Digital asset reporting: How the IRS’s proposed regulations could change tax collections

The Department of Treasury recently issued long anticipated proposed digital asset regulations under IRC Section 6045 regarding the implementation of information reporting as required by the Infrastructure Investment and Jobs Act of 2021. These regulations are a sea change in the type of information the IRS will receive with regards to digital asset transactions – brokers and taxpayers transacting in digital assets will need to take notice. It is believed that the implementation of these proposed regulations will bring in significant tax revenue that is currently uncollected, as well as bring the U.S. closer in line with the Organization for Economic Cooperation and Development (OECD) Crypto-Asset Reporting Framework (CARF) digital asset reporting requirements.

The implementation of these regulations will take some time and none of these regulations are immediately effective, but those that are covered by the regulations should start preparing for the impacts now. Much of the burden will fall on taxpayers who operate in niche areas of the digital asset ecosystem and those taxpayers will be forced to undertake significant steps to comply with the regulations. For the average taxpayer who holds digital assets as investments, there are some short to medium term impacts on what information the IRS is going to receive on digital asset gains and losses.

Standardized reporting

The clearest change in the proposed regulations is that digital asset reporting is going to shift to a more standardized format. These regulations require broker dealers to file a Form 1099-DA that is expected to be functionally equivalent to a 1099-B, Proceeds from Broker and Barter Exchange Transactions. The new format will serve as a replacement for the various 1099-B, 1099-K or 1099-MISC that have been issued by various digital asset institutions in an effort to report digital asset transactions without an appropriate form. The 1099-DA will include the taxpayer’s name, address, and tax identification number as well as the gross proceeds of the sale.

While basis is also required to be reported the proposed regulations, there are known issues with regards to how accurate the basis reported on the 1099-DA will be. Currently, the proposed regulations adopt the language of the securities regulations and will require companies who are subject to the definition of broker dealers in the proposed regulations to include adjusted basis on the 1099-DA to the extent it is known by the broker. To capture basis of assets purchased on one platform and then transferred to another platform, Treasury has stated that it is going to issue parallel regulations not only to require basis reporting upon sale but also for a transfer between reporting agents. These regulations will come into effect subsequent to the current proposed regulations. Under the current proposed regulations, there will be no adjusted basis reported on the 1099-DA if a self custody digital asset is transferred to and sold on a covered exchange. The net effect of this is that the 1099-DA will effectively report a gain equal to gross receipts for the sale of assets that were held on a cold (offline) wallet.