Crypto tax reporting might get more complicated

Ever since the language related to crypto reporting and potential tax collection made news during the summer of 2021, there has been a firestorm of debate around the subject. As of this writing, since the legislation has not yet become law, the final language and ultimate implications of this language remain unknown. However, there are several implications that every tax practitioner should be aware of. Setting aside any specifics, including those mentioned below, the first and best strategy for any practitioner with crypto tax clients is to be proactive in seeking and confirming taxpayer data.

Let’s dig into some of the implications of this proposed update to crypto tax-related legislation.

Not done yet. The drama around this proposed legislation seized the attention of the entire crypto community, and eventually the mainstream financial marketplace, due to the vigor and strength of the response from the crypto lobbying space. As a direct result of these lobbying efforts, two separate amendments were proposed that sought to exempt miners and other taxpayers that would otherwise be caught up in a much more robust and complex reporting environment.

Although these amendments failed to pass, and the original amendments with much wider encompassing language remains in the original bill, the legislative process moves at a deliberate pace. As the U.S. House of Representatives takes up debate around this bill, and ultimately has to work with both the U.S. Senate and the White House for it to become law, there is one critical point to remember: The language in this legislation can be changed or interpreted (more on that below) in a manner that differs from the specific written word in the bill itself.

A wider net. The most direct impact of this language has to do with which types of entities and individuals are going to be classified as a broker for tax compliance and reporting purposes. As a result of this language, any taxpayer that processes, validates, or provides any services related to a crypto transaction in return for consideration would have to, in essence, perform the same type of reporting as a crypto exchange, such as Coinbase.

Potential implications of this are far ranging and might ultimately be devastating to the sector. Those with capital and individuals involved in the space might end up relocating elsewhere to jurisdictions that are more crypto-friendly, and the specter of this increased compliance and reporting might do the same. Miners who validate transactions for consideration, stakers who provide liquidity for decentralized finance operation in return for consideration, and developers who code and develop the programming language would have to report in this manner.

Many, if not most, of these groups do not even have access to the required information to fully comply with Form 1099 and other reporting requirements this bill would mandate.

Interpretation matters.  A positive development that followed the failure of either amendment to be incorporated into the legislation was the fact that the U.S. Treasury stated they would interpret the definition of a broker differently from the current specific language. Clearly, it remains to be seen how this back-and-forth evolves, and how this interpretation is actually communicated and enforced, but this is a positive development for the crypto community and associated advisors.

The IRS has made no secret of the increased attention and focus that it will be paying toward crypto compliance, reporting, and taxation. The fact that the IRS also stated that the interpretation used to enforce tax enforcement and collection would be developed independent of this legislation should be viewed as a positive development.

In other words, the IRS seems to be actively listening to the feedback provided by the crypto community, and is attempting to communicate that it is receptive to this views. Enforcement and compliance may be priorities, but the IRS also seems to understand the need for transparency.

Practitioners must be proactive. The real takeaway from this proposal is that – and this is not anything new – practitioners with crypto clients need to remain informed and well educated around crypto tax issues. With the crypto tax landscape changing continually in the United States and overseas, there is no way to have authoritative answers all the time. What can be provided is realistic, objective, and level-headed advice that incorporates the specifics of the client, as well as the current outlook from a regulatory perspective.

Crypto taxation has been, and continues to be, a complicated and nuanced issue that has caused more than its fair share of headaches for practitioners seeking to provide sound advice. Looking forward to the end of 2021 and into 2022, however, it is increasingly apparent that these questions are only going to become even more complicated going forward.

With the U.S. Congress involved, alongside the IRS, the burden and expectations for practitioners will only increase as crypto continues to become integrated into mainstream financial conversations. As always, there is room for motivated, proactive practitioners and firms seeking to develop new competencies and services linked to these areas. The profession should seize on these, and continue to be a resource for clients, colleagues, and policymakers.