Reporting your cryptocurrency trades to the Internal Revenue Service will no longer be based on an honor system. Starting with tax year 2023, any of your potentially taxable digital asset transactions will be reported to the agency by an outside party.
If you’ve ever held a job or invested in stocks, you know the money you make is reported to the federal government. That’s because you and the IRS get a W-2 form from your employer that reports your annual earnings and a Form 1099 from your broker that reports your stock transactions.
Until now, however, there have been no comparable third-party reporting requirements in place for cryptocurrency trades and transfers – or for any other digital assets, such as NFTs.
But the recently passed infrastructure law includes provisions requiring crypto industry players that broker digital asset transactions to issue 1099-Bs for their customers’ accounts, which you will first receive in early 2024 to reflect your 2023 transactions.
And in a bid to make it harder to launder money, the new law also requires a business to report to the IRS whenever it receives more than $10,000 of cryptocurrency in a single transaction (or in two or more related transactions), just as it must when it receives cash above that threshold. Willfully failing to do so can be prosecuted as a federal felony.
These new reporting requirements will affect investors trading digital assets in a few ways.
You can’t stay anonymous
The new reporting requirements represent a potential upside for crypto investors in two ways: They’re a sign that crypto is here to stay. And given the headache of trying to keep track of all your transactions, getting a 1099 may prove helpful.
But the downside will be a loss of anonymity for those who want to keep their transactions private on principal, or who have not met their tax obligations.
When you open a bank or brokerage account, you have to provide a lot of personal information that gets cross-checked to confirm you are who you say you are. You have to provide your legal name, address, phone number and a Social Security number or other taxpayer identification number, among other things.
But when you set up crypto-related accounts, the information you’re asked to give varies by platform.
“Until this year, it was pretty common you could open [an account or digital wallet] with a name and email,” said Erin Fennimore, head of information reporting at TaxBit, a cryptocurrency tax software provider.
Come 2023, that will change in many instances. “You’re going to be asked for personal information that you most likely have not been asked for in the past,” Fennimore said.
And the platforms required to report on your transactions will have to verify that you are who you say you are.
In addition, when a digital asset is transferred from one broker to another, the transferring broker will have to issue a statement to the receiving broker that includes basis and holding period information on the transferred asset so the receiving broker can satisfy its 1099 reporting requirements.
What are reportable events
Not every crypto transaction will require third-party reporting because not every crypto transaction is a taxable event.
“Just buying crypto is not taxable or reportable under the law. You have to do something with it, such as sell or exchange it,” Fennimore said.
But since a reporting entity may not have all the information related to a transaction, “it’s going to be a practical challenge to always have the tax basis for each trade or transfer,” said Christopher Murrer, an associate in the Fintech group of Baker McKenzie Zurich.
For example, you might transfer bitcoin from one of your non-custodial digital wallets to an established crypto exchange, and then later sell it from that account. The cost basis on the sale may be reported as zero or as the price it was the day you originally transferred the currency, not the price it was the day you actually bought it.
So you’ll have to explain to the IRS why the information on your 1099 is wrong. “Ultimately, it’s incumbent on the taxpayer to report the accurate tax basis on their personal tax filings,” Murrer said.
Who exactly must report
Some in the crypto industry have suggested that the law is written so broadly that various players, such as miners and software providers, could be defined as “brokers,” even though they may not have anything to do with the brokering of a taxable transaction.
If so, those who may be wrongly classified could be saddled with “massive reporting obligations,” as Coinbase CEO Brian Armstrong said on Twitter.
There is a similar lack of clarity about what will be considered a business for the purposes of reporting large single transactions. “This is a new industry so it’s hard to know what regulators will think is a business,” Murrer said, noting that it’s unclear, for instance, how decentralized finance (DeFi) activities, staking pools and NFTs might be classified.
But greater clarity is expected when the Treasury Department issues regulations for how to interpret and implement the law’s reporting requirements.
A senior Treasury official said the department has been in discussions with industry players to better define which types of entities should be defined as brokers, trades and businesses for reporting purposes, noting that it’s highly improbable that miners would ever be considered brokers.
Crafting those regulations is a top priority for the department and they will be issued in the coming months, the official said.
When they are, there will be a public notice and comment period before the rules are finalized.