The impact of the infrastructure bill on crypto tax regulation ￼
- The days of digital asset holders not paying taxes or paying them incorrectly seem to be over.
- At Tearsheet's inaugural Bankchain conference, TaxBit's Seth Wilks took a deep dive into what the infrastructure bill means for crypto tax regulation, accounting guidance for digital assets, and how can a compliance program be created.
As institutional adoption of cryptocurrency grows, so is the Internal Revenue Service’s pursuit of Americans who aren’t paying or are incorrectly filing taxes on them.
The rules in the Biden administration’s $1 trillion infrastructure bill passed in November 2021 mandate that brokers must report all digital asset transactions, including new requirements to the Securities and Exchange Commission and the Internal Revenue Service.
The new cryptocurrency tax provision will come into effect in January 2023 but reporting would not be required until the 2024 deadline. This new bill has implications for millions of SMBs, enterprises, hedge funds, and any institution that holds digital assets.
“Crypto exchanges and banks planning to offer digital assets to their clients should be prepared to comply with the new reporting rules,” according to Seth Wilks, senior director of government relations at TaxBit, a platform for crypto tax and accounting.
Many House Democrats are calling for amendments in the bill, just like crypto supporters and many senators have already tried. The debate is centered around how the bill defines a “broker,” who, under the current text, will be required to report its customers’ crypto gains in a type of 1099 form.
So what’s in the infrastructure bill?
The first part of the new reporting rules in the infrastructure bill involves a modified definition of a broker.
“There was some gray area about whether centralized crypto exchanges fell under that definition but with the infrastructure bill in place, it is clear that they are part of that definition,” said Wilks.
Speaking at Tearsheet’s inaugural Bankchain conference, Wilks said a broker is any entity that is responsible for regularly providing any service in handling transfers of digital assets on behalf of another client, which crypto advocates say is too broad. The most controversial part of this bill is that DeFi platforms would be included in this definition – which could potentially include miners, software developers, and others involved in crypto that cannot know who their customers are because of the anonymous nature of crypto mining, and are therefore not equipped to report the required information that a broker is asked to report by the new law.
The second part of the new rules targets the crypto transfer statement requirement. This means if an exchange fits into the stated definition of a broker, it is required to file a new type of 1099 Form – likely to be called a 1099 DA (digital asset) by the IRS. This form would be used when customers move tokens from one entity to another, like from an exchange into their own electronic wallets. Today, many transfers don’t include sharing the original purchase information, and the cost basis data is lost. To prevent this loss, the IRS will require the broker to file a return report that otherwise would have been in a transfer statement, similar to a 1099 that traditional brokerages like TD Ameritrade and Merrill Lynch use.
“Most of this is all very similar to what's already happening in the traditional finance world, which I think is a good and maturing step for our industry,” said Wilks.
For example, if a consumer wants to move her Bitcoin from Coinbase to Kraken, more detailed information entailing how much the Bitcoin was bought for, when it was bought, the holding period and related information needs to be provided to the new exchange – so that when it is sold on Kraken, Kraken knows what to report in the consumer’s 1099.
Lastly, under the new rules, transactions that are over $10,000 will need to be reported to the IRS through the Form 8300. Failure to report the identity of the person or report crypto transactions of that size could lead exchanges to get hit with interest, penalties, or even criminal charges.
Before filing the new 1099, there are a few steps involved that exchanges need to take care of, like customer onboarding and KYC review – similar to how they transact in a traditional brokerage world.
The bill would require brokers to obtain a Form W-9, which is a request for a taxpayer identification number (TIN) and certification, from their US customers — both new and preexisting — or withhold 24% of the proceeds of sales.
There’s an operational lift for crypto firms to be able to handle this reporting, especially if they hadn’t built it at the onset. TaxBit uses an API with its clients so it can scan its crypto customers’ transactions at scale.
“We can transform those transactions to run validations on their socials to make sure that they're valid, just so that we know that we're ready and prepared for the next round of reporting,” Wilks said.
Accounting guidance for digital assets
The first comments by the IRS in this space came through Notice 2014-21 in 2014, where it acknowledged the use of virtual currency – and stated that for federal tax purposes, virtual currency is treated as property with the application of general tax principles.
The financial reporting for digital assets doesn’t fit cleanly into existing accounting guidance under US generally accepted accounting principles (GAAP), and therefore, many certified accounting firms have requested the Financial Accounting Standards Board (FASB) to address this concern and formulate new rules that reflect the reality of what these assets are and what is the nature of their business.
After years of foot-dragging on the crypto issue, it is on FASB’s roadmap to form new audit and accounting rules for crypto assets, more so after the infrastructure bill surfaced. On May 11, 2022, The FASB unanimously voted to add digital asset accounting to its technical agenda to analyze a fair value approach to this class of digital assets.
The purpose of adding digital assets accounting to FASB’s technical agenda list leads to the first step of it authorizing the staff to begin performing research and development on the accounting needs for stakeholders, and based on that coming up with recommended solutions. Once the working issues have been addressed, the Board will generally approve and publish an exposure draft made available for public comment. The staff will present the feedback to the Board, and the Board will again vote internally on whether or not to finalize the accounting guidance.
Accordingly, the accounting guidance becomes authoritative and companies will adopt and implement the guidance based upon the transition timeframe outlined within the standard.
How do the Treasury and IRS create a compliance program, and what are the challenges faced by enterprises and tax platforms?
The private sector is probably more equipped for these regulations than the IRS, according to Wilks, and so a lot of the executives in Treasury and the IRS are concerned about coping with their own systems that need to overcome technological obstacles.
“They should be thinking about major systems upgrades to be able to collect all this data. But once they have the data, they should be thinking about what do we do with this information? How to create a good compliance program? What should be the perimeters to create red flags, or dismiss one for something that's been properly reported?” he said.
A modern compliance program can be created if the Treasury and IRS develop new systems to be able to take in information to comprehend, assemble, and put it to good use.
One of the biggest challenges he sees for the exchanges and accounting platforms in building a compliance program to adhere to new tax rules is the challenge of conducting a deep dive into clients’ data starting from the onboarding process. In addition, brokers would need to implement processes to respond to notifications of name/TIN mismatches from the IRS.
“A major issue we have to deal with is a lot of data-digging – helping consumers clean up and un-clutter their data and put it into a better shape that is usable for compliance purposes,” Wilks told the attendees of the conference.
A lot of crypto exchanges have had explosive growth. As a result, their tax filing capabilities may have taken a back seat, which makes it harder and time-consuming for accounting platforms to retrieve the information they need.
End users also use different platforms, making it complicated to consolidate all their data. For example, they may use one platform for trading and another platform for lending. In this case, the data needs to be further assembled and merged to create a record of a single user.
To navigate this, Wilks encourages exchanges to come up with strategies about how to persuade customers into compliance. Like a two-sided coin, it has operational and user experience aspects to it. The challenge will be in striking a balance between the two.