Infrastructure and Jobs Act (IIJA) was enacted nearly two years ago; it expanded broker information reporting to digital asset transactions and required Internal Revenue Service (IRS) rulemaking to implement the law. The long-awaited IRS proposal arrived late last month, and it could end crypto in America.
The proposed regulation would require newly designated brokers to report digital asset transactions and exchanges. Although the rule would exempt miners and stakeholders from reporting requirements, the proposal’s scope would be detrimental to the entire ecosystem.
IRS and the SEC – a crypto match made in hell
Crypto investors in the United States have been under regulatory pressure from the SEC. As it stands, the IRS has joined in the regulatory war that could see crypto become non-existence in America. The union of these two entities on crypto regulation is one clearly made in hell.
The IRS, by broadening the categories of “digital assets” and “broker,” the plan would include people and projects that would not otherwise be subject to these tax reporting requirements.
These new brokers would be obliged to collect personal information from users, such as their name, address, and tax identification number, and then provide them with a form 1099 to aid in calculating the gains and losses from digital asset sales that the brokers helped “facilitate.”
Users have a lot of worries about the idea, namely their privacy, security, and ability to use decentralised protocols.
Most crucially, the proposal would impose impractical reporting requirements on a wide range of participants in the digital asset ecosystem, causing projects to close or relocate, stifling U.S. innovation in blockchain technology.
In fact, because of the nature of the reporting requirements, compliance would be impossible in the absence of a centralised point of control. This might have disastrous effects for the decentralised use of digital assets since it forces centralization, creates middlemen where none exist, and makes decentralised technologies almost difficult to access or develop in the United States.
In short, the IRS plan, as written, spells the end of DeFi in the United States and demonstrates the disastrous, far-reaching consequences of rulemaking.
How do taxes affect the decentralized market?
Nearly two years after the passage of the IIJA, the IRS has finally released its proposed rulemaking. In order for the digital asset ecosystem to have clarity in tax matters, the IRS will need to provide expeditious and well-informed guidance, which it has not done to date.
For instance, in July the IRS released guidance that said staking rewards should be taxed at receipt as gross income. This guidance, however, does not account for the realities and complexities of staking.
The IRS guidance on staking relies on an excessively simplistic description of staking that fails to acknowledge the variety of staking forms. For instance, the guidance does not specify whether the taxpayer’s staking reward consists of transfers of existing digital assets from other holders or of newly created digital assets.
The tax treatment under the first scenario could differ significantly from the tax treatment under the second scenario. Additionally, neither liquid staking nor delegated staking are addressed in the guidance.
There is potential for clarification in the taxation of digital assets in a number of areas, including staking, but there are many others that require attention. Clarity must not only be provided, but it must also not hinder the growth, innovation, and utility of digital assets.
When applying the tax code to this emerging space, digital assets have distinct characteristics that merit individual consideration. If there is any chance of enhancing the proposed rule and the tax treatment of digital assets, the industry must convey to Washington that the IRS’s digital asset tax agenda is infeasible and must be revised..
The new proposed broker rule should stand as a warning to demonstrate how quickly broad definitions and applications of tax policy to digital assets could spiral into deadly outcomes for a new and emerging industry.