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US Treasury, IRS Release Proposed Crypto Tax Reporting Rules

US Treasury, IRS Release Proposed Crypto Tax Reporting Rules

If approved, the US Treasury and IRS proposed crypto tax reporting rules mean big changes for DeFi in the US.

The financial press is abuzz with news surrounding the US Treasury Department’s proposed crypto tax regulations. These regulations, which could have far-reaching consequences for the crypto market, cover a range of crypto niches, including stablecoins, NFTs, and DeFi platforms.

This post looks at the origins of these regulations, the affected crypto niches, and an overview of what the rules could mean for the crypto landscape.

The Genesis of the US Treasury Crypto Regulations

In the summer of 2021, US politicians introduced the Infrastructure Investment and Jobs Act (IIJA ) bill, a colossal $1.2 trillion spending package. Within its 2,700 pages was a section of provisions to regulate the crypto industry, mainly focusing on defining a “broker.”

While it makes sense to include crypto exchanges under the definition of brokers, the provision’s wording raised some red flags in the crypto community. It broadly defined a crypto broker as “any person responsible for effectuating transfers of digital assets on behalf of another person.”

When taken literally, that definition could include exchanges and other players such as miners, validators, and decentralized applications (dApps), potentially subjecting them to KYC and IRS reporting requirements. The Treasury Department did clarify that it wouldn’t target cryptocurrency miners and validators but remained silent on other crypto niches like dApps.

The implications could be almost fatal for the crypto industry in the United States. Enforcement would effectively cripple various crypto activities, given that compliance with IRS reporting requirements would be impossible for many decentralized entities.

President Biden signed the bill into law in November 2021, laying the groundwork for the Treasury Department’s proposed crypto tax rules.

The US Treasury Proposed Crypto Tax Rules

Fast forward to the present, and the Treasury Department has unveiled a 300-page proposal for crypto tax rules that could affect DeFi, NFTs, and crypto wallets. It’s important to note that these rules are still in the proposal stage and open for public comments until the end of October 2022, with public hearings scheduled in early November.

If approved, these rules will go into effect in 2026, impacting crypto transactions starting in 2025. Companies that fail to adhere to the regulations may face a ban in the United States.

Key takeaways from the proposed rules:

  • Expanding the definition of who is and is not a “broker” in crypto.
  • Require brokers to begin sending Form 1099-DA to the IRS and investors in January 2026 to report crypto activity from 2025.
  • Crypto payment processors and wallets offering various features, such as fiat-crypto ramps, swaps, and connections to dApps, could be classified as brokers, requiring them to collect KYC information.
  • Multisignature wallets could also be classified as brokers, leading to KYC requirements and potential privacy concerns.
  • The Treasury explicitly targets decentralized exchanges within the DeFi space, aiming to expand the definition of brokers to include DeFi operators.
  • Stablecoins will be digital assets subject to IRS reporting like other cryptocurrencies. However, the Treasury is open to reclassifying stablecoins, potentially protecting them from specific tax rules.
  • NFTs remain in a gray area. Artists would not be considered brokers, but NFT marketplaces and exchanges might.
  • The Treasury’s actions could have a ripple effect globally as it collaborates with the Financial Action Task Force (FATF) on crypto regulations.

Wallets as Brokers

The Treasury’s broker definition aligns with that original one in the infrastructure bill, with an added provision stating that an individual qualifies as a broker “if the nature of their service arrangement with customers is such that they would typically possess knowledge of, or the capacity to discern, the identity of the party conducting the sale and the inherent characteristics of the transaction, which could potentially lead to the generation of gross proceeds.”

By the way, the word “person” also covers corporations because, in the US, corporations are people too.

This clause excludes cryptocurrency validators and some crypto wallet providers from the broker umbrella because they would not ordinarily know, or be in a position to know, who they are processing transactions for.

However, the document explicitly calls out some crypto wallet provider activities that would qualify them as brokers – “Some providers of unhosted wallet also provide their users unhosted wallet services with online platform services, which may include links or other mechanisms for direct access to third-party services that allow users to buy and sell digital assets held in their unhosted wallets.”

In simpler terms, if a personal crypto wallet provides access to converting crypto to fiat, swapping capabilities, or connections to DApps and DeFi protocols, it falls under the category of a broker.

This clause is ominous for the industry because it implies that most browser and mobile wallets may soon be obligated to gather KYC information from users. This situation could pose significant challenges, as many companies could not bear the associated costs. It could also lead to consolidation in the wallet industry, limiting consumer options and creating an oligarchy of wallet providers.

DeFi in Jeopardy

The Treasury’s proposed regulations explicitly target operators of decentralized exchanges within the DeFi space. The Treasury is attempting to expand the definition of a crypto broker to encompass DeFi.

Given that requiring DeFi protocols to collect Know Your Customer (KYC) information from all users is almost impossible, the rules raise concerns that the United States aims to ban DeFi.

This rule could hinder innovation and adoption at home and abroad since the US significantly influences how crypto regulation evolves in other developed markets. Higher compliance costs could also lead to consolidation and fewer options for consumers.

Heads or Tails with Stablecoins

Stablecoins face a critical question—whether regulators should classify them as digital assets or currency. Remember that stablecoins can represent competition for the US dollar in all forms, digital or fiat. Some analysts feel that the Treasury’s current stance on stablecoins may signal a preference for a central bank digital currency (CBDC) over privately issued stablecoins.

Regardless of the motivations, the proposed regulations consider stablecoins digital assets, subjecting them to the same reporting requirements as regular cryptocurrencies. The designation also classifies stablecoin issuers as brokers.

However, the crucial question is whether stablecoin issuers must collect KYC (Know Your Customer) information from stablecoin holders or solely from those who mint and redeem their stablecoins for fiat currency.

As the US government’s financial arm, the Treasury is keenly interested in stablecoins. After all, the US government debt often backs them. This fact means that when individuals buy stablecoins, they indirectly support US government spending—an outcome favorable to the Treasury.

Overall, the Treasury’s position on stablecoins is multifaceted, and it remains open to potential reclassifications or unique subsets that could provide stability for stablecoins against these proposed crypto tax rules.

(More) Bad News for NFTs

The Treasury’s proposed crypto tax rules also extend their reach to the world of non-fungible tokens (NFTs), marking a significant shift in their treatment. Under these rules, NFT marketplaces would be classified as brokers, potentially mandating KYC procedures on platforms like OpenSea if the regulations pass in their current form.

Furthermore, the US Securities and Exchange Commission (SEC) recently issued its first enforcement action related to NFTs, a departure from their previous approval of tokenized art offerings.

This change raises questions about why US authorities are altering their stance on NFTs. The Treasury’s proposed crypto tax rules shed light on this change, stating that “given that NFTs are popular investments, the buying and selling of NFTs raise Tax Administration concerns similar to the concerns associated with other types of digital assets that the physical analogues of NFTs do not.”

Additionally, NFTs are highly liquid and versatile, with the potential to evolve beyond collectibles, possibly serving as a means of payment or collateral for loans in the future.

One possible bright spot is that the Treasury doesn’t seem interested in pursuing creators of NFT collections who are primarily artists selling NFTs representing their work. However, there’s a potential gray area when creators maintain control over collections through governance tokens or multi-signature arrangements, as this could align with the rules governing other digital assets.

In summary, the US Treasury’s inclusion of NFTs in its proposed crypto tax rules signifies a shift in the regulatory landscape for these unique digital assets. Some analysts think the Treasury seems open to the evolving nature of NFTs, so further developments and clarifications in the regulatory environment for NFTs will likely evolve.

Moving Ahead

As the crypto community navigates the evolving regulatory landscape, the proposed tax rules have far-reaching implications for the industry. The decentralized nature of cryptocurrency is at odds with governmental control and consumer protection laws. The industry may have to make significant compromises to survive in the US. The outcome of the public comment period and subsequent decisions will determine the future of crypto in the United States, which will influence the global regulatory approach.

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This material has been prepared for informational purposes only and should not be interpreted as professional or legal advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.

Kala Philo