The IRS has just released much-anticipated guidance on crypto tax reporting for ‘crypto brokers’ - clarifying that both centralized and decentralized exchanges, as well as potentially even online wallets - will soon be required to report to the IRS using the new Form 1099-DA. Learn what it means for the crypto industry, as well as for you and your taxes.
What’s in the IRS proposed regulation?
The IRS released a 282-page document of proposed regulations for crypto brokers, designed to help end the confusion and administrative burden on taxpayers around crypto tax reporting. We haven’t all got time to read everything, so here’s the TLDR:
- The IRS has just released much anticipated proposed guidance on crypto tax information reporting for crypto brokers.
- The majority of the new guidance focuses on the new Form 1099-DA, which was first announced in 2021 as part of the Infrastructure Bill to specifically address reporting digital assets. The Joint Committee of Taxation (JCT) estimated that the Infrastructure Bill would raise almost $28 billion over 10 years.
- The IRS update outlines who needs to report and what is proposed to be reported. There are no additional taxes or a change to the tax rates for crypto as part of these updates. They cover what a broker is in the context of crypto which defines the type of businesses that need to report information to the IRS.
- The updated regulations are set to come in for the 2025 tax year, meaning brokers will need to report tax information to the IRS from 2026.
- The proposed form appears to include requirements to report wallet addresses and transaction hashes.
- The update outlines who needs to report and what needs to be reported.
- This includes outlining what a broker is in the context of crypto - and defining the kinds of crypto businesses that will need to report information to the IRS.
- Decentralized entities are brought into the definition of a ‘digital asset broker’.
- Miners and stakers are not brought into the definition.
- Unsurprisingly, the proposed guidance has been met with harsh criticism from the industry.
- The IRS is inviting comments on the proposed regulations within 60 days, and public hearings are scheduled for November 7 - November 8, 2023.
What’s a crypto broker under the guidance?
The IRS has included a clearer definition of the term broker in the proposal. As it stands, the definition in the context of crypto includes both centralized and decentralized crypto exchanges, crypto payment processors, and even some hosted crypto wallet providers. The inclusion of decentralized exchanges and wallets has caused many in the industry to voice concern about the new proposals, particularly as much of the information required on form 1099-DA is not retained by decentralized applications.
The proposal does not however include miners or stakers in the definition of crypto brokers. This will come as a welcome relief, as there was no clarity previously as to whether this proposal would create undue administrative reporting requirements on forgers.
Brokers would need to send the new 1099-DA form to both the IRS and digital asset holders to assist with their tax preparation.
The attempt to include hosted wallets in the definition of a broker is particularly confusing. The proposal states, "In general, only the user of an unhosted wallet has access to both the public and private keys necessary to effect transactions in the digital assets associated with those keys.”
However, despite recognizing this, the proposal also attempts to find third parties “responsible for effectuating transfers on behalf of” a wallet user. This could be particularly challenging for decentralized wallet providers who do not hold such information.
The small silver lining is that under the proposal, these new reporting requirements won’t come into effect until 2025, giving crypto businesses a much longer time period than previously expected to prepare for the new requirements.
1099-DA: What we know so far
The proposal didn’t actually include an example of the new 1099-DA form. The form 1099-DA was first proposed in the Infrastructure Bill as a new tax form (like the existing 1099 forms), specifically created to aid in reporting digital assets. While the proposal includes information about the new 1099-DA form - there are still many unknown specifics.
Form 1099-DA will report information about the sale or disposition of digital assets - including crypto, tokens, stablecoins, and NFTs. The form will report the same information that’s currently reported on Form 1099-B for stocks:
- When you got the digital asset (acquisition date)
- How much you paid for it (cost basis)
- When you sold or swapped it (sale or disposition date)
- How much money you got from selling or swapping it (sales proceeds)
- Gross proceeds (total proceeds from that exchange or broker, not taking cost basis into account)
Under the current proposal, you can expect your first 1099-DA in January 2026, as brokers will be required to begin issuing DA forms from the 2025 financial year and beyond.
The biggest implication of the introduction of the 1099-DA is that crypto brokers will have to start sharing information with the IRS, in particular, around the cost basis of assets.
While crypto exchanges do not currently do this, stock brokers often do. Of course, cryptocurrencies tend to be transferred more regularly than traditional assets. This may create a heavy administrative burden for crypto brokers to comply with new regulations. Additionally, there are also questions raised around whether the information reported will provide an accurate picture of gains and losses when individuals transfer crypto across multiple exchanges and wallets.
What else is in the proposal?
While the proposal largely focuses on the potential reporting requirements for crypto brokers, there are some other key pieces of information in there, including cost basis calculation, digital assets as a distinct third category of assets, and a reversal of the previous ruling on the tax treatment of hard forks. In brief:
- Cost basis calculation: The proposal addresses the calculation of the basis of digital assets, requiring the use of the Spec ID method.
- Third category of assets: The proposal clarifies that digital assets would be treated as a third distinct category of assets, separate from securities and commodities, with unique characteristics and tax treatment.
- Reversal of Revenue Ruling 2019-24: The proposal would reverse 2019-24, which states digital assets received following a hard fork are treated as taxable income. Under this guidance, taxpayers could provide information to the IRS regarding the claim and disposition of these assets.
What was the reaction from industry experts?
In a press release, IRS Commissioner, Danny Werfel, stated, “These proposed regulations are designed to help end confusion involving digital assets and provide clear information and reporting certainty for taxpayers, tax professionals, and others… We want to make sure everyone pays what they owe under the tax laws, and our research and experience demonstrate that third-party reporting improves compliance. We welcome comments on these proposed regulations as we work to finalize the rules in this complex and evolving area."
Meanwhile, the reaction from those in the industry - in particular from decentralized organizations - was largely negative. CEO of lobbying group DeFi Education Fund, Miller Whitehouse-Levine, tweeted that the rules were “confusing and self-refuting… as feared, it strains to find non-existence financial intermediaries in crypto”
Koinly’s Head of Tax, Danny Talwar, said, “These developments show the continued focus from the IRS on crypto taxation. It is likely that there will be increased scrutiny on crypto-related activities in the coming years, so it’s more important to calculate and report your crypto taxes to the IRS.”
What happens next?
The IRS is inviting comments on the proposed regulations within 60 days, and public hearings are scheduled for November 7 - November 8, 2023.
We’ll do our best to keep you updated but in the meantime, whilst the IRS is focusing on crypto tax, it’s important to consider how you’ll keep track of your crypto investments to report profit and losses at tax time this year. Koinly can help you keep track of your gains, losses, income, expenses, and more to help ensure you keep up to date with your crypto tax liability.
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