The US Treasury Department has unveiled proposed regulations aimed at enforcing taxation compliance for cryptocurrency dealings. The objective of the rules is twofold: to curtail tax evasion and raise US government revenue and to simplify tax reporting for those earnestly adhering to the law.
The proposed regulations are the product of provisions included in President Biden's 2021 infrastructure bill that mandated brokers to report crypto sales to the IRS and all businesses to report large crypto transactions like cash transactions. The revenue raising measures were projected to generate approximately $28 billion in tax revenue over a decade. Although the measures were intended to become effective from the 2023 tax year, the Biden administration missed the deadline for implementing regulations.
While industry advocates such as the Blockchain Association suggest that these rules could aid tax compliance for crypto traders if executed appropriately, there are concerns about the scope of the proposed regulations and in particular the range of crypto market participants who may be subject to reporting obligations and whether they can practically comply with the proposed rules.
Blockchain Association CEO Kristin Smith stated:
If done correctly, these rules could help provide everyday crypto users with the necessary information to accurately comply with tax laws. However, it's important to remember that the crypto ecosystem is very different from that of traditional assets, so the rules must be tailored accordingly and not capture ecosystem participants that don't have a pathway to compliance.
The scope of those covered by the proposed regulations as a "broker" in the context of crypto-asset services remains quite unclear despite significant industry concerns raised when the infrastructure bill was first passed. The proposed broker definition would apply reporting requirements to persons that:
provide facilitative services that effectuate sales of digital assets by customers...provided the nature of the person's service arrangement with customers is such that the person ordinarily would know or be in a position to know the identity of the party that makes the sale.
This unwieldy definition risks stretching far beyond just centralised cryptocurrency exchanges to DeFi platforms that operate via autonomous software as well as some wallet providers, although miners and validators appear likely to fall outside scope.
The proposed regulations will require all brokers, including cryptocurrency exchanges like Coinbase and Binance, to report to the Internal Revenue Service (IRS) in a manner akin to conventional brokers. A central element of the proposed regulations is the preparation and transmission of annual reports to the IRS, presented as 'Form 1099-DAs', detailing the gross proceeds from transactions.
Cryptocurrency exchanges will also need to report the cost base for crypto-asset transactions (i.e. revealing the amount customers paid for their holdings). The difference between the sale price and the cost base determines the capital gains (as is also broadly the case with Australian taxation law).
The regulations outline a timeline that requires brokers to provide reports on gross sale proceeds from crypto-asset transactions, beginning in early 2026. In the subsequent year, these platforms would be obliged to report the cost base for transactions, but only for assets acquired starting from 2023. It's important to note that these rules do not alter the taxable nature of transactions; rather, they focus on the methodology of reporting for each transaction and determining the capital gains.
The implementation of these rules also introduces potential challenges. The requirement to track and transmit cost base information when customers transfer assets between different cryptocurrency exchanges could result in complexities.
The newly proposed rules also do not deal with the situation where customers transfer assets from their personal digital wallets into their exchange accounts. For example, the situation where an investor who purchased BTC several years ago may transfer the asset to their exchange account in order to crystallize a gain and realize profit.
Third-party service providers have emerged to assist crypto investors in managing transaction records and tax preparation (like CryptoTaxCalculator). While these services can yield inconsistent results, leaving taxpayers with potential discrepancies in capital gains, they also provide an innovation solution which addresses some of the challenges which the US regulations seek to address.
While the proposed regulations could streamline tax procedures for investors, they also exemplify some of the challenges where government seek to simply read across existing regulatory concepts to novel technology. Australia would be well advised to consider these complexities and innovative solutions as part of its pending cryptocurrency taxation update. As the blockchain landscape continues to evolve around the world, the debate over effective regulation and taxation of digital assets remains a crucial point of discussion.