Regulation
US Crypto Taxes in 2024: Proposed IRS Regulations Explained
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August 2023: regulatory proposals
On August 25, 2023, the U.S. Treasury and IRS released proposed regulations that would require companies engaged in digital asset services to file information returns and provide beneficiary declarations for digital asset dispositions.
The proposed regulations clarify several important aspects, including which digital assets are subject to reporting, who qualifies as a broker-dealer, how to calculate the basis of a digital asset, and the treatment of digital assets as a separate category from securities and commodities.
Source: Federal Register
“A key part of this effort is part of the IRS’ broader compliance focus on wealthy taxpayers. We must ensure that digital assets are not used to hide taxable income, and the proposed regulations are designed to provide clearer visibility into the activities of high-income individuals as well as others who use them,” said IRS Commissioner Danny Werfel.
The regulations define “digital asset intermediaries” broadly, encompassing entities such as trading platforms, wallet providers and payment processors. Under these proposed regulations, broker-dealers would be required to report sales of digital assets, with an expanded definition of the term “digital asset.”
These regulations are expected to come into effect for transactions made on or after January 1, 2025, with some aspects of the declaration having later effective dates. It is important to note that these regulations are still in the proposal stage and may be subject to further revisions.
Definition of digital assets and brokers
Proposed regulations from the U.S. Treasury and IRS expand the definition of reportable digital assets to include stablecoins, NFTs, and tokenized stocks, excluding virtual assets limited to closed systems like video game tokens.
A digital asset is a representation of value recorded on a secure, distributed ledger. Common types include:
- Convertible virtual currency and cryptocurrency (e.g. Bitcoin, Ethereum).
- Stablecoins, which are cryptocurrencies linked to a stable asset like a fiat currency (e.g. USD Coin, Tether).
- Non-fungible tokens (NFTs), unique tokens representing ownership of digital assets like artwork or collectibles.
- These digital assets serve various purposes within blockchain and digital finance systems.
The definition of a “broker” is expanded to cover entities providing “facilitation services” for digital asset sales, requiring detailed transaction reporting including customer information and sale details.
Additionally, the Infrastructure Investment and Jobs Act expanded the definition of “broker” to include those who facilitate transfers of digital assets for third parties. This applies to any digital representation of value recorded on a distributed ledger.
American tax experts have denounced the lack of clarity in current tax regulations. For example, proposed regulation § 1.6045-1(a)(21)(iii)(A) defines a facilitation service like any service allowing directly or indirectly a sale of digital assets. This excludes persons solely engaged in providing distributed ledger validation services, such as proof of work or proof of stake, without offering other functions or services.
According to a Bloomberg law report, due to a lack of clarity, many proof-of-stake players and staking companies are taking a conservative approach. They report the value of the reward tokens as income at the time they are created, rather than when they actually receive income from selling their reward tokens.
Tracking Crypto Income via Request Forms
The IRS now tracks cryptocurrency income by asking taxpayers on Form 1040 about their crypto activities. The form specifically asks whether individuals participate in receiving, selling, sending, exchanging, or acquiring virtual currency. Providing false information may result in penalties, as tax returns are legally binding declarations.
On January 22, 2024, the IRS recalled Taxpayers must answer a question about digital assets and report any related income when filing their 2023 federal income tax return, the same as was required for 2022 tax returns.
The question appears at the top of the forms:
- 1040Personal income tax return;
- 1040-SRUS tax return for seniors;
- 1040-NRIncome tax return for non-resident aliens in the United States.
- 1041U.S. tax return for estates and trusts;
- 1065U.S. Partnership Income Return;
- 1120US corporate income tax return;
- 1120-S, US tax return for an S corporation.
The digital assets question asks taxpayers whether, at any time in 2023, they received digital assets as a reward, reward, or payment for goods or services, or whether they sold, exchanged, or otherwise disposed of an asset digital asset or a financial interest in a digital asset.
The question may vary slightly depending on the type of taxpayer (individual, corporation, partnership or estate/trust). In addition to checking the box, taxpayers must report all income related to digital asset transactions.
April 2024: draft form 1099-DA
On April 18, 2024, the IRS unveiled a draft Form 1099-DA aimed at calculating taxable gains or losses arising from transactions traded in digital assets. This form includes token codes and fields for wallet addresses, essential for reporting to taxpayers and the IRS.
Form 1099-DA includes individual token codes, spaces for wallet addresses, and details on how to locate transactions on the blockchain. Broker-dealers are required to report digital asset dispositions on this form to taxpayers and the IRS, which could lead to recognized gains for taxpayers.
However, the cryptocurrency industry remains uncertain about how the IRS will identify broker-dealers subject to these regulations, particularly with respect to different types of businesses like kiosks, payment processors, and wallet providers. The lack of a formal digital asset registry complicates compliance for brokers, including centralized exchanges and decentralized platforms.
Digital asset intermediary problem
The broad definition of “digital asset intermediary” in the proposed regulations could involve multiple broker-dealers in a single transaction. For example, if a user uses a self-hosted wallet with a DeFi platform for a token exchange, the wallet provider and the DeFi platform can be considered intermediaries.
Unlike the securities rules, there is no exemption for multiple intermediaries, so each must file its own Form 1099-DA with the IRS and the taxpayer. This could cause confusion among taxpayers, leading to excessive reporting or discrepancies with IRS data, thereby increasing the burden on taxpayers.
Additionally, the portfolio-by-portfolio identification approach proposed by the regulations could pose problems for taxpayers holding assets with low bases in specific portfolios. They may need to transfer significant assets to these wallets to identify them.
Crypto brokers: who are they?
The Infrastructure Investment and Jobs Act, which took effect January 1, 2024, requires crypto brokers to report transactions over $10,000 to the IRS. This has sparked controversy due to perceived burdens and implementation challenges.
Brokers must submit detailed reports to the IRS within 15 days of qualifying transactions, including sender information. The lack of guidance from the IRS leaves users uncertain about compliance, especially when it comes to miners, validators, decentralized exchanges, and anonymous transactions.
Beginning January 1, 2025, the proposed regulations would require broker-dealers such as digital asset trading platforms, payment processors, and specific hosted wallet providers to report gross proceeds using Form 1099-DA and to provide payee statements to clients.
Additionally, under certain conditions, brokers will be required to include gains/losses and basic details for sales made after January 1, 2026 on these returns and statements to assist clients in preparing their tax returns.
According to PwC report, the IRS expects to receive an unprecedented volume of “eight billion” 1099-DA reports per year, with associated costs estimated in the billions. Businesses will have difficulty implementing the proposed regulations if the effective dates remain unchanged.
Crypto Industry Reaction to the IRS
Variants Jake Chervinsky called the IRS’s proposed regulations rules that “don’t make sense.”
He believes the IRS’s approach is driven by a perception of tax evasion, which leads it to rely on financial oversight. Chervinsky says the IRS is neglecting technology that enables peer-to-peer transactions without intermediaries capable of performing KYC checks and reporting transactions.
Jason Schwartz, tax partner and co-head of digital assets at Fried Frank, highlighted how the new definition of digital asset intermediary does not help differentiate brokers.
On November 7, 2023, the DeFi Education Fund (DEF) submitted a brief support James Harper’s appeal against the IRS to limit government access to users’ transaction history on cryptocurrency platforms.
Harper was one of thousands of Coinbase users whose data was leaked to the IRS in 2017, leading to a legal challenge for stronger digital privacy rights. DEF argues that the regulations proposed on August 27 would expand the definition of “broker” too broadly, impose burdens on individuals and entities unable to comply, while endangering privacy.
Source: IRS.gov
IRS Guidance Sources
The processing of cryptocurrencies is subject to limited guidelines, including: