A&M Tax Advisor Weekly
New tax reporting requirements for cryptocurrency transactions established by the Infrastructure Investment and Jobs Act (IIJA), enacted into law on November 15th, are causing angst in the crypto community. The questions and concerns stem in part from requirements that, without further guidance from Treasury and the IRS, could be far-reaching and possibly contrary to positions the government has taken. In addition, the proposed Build Back Better Act (BBBA) reconciliation bill recently passed by the House (discussed here) sweeps in crypto transactions into existing anti-abuse rules.
Both the IIJA and proposed BBBA essentially integrate digital assets into existing frameworks in the Internal Revenue Code in what could be just the beginning of new rules affecting the crypto market. Specifically, this alert discusses:
Currently, the value of the worldwide cryptocurrency market is almost $2 trillion. (Please see our other alert introducing cryptocurrency and the blockchain.) With the innovation and burgeoning popularity of digital assets, evolving issues such as tax evasion and tax noncompliance prompted Congress to impose new tax reporting requirements for crypto transactions, which are estimated to raise $28 billion in new tax revenue over a 10-year period. It is important for affected members in the crypto market to start changing the way they operate to comply with the tax reporting rules.
The IIJA expands the definition of “broker” for purposes of reporting proceeds from certain transactions to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Additionally, the IIJA added “digital asset,” which is defined as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary,” to the list of specified securities. This broad definition could be interpreted as encompassing more than traditional crypto, and including, for example, non-fungible tokens (NFTs), tokenized real property, and other uses of blockchain technology. The new crypto broker reporting requirements apply to returns and statements required to be filed after December 31, 2023.
As a result, people who will be deemed crypto brokers must report specific information on Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” unless the IRS determines otherwise, to both customers and the IRS. That information includes: (1) the name, address, and phone number of each customer; (2) the gross proceeds from any sale of digital assets; and (3) long-term or short-term capital gains or losses on digital assets. Crypto brokers that fail to report such information will be subject to a $250 penalty per customer, up to a maximum penalty of $3 million.
A&M Insight: The expanded reporting is generally welcomed by retail investors, many of whom have had difficulty tracking their own cost bases, often requiring the use of third-party software. For many crypto companies, however, the new broad definition of broker could be overwhelming. Although the IIJA likely targets centralized exchanges where consumers trade digital assets, it also encompasses other participants in the crypto market, such as miners, software developers, node operators, and transaction validators, who would not be able to collect the relevant information for tax reporting. It would be helpful if Treasury could exclude non-custodial companies from the definition of “broker” in future guidance.
Several lawmakers recently expressed similar concerns with the broad reach of the provision and introduced legislation which has ranged from an outright repeal of the cryptocurrency provisions to other proposals, including the bipartisan “Keep Innovation in America Act,” which would narrow the definition of broker and essentially exclude market participants that would not have access to the required information.
Another change made by the IIJA is classifying digital assets as cash under the rules governing the reporting of cash receipts. As a result, any person engaged in a trade or business that receives more than $10,000 in digital assets in a single transaction must report to the IRS on Form 8300, “Report of Cash Payments Over $10,000 Received in a Trade or Business”: (1) the name, address, and taxpayer identification number of the person from whom digital assets were received; (2) the amount of digital assets received; and (3) the date and nature of the transaction. Failure to comply with this requirement can result in civil penalties up to a maximum of $3 million per year and much higher penalties if the recipient intentionally disregards the requirement. In addition, a recipient who “willfully” violates this requirement potentially commits a felony facing up to 5 years imprisonment or, for corporate violators, up to a $100,000 fine.
The cash transaction reporting requirements apply to returns and statements required to be filed after December 31, 2023.
A&M Insight: Since 2014, the IRS has held that virtual currencies are “property” for tax purposes, thereby requiring taxpayers to recognize gain or loss on all sales and exchanges of virtual currencies. Congress’ treatment of digital assets as cash seems contrary to that position and suggests that taxpayers may be able to claim that digital assets are currency for tax purposes. But without further guidance from the IRS, uncertainties remain as to what taxpayers should do.
To comply with the cash transaction reporting rules, taxpayers would need to be diligent in tracking crypto transactions and the valuations in US dollars of the digital assets received, which could be complex depending on how the transaction is facilitated. Under current IRS guidance, taxpayers generally need to determine fair market value of digital assets based on an exchange rate established by market supply and demand as of the date of receipt and determined in a reasonable manner that is consistently applied. Special rules apply for “off-chain” transactions not facilitated by a cryptocurrency exchange or for which a published value of the digital asset does not exist.
Although the BBBA is still under negotiation as the Senate’s process is underway, two anti-abuse rules that could affect the tax treatment of crypto transactions are noteworthy: the wash sale and constructive sale rules.
The proposed wash sale rules would prohibit taxpayers from reporting a loss from selling digital assets and then repurchasing them within 30 days. The constructive sale rules would prevent taxpayers from artificially deferring gains by taking offsetting long and short positions on a digital asset (e.g., short sales against the box). After taking the offsetting position, taxpayers would have to pay capital gains tax on the long position even if the asset is not actually sold.
The constructive sale rules would apply immediately after the date of enactment and the wash sale rules would apply beginning in 2022.
A&M Insight: Retail investors should consider whether to execute certain transactions as part of their year-end tax planning. The ability of Congress to pass the BBBA this year remains uncertain, but even if it is deferred until 2022, it is unclear the extent to which the crypto anti-abuse rules would be retroactive.
Lawmakers’ heightened attention on cryptocurrency is not surprising, but their solutions for integrating digital assets into existing tax frameworks present challenges for market participants and traps for the unwary. Entities affected by the new reporting rules should assess current capabilities and establish plans for ensuring compliance. Regarding the proposed anti-abuse rules, affected taxpayers should assess business and tax implications and plan accordingly. If you would like to discuss your situation and potential financial and operational challenges, please feel free to contact Chris Kotarba.