Crypto and other digital assets are currently facing the unprecedented prospect of 1099 tax reporting over transactions where substantive tax law about those transactions is still unsettled, according to Jessalyn Dean, vice president of tax information reporting at Ledgible.
In contrast, the traditional financial services industry has often had the benefit of a decade of largely settled tax law before being required to layer 1099 tax reporting on top of transactions.
"The traditional financial services industry has been given far more time to implement various components of tax reporting, while the digital assets industry is being given a shockingly short window to stand up their entire operating models," she said.
Dean made the point at an Internal Revenue Service hearing on
"It's an unusual set of rules," she said. "Most proposed regulations don't get that much attention from the public. There were 120,000 public comments, many from the general public, which makes it harder to find the comments from CPAs and organizations."
Ledgible was the first of 12 stakeholders to speak at the hearing, and the only one with a focus on how traditional financial products can fall under the rules. "For example, a mutual fund can be on a blockchain, but it's still a mutual fund," she said. "We don't believe that the IRS intended to capture those traditional products."
The proposed regulations will require tokenized mutual funds by default to be reported on a Form 1099-DA, Dean noted. "Recognizing that this is double reporting on a Form 1099-B, the IRS has proposed a coordinating regulation so the sales or exchanges of tokenized mutual funds would only be reportable on the Form 1099-DA and reporting on the 1099-B would end."
Ledgible strongly disagrees with this proposal and insists that 1940 Act mutual funds that are already reportable on Form 1099-B should remain so.
"Most alarmingly, the proposed regulations requiring Form 1099-DA reporting instead of the B reporting would cause tokenized money market funds to lose their exception to reporting and would therefore create a real de-incentivization to the mutual fund industry to tokenize their mutual funds," said Dean.
"For many decades, shareholder record-keepers have invested significant amounts of their operating budget into software and infrastructure that is adapted to these existing 1099-B tax form structures," she added. "The cost to these brokers would be enormous to overhaul their cost basis and 1099 reporting software and infrastructure for a specific subset of their mutual refunds, even though they are economically identical to and regulated in the same way as their non-tokenized counterparts."
Dean concluded her remarks by addressing tokenized real estate.
She observed that the IRS, in the proposed regulations, has spent considerable time addressing real estate transactions that involve digital assets. However, the explanation of provisions, the text of the proposed regulations, and the examples all fail to capture and address the reality of most real estate transactions that leverage blockchain technology. "In the U.S., single pieces of real estate are commonly sold as NFTs, but they still have an LLC interposed as the owner of the real estate, since in all cases we are aware of an NFT cannot hold legal title to real estate in the U.S.," she said.
"Where real estate is being sold as fractional ownership, there is typically a partnership or LLC interposed as the owner of the real estate for the same reason, but also to make partial ownership changes smoother," she continued. "Even where a partnership or LLC agreement has not been legally drafted, most every tax accountant would agree that a group of unrelated parties agreeing to pool their money together to purchase and hold real estate is a default partnership for tax purposes under the Internal Revenue Code."
"The cost basis rules of interest in an LLC partnership for tax purposes are complex and will never be information that is available to digital asset brokers," Dean concluded. "Not only is Form 1099-DA reporting therefore completely inappropriate for these transactions, but it will lead to double reporting due to the absence of a coordination regulation with Schedule K-1 reporting. This double reporting will create meaningless cost basis information and reconciliation nightmares with Schedule K-1 for the taxpayers."
Therefore, tokenized real estate where Schedule K-1 reporting applies should be exempted from the DA reporting requirement, she suggested.
No date has been set for issuance of the final regulations. However, with 120,000 public comments, it might be a considerable time before they are finalized, according to Dean.
