The Battle in Congress for Cryptocurrency Tax Reporting Rules – Who Will Win?

For the last several years, the IRS has effectively had carte blanche on governing cryptocurrency (crypto) tax rules, even though nothing specific to crypto has ever been written into law.  By virtue of the ongoing negotiations of the infrastructure bill, Congress has finally come around to writing crypto tax law into the Internal Revenue Code by revising the outdated language of the term “broker” and also providing a definition for digital assets.  While the proposed definition of digital assets was fairly self-explanatory and not controversial, the finagling with the term broker when it comes to crypto has effectively started a war.

Initially, the thought of having clear, common sense regulations of tax reporting by various crypto exchanges was not a surprise.  To many it was widely expected.  However, those non-threatening expectations came crashing down once the bill language was released to the public on the expanded definition of a broker to determine which crypto businesses would have to prepare burdensome year-end tax reporting requirements to its customers (e.g., 1099s), similar to regular equity investment brokers.  The expanded broker definition included the following insertion: “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets."

The uproar from this proposed language was deafening – from the individual bitcoin miner to the largest corporations and household-name business leaders.  Pro-crypto senators on a largely bipartisan basis expressed outrage at the broad language of this provision through various media interviews and tweets.  For those that understand the intricacies of blockchain, they realize that it is not just about buying and selling digital assets similar to standard stock trading.  There are multiple noncustodial services of a blockchain that could technically fall into the above definition – such as crypto miners and validators, smart contract service providers, DeFi platforms, non-fungible token (NFT) marketplaces, and even certain software and protocol developers.  Many of these businesses obtain their consideration through fractional shares of certain crypto (such as Bitcoin or Ether), and not direct compensation from a known customer.  The prospect of having all of these industries provide year-end tax reporting to each individual involved in a crypto transaction (such as dates, cost basis and proceeds of each transaction) would not only be oppressive, but would unwind several privacy and confidentiality elements – one of the pillars of blockchain.  Some lawmakers have cautioned it could suffocate innovation in the U.S. or push crypto businesses to look elsewhere.  Ironically, such tax reporting requirements on all ancillary crypto businesses may not even contribute one dollar of income tax revenue, which runs counter to a key funding goal of the infrastructure bill.

As the conflict raged on and senators heard the pleas from the crypto universe, a hero amendment emerged from the fog.  The Senate came to an apparent unanimous consent to update the language of the broker crypto addition that essentially puts the proposed tax reporting requirements in the hands of crypto exchanges, such as Coinbase, and non-exchange crypto businesses would be largely exempt, including miners, validators and software developers.  When it appeared certain that all 100 senators would vote in favor of the new amendment, which is required in this case and not merely a majority, it was defeated by Richard Shelby (R-AL) who would not vote in favor of the amendment without getting an extra $50 billion of new military infrastructure spending – a separate request that was ultimately denied.  Although senators shook their heads at this move, there was nothing that could be done in accordance with Senate rules.  Therefore, the bill could only pass with the original crypto language (as shown above) and we are back to square one in the battle as the House now takes over.

The good news is that although the Senate failed to amend the broker provision regarding crypto exchanges, the Congressional Blockchain Caucus in the House (made up of about 30 members) has already stated they are prepared to roll up the sleeves and update the broker language so it gets included in the eventual House version of the bill.  Assuming passage in the House, the bill would then go to Conference Committee, where the Senate and House work out any language differences on each version of the bill.  Knowing that 99 Senators already voted yes to the amended crypto tax reporting language to focus on exchanges, there would appear to be a low chance of failure.

Even if the crypto tax reporting rules ultimately stay broad in the final version of the infrastructure bill, the tax reporting changes are not slated to take effect until 2024.  This scenario would allow plenty of time for a new bill to be crafted that could revive the more favorable amendment noted above, or at least provide crypto companies with a necessary time cushion to prepare.  If Congress fails to act, it could act as a catalyst for crypto companies to look outside the U.S. and setup operations in friendlier locations. 

In This Issue:

• Outdated “Responsible Party” Information May Slow Down Your Tax Refund
• The Battle in Congress for Cryptocurrency Tax Reporting Rules – Who Will Win?