How are you calculating taxes on Steem income?

Tax treatment of cryptocurrencies has always been difficult. According to IRS guidelines a cryptocurrency should be treated and taxed like property based on its dollar value at the time you receive it and/or spend it. This guidance makes using cryptocurrency for real world purchases a nightmare, but technically doable.

I am not a tax accountant, so please get professional advice. You are fully liable for the consequences of acting on my opinion. What follows is just one opinion on what I think might be a reasonable stance to take.

Factoring in Low Liquidity

It is less clear how to establish the value of a cryptocurrency when the total daily volume is statistically insignificant let alone when the depth of the various order books is less than the amount you might want to sell.

We all know that paying someone 100,000 STEEM based upon the current "market price" of 1 STEEM is not the same as paying them $32,500. Attempting to sell 100,000 STEEM would be selling 2x the entire order book on the highest volume exchange.

In other words the value of 100,000 STEEM, the instant you receive it, is not the marginal market price times the quantity, but the theoretical amount of dollars you would have in your pocket if you dumped it all at once. For highly liquid coins, like Bitcoin or Ethereum, this is effectively the same for 99% of all payments which are for amounts that would not move the market. For illiquid coins, market depth matters.

This has an interesting implication for estimating value. Receiving 1 STEEM could be taxed at a higher valuation than receiving 100,000 STEEM. Right now the theoretical value of 1 STEEM is $0.325 which means 100,000 STEEM would be worth $32,500. Paying self-employment income taxes on $32,500 would yield a tax obligation of (15% FICA+25% INCOME) totalling 40% or $12,800. Based upon current market depth, selling all 100,000 STEEM wouldn't even yield enough to pay theoretical taxes.

Considering the unreasonable outcome of using the marginal price, I would use the estimated value based on selling it all on the market. It is also reasonable to group income from the same day. Receiving 100,000 STEEM in 100,000 payments on one day is no more "real income" than receiving 100,000 STEEM in one payment.

Factoring in Steem Power Vesting

Steem Power is an interesting beast, not only is it measured in STEEM, a low liquidity asset, but it is technically impossible to sell more than 1% per week. The IRS has not given any guidelines on how to deal with complex smart contracts for tax purposes.

This means that the Steem community needs to adopt a consistent theory and apply it until guidelines are made clear. The one thing that we cannot do is change our theory from year to year in whatever way makes taxes the least.

When you receive Steem Power it is economically equivalent to having funds deposited to a Spendthrift Trust where you are the beneficiary. The "trustee" that gets to make decisions over dispersion is the blockchain itself. The beneficiary of a trust only pays taxes at the time funds are disbursed from the trust.

The implication here is that you can defer income taxes until you receive funds from the "trust". The side effect is that you will pay the full income tax rate on any capital gains earned on your Steem Power while it is held by the trust. If Steem never amounts to anything and you never withdraw your Steem Power then in theory no taxes are due.

An interesting side effect of this interpretation is that dispersions from the trust do not normally pay self-employment taxes. This means you would pay a 25% tax rather than 25% + 15%. Normally the trust would pay taxes at the time the trust earns income, however, a blockchain based smart contract is not a legal entity, has no jurisdiction, and is technically incapable of paying any taxes on its income.

Selling an Account

The trust angle has one extra caveat: you have the ability to sell the trust. This is made possible by updating the owner key on the account to a key that belongs to someone else. Having the ability to sell your account means that you have technically receive an immediate benefit anytime Steem Power is added to your account. The value you receive would increase the value of your account which could be interpreted as income.

This is where things get interesting. Because the account is "indivisible" any gains in its value could be considered capital gains. It would be like owning shares in a company. Income to the company that is kept in the company's bank account results in capital gains for the shareholder. You only pay taxes on capital gains when you sell your stock, not when the company receives income. Normally the company would pay taxes on retained earnings, but in this case the "company" is not a legal entity and has no ability to pay taxes on the retained earnings.

This means that tax planning just got a lot more complicated. Which is better:

• Pay 25% income tax as you receive income by powering down
• Pay 15% long term capital gains tax, but be forced to find a buyer for your full account

Steem Dollars

Income earned from Steem Dollars is significantly easier to tax. I would count it as self-employment income valued at $1.00. If you are unable to sell it for $1.00 then you can claim a capital loss on the difference at the time of sale. If you sell it for more than $1.00 then you will have to pay a capital gains tax.

In the event that Steem Dollars are illiquid and you would reasonably expect to take a haircut by selling all of your Steem Dollars the moment you receive them, then you might be able to use a similar valuation estimate as used for other illiquid cryptocurrencies. This may lower your income tax the year you receive it, but you will have to pay a corresponding capital gains tax if and when you do sell them for a dollar in the future.

Impact of Powering Up

When you convert Steem into Steem Power it could be viewed as depositing money into a self-settled trust. The money deposited is assumed to be after-tax money. This means that if you use Steem Dollars to buy STEEM and then Power Up, you may still owe taxes on the Steem Dollars received. In other words, Powering Up is not a means to escape taxes on income.

When you eventually Power Down you do not have to pay income taxes on the principle you originally Powered Up, only any gains. In this case, the gains would be measured as capital gains on the VESTS asset that you purchased when Powering Up. VESTS is how Steem keeps track of your share in a global fund holding the STEEM of all users who have powered up. This fund receives new STEEM every block, but that new STEEM should not be considered as income or interest to holders of VESTS. It is income to the fund, which may result capital gains to the holders of VESTS. The true value of VESTS depends upon the market value of all STEEM held in the fund. The issuing of new STEEM to the fund is really more similar to a stock-split than interest. From this perspective, VESTS should be considered its own cryptocurrency token that is bought and sold for STEEM.

Alternative View

There is an alternative view that could also be applied to Steem and could drastically simplify your tax accounting. If you view Steem as a massively multiplayer online game (MMOG) then all of the STEEM, STEEM Dollars, and Steem Power you earn are just valueless points in a game. When it comes to online games, most players only choose to report income the moment they sell their game tokens for fiat. From this perspective, you would only owe income taxes the moment you decide to cash out.

This view is also supported by the like-kind exchange laws. STEEM, Steem Power, and Steem Dollars are all crypto-assets. More specifically, they are all crypto-assets on a single blockchain whose value is ultimately backed by the same token, Steem.

Some people may even argue that all cryptocurrencies are of a like-kind. According to Wikipedia:

Six types of property are not eligible for a like-kind exchange: (1) stock in trade or other property held primarily for sale; (2) stock, bonds, or notes; (3) other securities or evidences of indebtedness or interest; (4) interests in a partnership; (5) certificates of trust or beneficial interests; and (6) choses in action.

According to a recent report cryptocurrencies are substantially different from all other existing investments. Reasonable people have made a compelling case that this is a new asset class. Given this class has not been explicitly noted as ineligible for like-kind exchange status, one might reasonably adopt this position when filing taxes. It all depends upon whether the subjective opinion of a judge. A judge might consider the tokens "other property held primarily for sale" classify them with other assets excluded from "like-kind" exchanges.

There is only one reason to hold purse currencies: speculation and future sale. That said, it is clearly not "stock in trade" or "inventory" which may be closer to the intent of the phrase. Currencies such as Ethereum and Steem and WoW gold have other reasons to hold them which will help defend this position.

Don't worry about being wrong

This area of the tax code is so vague that any reasonable theory that is consistently followed will likely protect you from any criminal charges or heavy fines. The most likely outcome in the event the government disagrees with your theory is a reassessment of your taxes due plus interest. The likelihood of an audit that could trigger such a reassessment is also astonishingly small.

Tax Laws are not Logical

There is no requirement for governments to be rational nor logically consistent. Future rulings by unelected bureaucrats interpreting the incomprehensible tax codes may find one or more of the opinions expressed above to be invalid. Unfortunately we live in a world where the government often expects us to have the superhuman ability to predict how their unfathomable laws will be interpreted by a partisan judge.

There are no guarantees. Find a reasonable opinion, stick to it, and in the event you are forced to defend it I am sure you can make ample money blogging about your experience on Steem.