America is looking to tax cryptocurrency more strictly than ever.
The 2021 infrastructure bill seeks to raise $28 billion dollars through tighter enforcement of cryptocurrency tax law. The bill is currently with Congress, but may be signed into law very soon.
While the bill is still being debated, it’s important to keep track of the latest news and updates on crypto tax policies and how they might affect you. We’ll be updating this article regularly to reflect the latest developments on this issue.
What’s changing with cryptocurrency tax law?
Technically, crypto tax rates are not going up. However, the federal government is trying to take steps to fight possible tax evasion. If the proposal passes, cryptocurrency brokers will be required to report traders’ information on transactions that are greater than $10,000. In addition, brokers will be required to report customer transactions to the IRS via form 1099-B.
This means that the IRS will become aware of who exactly is trading cryptocurrencies within the United States.
Why are crypto companies opposing this policy change?
Some of the biggest companies in the cryptocurrency space such as Coinbase, Square, FTX, and Kraken have come out in opposition to this new tax law. While most crypto companies are in favor of regulation, the general consensus is that the bill presents more problems than solutions.
One concern is that the bill’s definition of “broker” is too broad and could potentially encompass anyone who facilitates a digital asset transfer, including cryptocurrency miners and open source developers.
This is problematic as these market participants (as well as others within the DeFi space) do not have the ability to report customer information via 1099’s to the government, yet this law could potentially require them to. This could force businesses and future cryptocurrency innovation overseas.
How are 1099-B reporting requirements changing?
1099 information reporting has existed within the traditional finance space for a long time, and all 1099 reporting serves the same purpose: to report non-employment related income—i.e. income earned outside of a W2 such as capital gains from equities or stock trading.
Given that cryptocurrencies and stocks are treated very similarly from a tax perspective, it makes sense why governments want to implement similar 1099 information reporting within the cryptocurrency ecosystem.
However, it’s important to note that cryptocurrency has key technological differences from traditional finance that could present problems within the 1099 reporting regime.
Cryptocurrency is designed to be transferable, peer-to-peer, and operate without the need for a third-party. This is fundamental to the technology, and transfers into and out of centralized exchanges like Coinbase and decentralized platforms like software wallets happen regularly.
These transfers makes it difficult for cryptocurrency exchanges to provide cost basis information within a 1099-B—which is needed for proper reporting. Consider the following scenario pictured below:
When that amount of BTC shows up in David’s BlockFi wallet, BlockFi has no way of knowing what US Dollar value David actually acquired the BTC at (i.e. his cost basis). BlockFi simply sees that an amount of BTC showed up in his wallet. If David later sells that BTC on BlockFi, how would BlockFi report the gain upon sale? Did David originally buy this BTC for $5,000? $10,000? What is his cost basis? Was his gain $40,000 or $5,000?
BlockFi doesn’t know.
Quickly you can see the problem that centralized crypto brokers face when it comes to reporting gains, losses, and income on a 1099-B due to the transferable and open nature of cryptocurrencies.
Entities like Coinbase and BlockFi could share cost basis information with one-another, but what if the transfer actually came from a cold wallet? Or a mining pool? Or anywhere else that isn't 3rd-party owned?
1099 information reporting cannot simply be copy pasted 1:1 from the equities world to crypto. It appears that regulators aren't intimately aware of these potential issues.
How will this policy change affect the average cryptocurrency investor?
While it’s reasonable to be concerned about the bill’s broad definition of broker, potential privacy issues, and its impact on the cryptocurrency ecosystem, the bill won’t raise the taxes for cryptocurrency investors. It will simply create mechanisms for the government to better enforce tax compliance as the IRS will have more information on who is earning crypto-related income.
Ultimately, this infrastructure bill highlights the government’s focus on cracking down upon cryptocurrency tax enforcement. We only expect these crackdowns to increase in the coming years.