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At the end of 2024, the Internal Revenue Service (IRS) of the United States issued new regulations on tax reporting for cryptocurrency brokers, sparking a huge controversy between regulators and the industry. This article will delve into the details of the new regulations and their potential impact, exploring the challenges and strategies for the cryptocurrency industry, individual investors, and future innovation.
Introduction
In December 2024, the IRS released the final version of the new regulations on tax reporting for cryptocurrency brokers, marking a new phase in the US cryptocurrency tax system.
Against the backdrop of Donald Trump winning the election and holding a cryptocurrency-friendly stance, it was widely believed that the US would see favorable cryptocurrency policies this year. However, the recent release of the “Periodic Reporting Requirement for Broker Sales of Digital Assets” by the IRS has directly intensified the tension between US regulatory agencies and cryptocurrency stakeholders. a16z Crypto has supported lawsuits filed by the Blockchain Association, DeFi Education Fund, and Texas Blockchain Council, accusing the IRS of overreach, alleged violations of the law, and even the Constitution.
According to the IRS, the new rules aim to broaden the tax base, address tax evasion, and combat money laundering and terrorist financing. However, concerns about the new rules are multifaceted, including worries about data privacy breaches, exacerbation of centralization, and increased tax burdens. Additionally, the industry is concerned that these regulations may stifle innovation in the US and lead to a loss of talent, as strengthened regulations will force cryptocurrency companies and practitioners to choose more favorable jurisdictions. For ordinary investors/users, the introduction of the new regulations means more complex tax reporting. TaxDAO will explain the main content of these new regulations, analyze their potential impact, and propose strategies from different perspectives.
Overview of the Main Content of the New Regulations
On December 30, 2024, the IRS, under the US Department of the Treasury, released the final regulations on reporting cryptocurrency broker sales and transactions. The regulations, titled “Periodic Reporting Requirement for Broker Sales of Digital Assets,” provide tax reporting guidelines for cryptocurrency brokers who provide services for the sale and trading of digital assets. It requires cryptocurrency companies that fall under the category of brokers to submit tax information returns and related explanations. The most notable aspect of these new regulations is that they also classify DeFi front-end platforms as cryptocurrency brokers, requiring them to report detailed tax information about their users.
2.1 Scope of Brokers
The new regulations clearly define which entities should be classified as “brokers.” In the field of cryptocurrency transactions, the following entities are considered brokers:
(1) Centralized exchanges, such as Coinbase, which provide services for purchasing, selling, and trading cryptocurrencies.
(2) Decentralized exchanges, such as Uniswap, which, despite being decentralized, are still considered brokers in cryptocurrency transactions.
(3) Wallets with trading functionality, which allow users to directly purchase, sell, and trade cryptocurrencies on their platforms, such as Metamask.
(4) Cryptocurrency ATMs and kiosks, including Bitcoin ATMs and other forms of cryptocurrency trading terminals.
At the same time, the following entities are not considered brokers:
(1) Blockchain maintainers, including miners and node operators, who only participate in maintaining the blockchain without directly engaging in transactions, so they are not considered brokers.
(2) Non-trading hardware wallets that require connection to other exchanges to complete transactions. Their service providers are not considered brokers.
(3) Developers who indirectly facilitate transactions by developing software for exchanges and other platforms but do not directly participate in transactions.
(4) Inactive smart contract developers who earn income from smart contracts but are not responsible for their maintenance and updates.
2.2 Why are DeFi front-ends within the regulatory scope?
According to the IRS, “trading front-end service” refers to services that:
(1) Receive user trading orders.
(2) Allow users to input transaction details through a user interface, such as a graphical or voice interface.
(3) Transmit these transaction details to the decentralized ledger network for execution of transactions on the blockchain.
Even though DeFi front-ends do not directly hold users’ funds or private keys, they still participate in the initiation and execution process of transactions. Therefore, the IRS considers DeFi front-ends to play a role similar to traditional brokers in transactions and should bear corresponding reporting obligations. Additionally, the IRS explicitly states that the inclusion of intermediate steps in the transaction process, such as through DeFi aggregators, does not change the fact that DeFi front-ends are considered brokers.
2.3 Obligations for Cryptocurrency Brokers
According to the “Periodic Reporting Requirement for Broker Sales of Digital Assets,” cryptocurrency brokers must fulfill the following reporting obligations and other related duties:
(1) Submitting Information Reports
Form 1099-DA: Starting from January 1, 2025, all brokers who hold users’ sales of cryptocurrencies must use the new Form 1099-DA to report detailed information to the IRS for each transaction. The form requires disclosure of the following key details:
A. Total income from cryptocurrency transactions.
B. Information about the parties involved in the transaction (such as identity and address).
C. For each transaction, record the transfer price and cost basis of the assets.
(2) KYC Policy
To meet strict reporting standards, brokers must fully implement Know Your Customer (KYC) policies to ensure they can obtain and verify users’ identity information. If users are US taxpayers, brokers must comply with relevant tax reporting requirements.
(3) Monitoring and Recording Transactions
Brokers need to establish systems to monitor and record all cryptocurrency-related transaction activities to ensure timely and accurate generation of required reports. This includes collecting, organizing, and storing transaction data to provide to the IRS when needed.
(4) Anti-Money Laundering and Counter-Terrorist Financing MeasuresBrokers have an obligation to monitor and report suspicious transactions to help combat money laundering and terrorist financing activities. As important participants in the financial market, brokers possess transaction data and user information that serve as crucial foundations for anti-money laundering monitoring.
3. Impact on the Cryptocurrency Industry
3.1 Individual Investors
The regulations aim to ensure that individual investors comply with cryptocurrency asset tax regulations. With the introduction of these regulations, investors can rely on brokers to obtain relevant information, making it easier for them to report their earnings and tax obligations. However, a corresponding risk is an increase in scrutiny and audits, which may exceed people’s expectations.
Another consequence of the regulations is that tracking the cost basis of cryptocurrency assets across multiple wallets and exchanges will become more complex. It is not uncommon for cryptocurrency users to hold assets across various exchanges or execute transactions on different platforms. Tracking the cost basis of all these mediums requires the assistance of tax professionals and specialized tax reporting software.
3.2 Decentralized Platforms
Decentralized platforms operating in the United States and serving U.S. users will face the greatest challenges in adapting. Clearly, stricter reporting requirements will force these platforms to introduce new Know Your Customer (KYC) policies in their service offerings. From any perspective, this introduction threatens the fundamental foundations or decentralized nature represented by the cryptocurrency asset field.
According to the regulations, even decentralized platforms now need to disclose user personal transaction data, proof of identity, and other information. The anonymity features of these platforms are undoubtedly weakened. Although disclosing information from a regulatory perspective aims to combat money laundering and terrorist financing, from a user’s perspective, it may lead to user aversion, causing U.S. users to migrate to other platforms not bound by these rules.
Another impact of the regulations is the exacerbation of concerns regarding centralization. Under the new regulations, decentralized platforms and centralized platforms are placed on the same starting line, giving the government an opportunity to control the operation of decentralized platforms and the trading behavior of its users. Fundamentally, users will be fully exposed to regulators, and decentralized platforms will be greatly restricted, contradicting the initial intention of decentralization in the cryptocurrency industry.
3.3 Developers and Innovators in the Cryptocurrency Industry
Compared to the previous impacts, since the announcement of the regulations, the main concern of the cryptocurrency industry revolves around whether the regulations will stifle innovation in the U.S. cryptocurrency asset field. The regulations may lead to small or startup projects exiting the market due to the difficulties of bearing compliance costs, thereby intensifying market competition and industry reshuffling. Top projects may occupy larger market shares but also face stricter regulatory pressures. In the current situation, the regulations will compel developers and innovators in the cryptocurrency industry to seek more suitable countries and regions.
3.4 Cross-Border Transactions
The introduction of the regulations may prevent non-U.S. exchanges and trading platforms from serving U.S. users. Therefore, U.S. users may face limited trading choices and more challenges when executing cross-border cryptocurrency asset transactions. This in itself restricts the borderless nature of decentralized cryptocurrency assets and is not conducive to equal participation of people from different countries in areas such as DeFi. In addition, these entities also face challenges in limited service and integration cooperation to improve user service and experience.
4. Strategies for Cryptocurrency Companies and Individuals
4.1 Collaborate with Tax Professionals
Obtaining professional support is crucial for companies to effectively implement reporting standards required by tax regulations. With the assistance of tax professionals, companies can ensure that their policies fully comply with applicable regulatory requirements.
Given the constantly changing regulatory environment surrounding cryptocurrency assets, it is necessary for individual investors and cryptocurrency companies to consult cryptocurrency tax experts. Collaborating with such professionals ensures compliance with regulatory frameworks, thereby minimizing regulatory or tax evasion risks. Additionally, these experts can assist in mitigating penalties, reducing tax compliance risks, and identifying opportunities beneficial to their own development within the tax law.
4.2 Use Tax Reporting Software to Organize Cryptocurrency Asset Financial Records
Cryptocurrency asset investors can alleviate reporting burdens by maintaining detailed logs of transactions, transfers, etc. However, considering that cryptocurrency asset transactions often involve multiple wallets, exchanges, and blockchains, involving large transaction volumes, individual investors and companies can utilize professional cryptocurrency asset financial management and tax reporting software like FinTax to facilitate cost basis tracking and calculate gains/losses.
4.3 Choose Compliant Platforms
Strict tax reporting systems imply that IRS enforcement will become stricter. Therefore, it is recommended for U.S. cryptocurrency asset investors and companies to restrict their activities to platforms that comply with the new reporting requirements, avoiding tax risks associated with non-compliant platforms.
4.4 Develop Appropriate Tax Strategies
Cryptocurrency asset investors can implement various tax strategies to minimize tax liabilities and ensure compliance with regulatory frameworks. These methods include tax loss harvesting, donating appreciated cryptocurrency assets, and managing wagering income, among others. However, investors should consult tax professionals before implementing these strategies.
5. Conclusion
Since the implementation of the broker regulations is still some time away, the cryptocurrency community may not immediately feel the impact of the regulations. However, the introduction of these regulations will affect the cryptocurrency asset industry in the United States and even globally, intensifying the tension between the cryptocurrency industry and U.S. regulatory agencies. It is worth considering that even though the United States aims to effectively enforce cryptocurrency asset tax systems and reduce tax evasion in this field, the proportionality between objectives and means should be observed. If the cost of implementing tax systems results in a heavy blow to DeFi and the entire cryptocurrency asset industry, such actions would be counterproductive.
TaxDAO believes that in the future, the United States may provide a more lenient tax environment and more tax incentives for the cryptocurrency asset industry. However, this does not mean that the IRS will relax its collection of cryptocurrency asset taxes. On the contrary, a low tax burden and healthy tax system are often closely linked to strict enforcement. We will continue to monitor the implementation and subsequent impacts of the regulations and share our latest perspectives in a timely manner.