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U.S. Tax Status: Dealer, Trader, or Investor?

Author: Mark Leeds and Brennan Young, Mayer Brown LLP
Published:  January 23, 2020

This White Paper is presented for general information only. It may not be relied upon as legal or tax advice. The distinctions discussed in this White Paper are highly factual and are determined on a case by case basis. Interested persons should seek direct advice with respect to the matters covered herein to their own situations.


Investors in cryptocurrency take many forms and can have a variety of U.S. federal income tax classifications. The different classifications can lead to disparate tax treatments for similar  transactions. One characteristic to consider for federal tax purposes is whether a taxpayer  investing in cryptocurrency is treated as a dealer, trader, or investor for federal tax purposes.  


The first distinction is between a dealer and a trader. The U.S. Tax Court has distilled the  distinction.1 It has described dealers as sellers who purchase their stock in trade with the  expectation of reselling at a profit, not because of a rise in value during the interval of time  between purchase and resale, but merely because they have or hope to find a market of buyers  who will purchase the assets at a price in excess of their cost. By comparison, it described traders  as those sellers whose source of supply for assets is not significantly different from that of those  to whom they sell, but who seek to earn a profit from an advantageous purchase price or  fluctuations in value. In other words, a dealer makes a profit from a bid-ask spread and a trader  depends upon changes in prices to earn a profit.  

If a taxpayer is not considered to be acting as a dealer, the next issue is whether a taxpayer  investing in cryptocurrency is considered to be engaged in a trade or business as a trader or is a  an investor for federal income tax purposes. This distinction generally boils down to the  frequency, continuity, and regularity of the activities of the participant, which is analyzed on a  case by case basis under the relevant facts and circumstances. In making this determination, the  U.S. Tax Court has looked to the number of purchases and sales transacted by a taxpayer in a  taxable year, the number days on which the taxpayer traded assets and whether the activities  were conducted in a business-like manner. There is no bright line rule as to how many trades  needs to occur during a taxable year in order for activity to rise to the level of a trade or business  in trading. In the stock context, the Tax Court has ruled that 86 purchases and 257 sales in a  single taxable year was not sufficiently extensive to give rise to a trade or business.2 In addition  to trading volume, cryptocurrency trading activity would need to be continuous in order for such  activity to give rise to a trade or business. For example, the Tax Court has ruled that daily trading  that occurs only during a single quarter of a taxable year did not result in a taxpayer being treated as a trader.3 Finally, even an active investor may not be treated as a trader for federal income tax  purposes where the investor seeks to derive profit from long-term appreciation.4

U.S. Federal Tax Significance  

The distinctions discussed above generally have tax implications in three areas: (1) whether  expenses can be deducted with respect to a trade or business, (2) whether a mark-to-market  election under Code § 475 is available, and (3) whether a non-U.S. entity is engaged in a U.S.  trade or business and subject to tax in the United States on a net income basis on income  effectively connected with that trade or business. Each is discussed below.  

Deductibility of Expenses  

If a taxpayer investing in cryptocurrency is characterized as an investor for federal income tax  purposes, the taxpayer’s investment expenses are generally miscellaneous itemized deductions.  For taxable years beginning after December 31, 2017 and before January 1, 2026, these items are  not deductible.  

In contrast, if taxpayer investing in cryptocurrency is better characterized as a trader or a dealer,  the taxpayer’s expenses associated with its trade or business would generally be deductible.  

Mark-to-Market Accounting  

Code § 475 permits dealers in commodities to elect to mark their securities to market on the last  business day of every taxable year and to report unrealized gains and losses as ordinary income  or loss. The IRS and the Commodity Futures Trading Commission have issued rules stating that virtual currencies can be treated as commodities.5 For an asset to be considered a commodity  eligible for this election, it must be actively traded within the meaning of Code § 1092(d)(1).  Whether a particular cryptocurrency is actively traded, and therefore potentially a commodity  eligible for mark-to-market treatment, is another factual analysis.  

Under Code § 475(f), a trader can elect mark-to-to-market treatment for its securities or  commodities, with some exceptions. The advantage of using mark-to-market accounting is that  net losses will be treated as ordinary losses that, subject to certain limitations, can be used to  shelter other forms of income. The disadvantage of using mark-to-market accounting is that  income will always be ordinary and regardless of the taxpayer’s holding period, gains will never  be characterized as long-term capital gains.  

U.S. Trade or Business  

Assume a corporation that invests in cryptocurrency is organized in the Cayman Islands, is  treated as a corporation for U.S. federal income tax purposes, but is externally managed from the  United States. The activities of the manager could be attributed to the Cayman corporation. The  question is whether this activity gives rise to a trade or business in the United States, such that  income effectively connected with that trade or business is subject to U.S. federal income  taxation on a net basis.  

If the Cayman corporation is treated as a dealer for federal tax purposes, the corporation is likely  to be treated as engaged in a U.S. trade or business.  

If the Cayman corporation is treated as an investor, its gains from cryptocurrency trading should  not be subject to net U.S. federal income tax. If the Cayman corporation is treated as a trader for  federal tax purposes, if the cryptocurrency is properly treated as a commodity, an exception to  the corporation being treated as engaged in a trade or business may be available. Under Code §  864(b)(2), a taxpayer that is trading in securities or commodities for its own account is not  treated as engaged in a trade or business in the United States. As discussed above, a  cryptocurrency may be a commodity for this purpose (and under current law, is unlikely to be  treated as a security). The trading safe harbor for commodities is generally available if (a) the  commodities are of a kind customarily dealt in on an “organized commodity exchange,” and (b)  the transaction at issue is of a kind customarily consummated at such place.  

If the above exception does not apply and the Cayman corporation is a trader, it may be treated  as engaged in a U.S. trade or business and be subject to U.S. federal income tax on a net basis on  income effectively connect with that trade or business.  


1 See Kemon v. Commissioner, 16 T.C. 1026 (1951).  

2 See Neuman de Vegvar v. Commissioner, 28 T.C. 1055 (1957).

3 See Chen v. Commissioner, T.C. Memo 2004-132 (2004).  

4 See Yaeger v. Commissioner, 889 F.2d 29 (1989), holding that over 1,000 purchase and sale transactions in a  taxable year did not cause a taxpayer’s trading activities pursued “vigorously and extensively” to rise to the level  of a trade or business of being a trader, because most of the taxpayer’s sold securities were held for more than a  year and none were held for less than three months.  

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