned to impose a 20% tax (22% local tax) on cryptocurrency gains, originally scheduled to take effect on January 1, 2022. However, due to strong opposition from investors and the industry, this plan has been postponed twice to January 1, 2025. Following a press conference on December 1, 2024, the tax enforcement was postponed again to 2027. The ruling People Power Party has further proposed a delay in implementation until 2028.

However, overall, South Korea has taken a cautious approach to cryptocurrency taxation, refraining from mandatory regulation of the market. On one hand, this has provided the market with time and space for natural development, and on the other hand, it has offered a valuable window for observing the effects of policy implementation in other countries and global regulatory trends. Based on the lessons learned from others' experiences, South Korea aims to establish a more comprehensive tax system.

The attitude of the United States towards the crypto market has been positive since the Trump administration. From the SEC chairman to the Treasury Secretary, and to the "Crypto Tsar" overseeing coordination, the "Crypto Team" of the Trump administration not only represents significant policy adjustments but also signals a potential major turning point for the U.S. cryptocurrency industry. However, regarding the government's stance on taxation, tax experts at FinTax hold a conservative view, believing that while Trump made many favorable policy commitments to the crypto industry before taking office and will continue to roll out policies thereafter, taxation will only become stricter. The reason is that Trump's support for the crypto industry stems from recognizing its crucial role in the U.S. financial system and technological development, believing that it can bring new increments to the fintech field, and this increment must be reflected at the tax level. Therefore, the future of crypto taxation will become clearer, and tax administration will move towards more stringent measures.

An ironic picture posted by Musk triggered a coin frenzy, sparking new imaginations in the crypto space. In the U.S. Treasury's release of the 2025 cryptocurrency tax system, rules related to DeFi and non-custodial wallet providers have been temporarily suspended, indicating the U.S. government's cautious approach to cryptocurrency tax policy development. In the future, whether in terms of the adaptability of tax policies or regulation of tax evasion, the U.S. tax law still has a long way to go. We look forward to the cryptocurrency industry galloping forward like a wild horse breaking free, while also being guided in the right direction by a strong rein.

References:

Overview of U.S. Cryptocurrency Tax System;

IRS Regulation: Staking Rewards Taxed as Ordinary Income;

Ordinary Income Tax Rates and Capital Gains Tax Rates;

Individuals' Capital Losses in Excess of Capital Gains can Offset up to $3,000 of Ordinary Income;

Cryptocurrency Asset Income categorized as Ordinary Income;

Cryptocurrency Asset Transactions subject to Capital Gains Taxation;

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