The Internal Revenue Service’s proposed classification of non-fungible tokens (NFTs) as digital assets has raised concerns in the blockchain industry and among stakeholders. While these tokens are unique, the IRS’s broad categorization of NFTs as securities has led to calls for clearer regulations, especially as NFTs can also be collectibles. Industry experts seek clarification on when NFTs should be treated as collectibles or financial instruments. Additionally, the IRS’s intent to issue guidance on NFTs as collectibles conflicts with these proposed rules. As NFTs are distinct from cryptocurrencies and represent ownership of various items, there’s a need for clear tax rules. Despite the IRS’s expanded digital asset enforcement, NFTs currently don’t pose a significant enforcement challenge compared to cryptocurrencies.
Law360 covered the topic in an article on September 14, 2023 where Gray Reed Partner Joshua Smeltzer was one of the experts interviewed. Board Certified in Tax Law by the Texas Board of Legal Specialization, Joshua uses his experience as a former litigator for the U.S. Department of Justice to defend clients in tax audits, tax appeals, and litigation in Federal District Court, U.S. Tax Court, the U.S. Court of Federal Claims, and tax issues in U.S. Bankruptcy Court.
The IRS also announced this month the expansion of its digital asset enforcement as part of a heightened scrutiny on ultra-wealthy businesses and individuals. The agency expects to develop more digital asset cases in fiscal year 2024 to narrow the annual tax gap — the difference between taxes owed and taxes actually paid —which is estimated to have hit nearly $500 billion However, the IRS warned that the actual amount might be more due to the increased use of cryptocurrency and offshore tax noncompliance. But unlike cryptocurrencies, NFTs currently do not pose a huge enforcement problem for the IRS, according to Joshua Smeltzer, a tax attorney who co-leads Gray Reed & McGraw LLP’s blockchain and digital assets practice.
Subjecting NFTs to the digital asset reporting rules would impose a significant burden on business owners who end up being considered NFT brokers and have to set up a compliance system to avoid being penalized, Smeltzer said.
For that reason, it is premature for the IRS to subject NFTs to the digital asset reporting rules, Smeltzer said. In contrast to cryptocurrencies, for which the IRS has a trove of data detailing issues with underreporting of trades and exchanges, the agency has relatively little data on NFTs, he said.
“There doesn’t seem to be any sort of basis or support that NFTs themselves pose a huge enforcement risk,” Smeltzer said.
The proposed rules seem like a “theoretical justification that it could or might be an enforcement problem in the future,” he said.
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