What Tax Payers Need to Know About the IRS’s New Digital Asset Reporting Proposal
On August 4, 2023, the Internal Revenue Service (IRS) released proposed regulations (the "Proposed Regulations") that would require brokers to report gross proceeds from sales or exchanges of digital assets occurring on or after January 1, 2025, and provide gain or loss and basis information for sales and exchanges that occur on or after January 1, 2026, for digital assets acquired after January 1, 2023. This is something that cryptocurrency supporters are arguing will create unnecessary rules that will in-turn negatively impact taxpayer services - the same ones that the IRS are trying to improve.
In a letter from the Vice President of Tax for Coinbase, Lawrence Zlatkin, "These rules would establish incomprehensible and unduly burdensome set of new reporting requirements that will degrade and displace the same taxpayer services the IRS is seeking to improve."
The Proposed Regulations are a significant development for the taxation of digital assets, as IRS claims it would provide them with much-needed information about the volume and value of digital asset transactions. The IRS says this information would help them to enforce the tax laws and to identify potential tax evaders.
Background
The taxation of digital assets has been a complex and evolving area of tax law. In 2014, the IRS issued Revenue Ruling 2014-21, which provided guidance on the taxation of virtual currency. Revenue Ruling 2014-21 treated virtual currency as property for tax purposes. This meant that taxpayers were required to report gains and losses from the sale or exchange of virtual currency on their tax returns.
In 2021, the Infrastructure Investment and Jobs Act (IIJA) was signed into law. The IIJA included a provision that required brokers to report digital asset transactions to the IRS. The IIJA also required the IRS to issue regulations to implement this reporting requirement.
The Proposed Regulations are the IRS's first attempt to implement the digital asset reporting requirement in the IIJA. The Proposed Regulations define the term "broker" broadly to include digital asset trading platforms, digital asset payment processors, and certain digital asset-hosted wallet providers.
Gross Proceeds Reporting
The Proposed Regulations would require brokers to report gross proceeds from sales or exchanges of digital assets occurring on or after January 1, 2025. Gross proceeds are defined as the fair market value of any consideration received in exchange for the digital asset, including cash, other digital assets, and property.
Brokers would be required to report gross proceeds on a new Form 1099-DA, which would be provided to the taxpayer and to the IRS. The Form 1099-DA would include information such as the taxpayer's name and taxpayer identification number, the date of the sale or exchange, the type of digital asset sold or exchanged, and the gross proceeds from the sale or exchange.
Basis and Gain or Loss Reporting
The Proposed Regulations would also require brokers to report the taxpayer's basis and gain or loss from sales or exchanges of digital assets occurring on or after January 1, 2026, for digital assets acquired after January 1, 2023.
Basis is the amount that a taxpayer has invested in a digital asset. Gain or loss is the difference between the taxpayer's basis in a digital asset and the fair market value of the digital asset when it is sold or exchanged.
Brokers would be required to report basis and gain or loss on the Form 1099-DA. The Proposed Regulations provide guidance on how brokers should calculate basis and gain or loss for different types of digital asset transactions.
Determination of Amount Realized and Basis
The Proposed Regulations also clarify the rules for determining the amount realized and the basis for digital asset transactions.
The amount realized from a sale or exchange of a digital asset is the fair market value of any consideration received in exchange for the digital asset. The basis of a digital asset is the amount that a taxpayer has invested in the digital asset.
The Proposed Regulations provide guidance on how to determine the fair market value of digital assets and how to calculate the basis for different types of digital asset transactions.
Impact on Taxpayers
The Proposed Regulations are expected to have a significant impact on taxpayers who hold digital assets. The new reporting requirements will make it easier for taxpayers to comply with their tax obligations. However, taxpayers should be aware of the new requirements and should take steps to ensure that they are able to provide their brokers with the information that they need to comply with the new requirements.
Here are some specific steps that taxpayers can take to prepare for the new reporting requirements:
Gather information about your digital asset transactions. This includes the dates of the transactions, the types of digital assets involved, and the fair market value of the digital assets on the dates of the transactions. You can use this information to calculate your basis and gain or loss for each transaction.
Choose a broker that is prepared to comply with the new reporting requirements. Not all brokers are currently ready to comply with the new reporting requirements. It is important to choose a broker that has the systems and processes in place to report your digital asset transactions accurately and timely.
Provide your broker with the information that they need to comply with the new reporting requirements. This includes your name, taxpayer identification number, and information about your digital asset transactions. You should also provide your broker with any other information that they request.
Review your Form 1099-DA carefully. Once you receive your Form 1099-DA from your broker, be sure to review it carefully to make sure that it is accurate. If you have any questions or concerns, contact your broker immediately.
Keep accurate records of your digital asset transactions. Even though your broker will be reporting your digital asset transactions to the IRS, it is still important to keep your own records. This will help you to prepare your tax return accurately and to support any claims that you make on your tax return.
Additional Tips & Tricks:
If you have a significant amount of digital assets, you may want to consider working with a tax professional to help you comply with the new reporting requirements.
The Proposed Regulations are still in the proposal stage. It is possible that they could be changed before they are finalized. Taxpayers should stay informed about the latest developments.
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