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US Cryptocurrency Taxes in 2024: IRS Proposed Regulations Explained
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August 2023: proposed regulations
On August 25, 2023, the U.S. Treasury and the IRS released proposed regulations that would require companies engaged in digital asset-related services to file disclosure statements and provide beneficiary statements for digital asset-related provisions.
The proposed regulations provide clarification on several important aspects, including which digital assets are subject to reporting, who qualifies as a broker, how to calculate basis in a digital asset, and the treatment of digital assets as a separate category distinct from securities and commodities.
Source: Federal Register
“A key part of this effort fits into 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 insight into assets of high-income individuals as well as others who use them,” said IRS Commissioner Danny Werfel.
The regulations define “digital asset intermediary” broadly, including entities such as trading platforms, wallet providers and payment processors. Under these proposed regulations, brokers would be tasked with reporting sales of digital assets, with an expanded definition of “digital asset.”
These regulations are expected to become effective for transactions occurring on or after January 1, 2025, with certain reporting aspects having later effective dates. It is important to note that these regulations are still in the proposal stage and may undergo further revisions.
Definition of digital assets and brokers
The proposed U.S. Treasury and IRS regulations expand the definition of reportable digital assets to include stablecoins, NFTs and tokenized stocks, excluding virtual assets limited to closed systems such as 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 pegged to a stable asset such as a fiat currency (e.g., USD Coin, Tether).
- Non-fungible tokens (NFTs), unique tokens that represent ownership of digital assets such as works of art or collectibles.
- These digital assets serve various purposes within blockchain and digital finance systems.
The definition of “broker” is expanded to cover entities that provide “facilitation services” for the sale of digital assets, requiring detailed transaction reporting, including customer information and specifics of the sale.
Additionally, the Infrastructure Investment & Jobs Act expanded the definition of “broker” to include those who facilitate digital asset transfers for others. This applies to any digital representation of value recorded on a distributed ledger.
US tax experts have been vocal about the lack of clarity in current tax regulation. For example, proposed regulation § 1.6045–1(a)(21)(iii)(A) defines a facilitation service as any service that directly or indirectly enables the sale of digital assets. Excludes persons engaged solely in providing distributed ledger validation services, such as proof-of-work or proof-of-stake, without offering any other functions or services.
According to a Bloomberg law relationship, due to the lack of clarity, many stakers and staking companies are taking a conservative approach. They report the value of reward tokens as income when they are created, rather than when they actually receive income by selling their reward tokens.
Tracking crypto revenue via application forms
The IRS is now tracking cryptocurrency earnings by asking taxpayers on Form 1040 about their crypto assets. The form specifically asks whether people are engaged in receiving, selling, sending, exchanging or acquiring virtual currency. Providing false information can lead to penalties, as tax returns are legally binding declarations.
On January 22, 2024, the IRS remembered Taxpayers must answer a question about digital assets and report any related income when filing their 2023 federal tax return, similar to what is required for their 2022 tax return.
The question appears at the top of the forms:
- 1040Tax return for natural persons;
- 1040-SRUS Income Tax Return for Seniors;
- 1040-NRIncome Tax Return for Nonresident Aliens in the United States.
- 1041US Income Tax Return for Estates and Trusts;
- 1065US Return of Partnership Income;
- 1120US Corporate Income Tax Return;
- 1120-S, U.S. Income Tax Return for an S Corporation.
The Digital Assets question asks taxpayers whether, at any time during 2023, they received digital assets as a reward, prize, or payment for property or services, or whether they sold, exchanged, or otherwise disposed of a digital asset or financial interest in a digital resource.
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 submitted a draft Form 1099-DA aimed at calculating taxable profits or losses arising from intermediated digital asset transactions. This form includes token codes and wallet address fields, which are essential for reporting to both taxpayers and the IRS.
The 1099-DA form includes individual token codes, wallet address spaces, and details on how to locate transactions on the blockchain. Brokers are required to report digital asset arrangements on this form to both taxpayers and the IRS, potentially leading to recognized gains for taxpayers.
However, the cryptocurrency industry remains uncertain as to how the IRS will identify brokers subject to these regulations, particularly regarding different types of businesses such as kiosks, payment processors, and wallet providers. The absence 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 regulation could involve multiple brokers in a single transaction. For example, if a user uses a self-hosted wallet with a DeFi platform for a token exchange, both the wallet provider and the DeFi platform could 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 confuse taxpayers, leading to over-reporting or discrepancies with IRS data, adding to the burden on taxpayers.
Additionally, the proposed rule’s portfolio-by-portfolio identification approach could pose a challenge to taxpayers who hold assets with low basis in specific portfolios. You may need to transfer high-basis assets to such wallets to identify them.
Cryptocurrency Brokers: Who Are They?
The Infrastructure Investment and Jobs Act, effective January 1, 2024, requires cryptocurrency brokers to report transactions over $10,000 to the IRS. This has sparked controversy due to perceived burdens and implementation challenges.
Brokers must file detailed reports with the IRS within 15 days of qualifying transactions, including sender information. The lack of guidance from the IRS leaves users uncertain about compliance, particularly regarding miners, validators, decentralized exchanges, and anonymous transactions.
Starting January 1, 2025, the proposed regulations would force brokers such as digital asset trading platforms, payment processors, and specific hosted wallet providers to report gross proceeds using Form 1099-DA and provide customers with beneficiary account statements .
Additionally, under certain conditions, brokers should include details of profit/loss and basis for sales occurring after January 1, 2026 in such returns and statements to assist clients with tax preparation.
According to PwC relationship, the IRS expects to receive an unprecedented volume of “eight billion” 1099-DA reports each year, with associated costs expected in the billions. Businesses will face challenges implementing the proposed regulations if the effective dates remain unchanged.
Cryptocurrency Industry Reaction to IRS
Variants Jake Chervinsky characterized the IRS’s proposed regulations as rules that “don’t make sense.”
He believes the IRS’s approach is driven by a perception of tax evasion, leading them to rely on financial surveillance. Chervinsky argues that the IRS is overlooking technology that enables peer-to-peer transactions without intermediaries capable of conducting KYC checks and reporting transactions.
Jason Schwartz, tax partner and co-head of digital assets at Fried Frank, noted that the new definition of digital asset broker does not help differentiate brokers.
On November 7, 2023, the DeFi Education Fund (DEF) filed a brief supporting James Harper’s appeal against the IRS, with the aim of limiting government access to users’ transaction history on cryptocurrency platforms.
Harper was one of thousands of Coinbase users whose data was disclosed to the IRS in 2017, prompting a legal challenge to strengthen digital privacy rights. DEF argues that the regulations proposed on August 27 would overbroaden the definition of “broker,” impose burdens on individuals and entities unable to comply, and jeopardize privacy.
Source: IRS.gov
IRS guidance sources
The processing of cryptocurrency is subject to limited guidelines, including: