Two Things That Are Certain in Life: Taxes and the Regulation of Cryptocurrency

The year 2021 proved to be a significant year for cryptocurrency (“crypto”). (Nikita Prasad, NDTV). With El Salvador becoming the first country to use Bitcoin as their legal currency and Tesla, Inc.––one of the world’s most valuable companies––accepting Bitcoin as payment, public interest and the potential for general mainstream acceptance have grown exponentially. Id. This increase in popularity has unsurprisingly exposed crypto to the focus of the Internal Revenue Service (“IRS”) because of the present need for tax dollars and governmental spending. (Alex Gailey & Kendall Little, Time; Robert W. Wood, Forbes).

President Biden recently signed the Infrastructure Investment and Jobs Act (“Infrastructure Act”), which includes a crypto-tax reporting provision that is projected to bring in $28 billion in tax revenue over the next decade. (Robert W. Wood, Forbes). While a strong and costly national infrastructure may sound appealing because of its need across the nation, many crypto investors are more worried about the implications the Infrastructure Act will have on their investments and transactions involving crypto-assets and non-fungible tokens (“NFTs”). (Robert W. Wood, Forbes; Rachel Wolfson, CoinTelegraph). Specifically, crypto investors are worried about the deterioration of crypto’s anonymous nature due to the stringent regulation and new tax reporting requirements. (Rachel Wolfson, CoinTelegraph).

As a historical background, the IRS began to treat crypto as property for tax purposes in 2014. (Robert W. Wood, Forbes). This meant that crypto would not be considered currency and would be taxed the same way as any other asset. (Alex Gailey & Kendall Little, Time). For example, if crypto tokens were received as compensation, the amount of compensation earned would need to be reported as income under traditional reporting rules. Id. If, however, crypto tokens were used for investing purposes, the transaction would become taxable based on capital gains or losses in the same way that securities are taxed. Id. Now, becoming effective December 31, 2023, the Infrastructure Act has broadened the scope of crypto tax reporting with two rules that focus on broker reporting requirements and reporting crypto as “cash-like” transactions. (Robert W. Wood, Forbes).

Under the Infrastructure Act, the definition of a “broker” within Section 6045 of the Internal Revenue Code (“IRC”) has been amended to include “any person (for consideration) … responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Id. The Infrastructure Act has further defined digital assets as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary [of the Treasury]”. Id. This new definition of digital assets encompasses crypto and NFTs, which are now both considered specified securities subject to reporting on IRS Form 1099-B. (Taylor Locke, CNBC). A 1099-B is a form that a broker files for each customer who sold stocks, futures, or several different financial instruments for cash. (IRS). The goal of the IRS and the Biden Administration in making this change is likely to combat the ongoing concealment of crypto assets and taxable crypto income due to the anonymous nature of crypto transactions. (Stanley Foodman, JD Supra). However, the definition of a broker under Section 6045 has created great concern within the crypto industry. (Rachel Wolfson, CoinTelegraph).

The consensus is that the current language of the bill designates anyone participating in decentralized finance as brokers, which may include network validators, bookies, software developers, and more. Id. This will likely cause issues in the “broker’s” compliance due to potential anonymity of the transactions and will also create problems on the part of the IRS to ensure broker’s compliance for the same reason. Id. For example, a software developer that earns a small fee for maintaining a smart contract may be a broker under the rules subject to reporting the transactions that are effectuated by that smart contract. Id. However, compliance will depend on whether the developer has access to the identity of the transferor. Id.

Although the IRS does not recognize crypto as currency, the second set of rules laid out in the Infrastructure Act has ironically taken a piece from cash reporting, specifically anti-money laundering and know-your-customer requirements. (Robert W. Wood, Forbes; Rachel Wolfson, CoinTelegraph). As stated in IRC Section 6050I, cash transactions of over $10,000 will trigger the filing of a Form 8300 to report the cash transaction to the IRS. (Rachel Wolfson, CoinTelegraph). A Form 8300, made to combat money laundering, includes the name, address, social security number, and occupation of the person from whom the cash was received. (Robert W. Wood, Forbes). For example, a withdrawal of over $10,000 of your own money at a bank or using cash for installment payments that total over $10,000 both require the gathering of information to file a Form 8300. Id. The Infrastructure Act has expanded this requirement to encompass crypto by treating any digital asset as cash for the purposes of Section 6050I. Id. Thus, recipients of over $10,000 in digital assets will need to report the required information or else such recipients could face criminal penalties. Id. 

While a noble attempt to combat money laundering, this rule raises similar questions as the broker requirements regarding anonymity. (Rachel Wolfson, CoinTelegraph). Shehan Chandraskera, a certified public accountant and the head of tax strategy at CoinTracker, explained that this rule doesn’t necessarily burden the tax payer, but the rule does largely impact their privacy. (Taylor Locke, CNBC). Many crypto investors are already privacy conscious and do not want to give up such information, which raises the issue that the Biden Administration is trying to combat: the unwillingness to comply with tax reporting rules. Id.

The negative implications of these new rules and definitions are apparent and widespread within the crypto industry. (Rachel Wolfson, CoinTelegraph). With crypto, and decentralized finance (“DeFi”) more broadly, being the epitome of anonymity and self-reliance, identification requirements and regulation in general will undoubtedly disrupt the blockchain ecosystem. This increased regulation, coupled with the fact that the legislatures may not be in the best position to define and regulate the ever-changing crypto market, may lead to crypto infrastructure moving outside the U.S. Id. If misinformed policies continue to heckle the crypto industry, more crypto participants will look for other places that have more relaxed restrictions. Id. However, some positive may come from all of this. Id. As more focus and attention has been directed at crypto, the crypto community has begun creating committees for policymaking and starting discussions with regulators on how the industry works and functions. Id. The crypto industry can be confusing to some, so it is crucial for crypto-savvy people to discuss and explain in detail the implications that regulations may have on the industry. While there are initial reservations and concern that have come from the Infrastructure Act and other recent regulation over crypto, there are positive effects that may prove to be beneficial for crypto in the long run. Id.