IRS Proposed Rule on Digital Asset Broker Reporting Could Kill Crypto in America

Nearly two years ago, the Infrastructure and Jobs Act (IIJA) passed – a bill that expanded broker information reporting to digital asset transactions and mandated Internal Revenue Service (IRS) rulemaking to implement the statute. Late last month, the IRS’s long-awaited proposal arrived, and it could kill crypto in America.

The proposed rule would require newly designated brokers to report sales and exchanges of digital assets. Although the rule would exclude stakers and miners from reporting requirements, the proposal’s breadth would harm all parts of the ecosystem.

This article is part of CoinDesk's "Staking Week." Sarah Milby is senior policy director for Blockchain Association.

By expanding the definitions of “digital assets” and “broker,” the proposal would pull in people and projects who would not otherwise fall within the scope of these tax reporting obligations. These new brokers would be required to collect personal information of users – including their name, address and tax identification number – and then furnish them with a form 1099 to help calculate the gains and losses for the digital asset sales that the brokers helped “facilitate.”

The proposal raises a number of concerns for users – especially regarding their privacy, security and ability to access decentralized protocols.

Most importantly, the proposal would create unworkable reporting requirements for a wide array of participants in the digital asset ecosystem and would cause projects to shut down operations or move offshore, inhibiting U.S. innovation in blockchain technology.

In fact, due to the nature of the reporting requirements, compliance would be impossible where there does not exist a central point of control. This could have catastrophic consequences for the decentralized use of digital assets by forcing centralization, creating intermediaries where none exist and rendering decentralized technology virtually impossible to access or develop in the U.S.

In short, the proposal – as currently written – spells the end of DeFi in the United States and shows the catastrophic, far reaching effects that rulemaking can have.

Digital assets have unique characteristics that deserve individual consideration when applying the tax code

Although the IRS has finally released its proposed rulemaking, it did so nearly two years after the IIJA was passed. If the digital asset ecosystem is to have clarity in tax matters, it will require the IRS to provide both timely and well-informed guidance — something it has fallen short of doing to date. For instance, in July the IRS released guidance that said staking rewards should be taxed at receipt as gross income. However, this guidance does not take into account the realities and complexities of staking.

The IRS staking guidance relies on an overly simplistic description of staking that fails to recognize the many forms that staking can take. The guidance, for instance, does not tell us whether the taxpayer’s staking reward consists of transfers of existing digital assets from other holders or whether the reward consists of newly minted digital assets. The tax treatment under the first scenario could be vastly different from the tax treatment under the second scenario. Additionally, the guidance does not contemplate liquid staking or delegated staking.

See also: Staking Brings Decentralization Back to DeFi | Opinion

The guidance states that staking rewards should be taxed as gross income when they are received. Instead, staking rewards should be treated as property created by the taxpayer and therefore should be taxed upon sale, not receipt. As a general rule, a taxpayer who creates property does not realize income at the time of the property’s creation but at the time the property is sold. For example, a farmer who grows corn does not pay tax on that corn until it is sold because the sale is the point where income is realized. The same should apply to staking.

Staking is just one area in which there is room for more clarity in the taxation of digital assets, but there are many others that demand attention. Not only must clarity be provided, but it must not inhibit the development, innovation and utility of digital assets. Digital assets have unique characteristics that deserve individual consideration when applying the tax code to this emerging space.

If there is any hope in improving the proposed rule and the tax treatment of digital assets, industry must clearly communicate to Washington that the IRS’s digital asset tax agenda is unworkable and must be fixed. Consider submitting a comment for the proposed rule — the Department of the Treasury and IRS are accepting responses until Oct. 30.

The new proposed broker rule should stand as a warning to show how quickly broad definitions and applications of tax policy to digital assets could spiral into deadly outcomes for a new and emerging industry.