IRS Crypto Proposals Leave Potential Lacuna for Digital Brokers

The US Treasury has opened consultations and public hearings on a new regulatory regime aimed at the transparent taxation of crypto assets. The proposal would extend existing IRS reporting rules for non-digital financial products and bring reporting for digital assets in line with traditional finance requirements.

Despite this, there are early concerns over the potential limitations of this proposal and its ability to effectively manage the evolving digital assets space.

The new regime would leave a large potential lacuna, as the rules would only apply to US-based sales and brokers and wouldn’t effectively tackle the cross-border nature of many digital asset transactions. The territorial limits of the proposed rules are clear and, while the definition of “broker” is broadly drawn, the application in the sales context is limited to US-based transactions.

Casting a Wide Net

Under the proposed regulations, digital asset brokers would have to collect internal customer information and report digital asset sales and exchanges. This is a shift away from the current tax system, which places the burden on individual taxpayers and can require them to provide information more easily gathered by digital asset service providers.

Brokers, as a category, would include digital asset trading platforms, payment processors, and some hosted wallets. Certain real estate transactions involving digital assets as consideration would be caught in this dragnet as well. But crypto miners, who work to verify blockchain transactions, would be exempt.

The new regulatory regime would also extend beyond cryptocurrencies to other types of digital assets, such as NFTs. This wider definition builds some future-proofing into the framework against new digital asset innovations and products.

Transfers of digital assets are recorded on the blockchain or similar distributed ledger technology. While the transfers themselves are visible, the ultimate owners—whether they hold the private and public keys or whether there are custodial arrangements in place—aren’t publicly recorded.

Where tax reporting and calculations are left to individuals who may have tax liability, the pseudonymous nature of blockchain transactions can therefore make it easier for those individuals to successfully bring that liability to the attention of the IRS.

Moving the burden to defined brokers and digital asset trading platforms is seen as a way to make these transactions more visible to the US tax authority. By casting the net to a wider set of transactions, and reducing evasion in this way, the new rules would bring in an estimated additional tax revenue of about $28 billion over a decade.

However, if a transaction occurred at an office outside the US, it would be exempt unless it involves a US payor or middleman. Non-broker and peer-to-peer transfers, as well as a potentially enormous number of offshore digital asset sales, would no doubt also limit the effect of the regulations.

The reality is that the burden on individual taxpayers may not change significantly due to the number of transactions that would occur across borders. Enforcement in certain multi-jurisdiction transactions that are technically caught in the net would likely prove to be difficult.

Mixed Reactions

The proposed rules look to target the increased usage of digital assets as well as transactions that would attract reporting requirements if they were carried out in standard currency. They also aim to reduce the scope for digital assets to be used for tax evasion and avoidance. Given the prevalence of this form of financial crime that’s calculated to exist in the sector, it’s unsurprising that the Treasury is looking to crack down on crypto—or that these proposals arrive amid a landscape of increasing regulatory action in the crypto industry.

Investor groups seem to welcome the regime as giving greater clarity to individual taxpayers, as much of the legwork for applicable transactions, including complex calculations, move away from them. Political reactions, however, have been divided. While Republican commentators have framed these proposals as anti-industry, key Democratic actors have stated they don’t go far enough to police the sector and will move too slowly in a fast-paced an industry.

Crypto insiders are expected to carefully scrutinize whether the proposed framework properly describes the “broker” role, where the intermediary function may be minimal or non-existent. This may affect the degree to which this regime would be effective.

With public hearings scheduled for November 2023, industry players will likely offer written and oral comments to the proposed regime. The initial target to finalize the rules by the end of this year is unlikely to be met. The new rules are scheduled to be implemented in stages, with reporting requirements on sales due to be introduced first, followed by implementation of reporting on transfers, so that the first real revenues would be collected no earlier than 2026.

A broad spectrum of regulations and cross-border cooperation would still be required if full oversight and regulation of the sector is the aim.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Nicola McKinney is a partner at Quillon Law in London and a commercial litigator with nearly 20 years of experience specializing in complex commercial and cross-jurisdictional disputes.

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