The Internal Revenue Service has been focused for several years on addressing perceived underreporting of digital asset transactions. The IRS has a question on Form 1040 about digital asset transaction reporting that it has modified from time to time, and it has been issuing subpoenas to crypto exchanges to try to identify taxpayers engaged in digital asset transactions. The service has been supporting further congressional action on digital assets. The Infrastructure Investment and Jobs Act broadened the definition of "broker" to increase obligations to report digital asset transactions.
Now, the IRS has issued proposed regulations seeking to clarify and expand the definition of digital assets and who is a broker for purposes of reporting requirements.
Digital assets
The proposed regulations define a digital asset as any digital representation of value that is recorded on a cryptographically secure distributed ledger or any similar technology. The IRS intends a broad definition that would include non-fungible tokens and stablecoins, whose value is pegged to another asset, such as a currency. However, the IRS has requested comments on when some stablecoins may qualify for exclusion. The ledger need not be widely distributed. The proposed regulations discuss digital assets that may also be classified as securities, commodities, or real estate. Tokens that are both securities and digital assets are to be reported as digital assets. Digital assets include digital assets held in a custodial account.
Excluded from the definition are cash and government-issued currencies in digital form. The definition of what constitutes a sale of digital assets has also been expanded in the proposed regulations. Digital assets that are treated as covered securities require basis tracking if they are acquired on or after Jan. 1, 2023, in a customer's account by a broker providing hosted wallet services.
Broker
The Infrastructure Investment and Jobs Act defined a broker to include any person who, for consideration, regularly provides any service effectuating the transfer of digital assets on behalf of another person. The proposed regulations expand this definition to include any person that stands ready to effect sales to be made by others in the ordinary course of a trade or business. The IRS gives a very broad definition to "effect" and "person." The definitions are sufficiently broad that they may include persons who would not have access to the information to comply with the broker reporting requirements. The IRS also requests comments on such persons.
Reporting requirements
It appears that there will be a new broker reporting form, Form 1099-DA, to address the reporting of digital assets. For every digital asset sale, the broker is required to report the following:
1. Name, address and TIN of the customer;
2. Name or type and number of units of digital assets sold;
3. Time and date of sale;
4. Gross proceeds of sale;
5. Transaction identification number;
6. Address from which digital assets were transferred;
7. The type of consideration received, such as cash, other digital assets, other property or services; and,
8. Any additional information required by forms or instructions.
Many persons who meet the definition of broker may not have access to all or part of this information.
Effective dates
Regs with respect to the computation of gain or loss and the basis of digital assets are proposed to apply to tax years after the finalization of the proposed regulations. The proposed rules with respect to broker reporting of gross proceeds apply if the sale is on or after Jan. 1, 2025. The proposed rules on broker reporting of adjusted basis apply if the sale or exchange is effected on or after Jan. 1, 2026. The information required to be reported may relate back to Jan. 1, 2023.
Taxpayers may rely on the proposed regulations for dispositions in tax years ending on or after Aug. 29, 2023, as long as they are applied consistently and in their entirety.
Staking
In addition to the proposed regulations, in Revenue Ruling 2023-14, the IRS ruled that rewards received by a taxpayer staking cryptocurrency in connection with validating a blockchain transaction must be included in the taxpayer's taxable income in the tax year the taxpayer receives or gains control over the rewards.
The IRS has been involved in litigation over staking in the case of Jarrett v. U.S., in which the taxpayer sought a refund of the tax paid on staking rewards under the theory that staking rewards are only taxable when disposed of, not when received. In spite of the position of the IRS, the agency issued a refund to the taxpayer, resulting in the federal district court dismissing the case as moot. The Sixth Circuit recently upheld the dismissal over the taxpayer's objections. The IRS now has the revenue ruling to support its position in response to further challenges to the taxation of staking rewards.
Summary
With the additional resources received from the Inflation Reduction Act, the IRS is likely to continue its increased focus on the taxation of digital asset transactions as part of its efforts to reduce the tax gap. While for the most part the proposed regulations on broker reporting are not immediately effective, the reporting requirements can relate back to current transactions. Taxpayers, potential brokers, and tax advisors should be alert to the information required in the reporting requirements and begin immediately to preserve such information for those future reporting requirements.
