Crypto Tax Provision May Prompt Investors to Push Industry for More Compliance Help

The congressional debate over new tax compliance measures for cryptocurrency investors has primarily focused on two issues-the potential to raise new revenue and what parts of the industry may be reclassified as "brokers" who must transmit data on customer gains and losses to the IRS. But the bipartisan infrastructure bill seeks to do more than just expand the definition of a broker in the crypto space.

It would also require brokers to alert the IRS when customers move their crypto assets to an account that doesn't have a broker keeping tabs on trades and purchases made by an investor. So, even if the definition of a broker is kept fairly narrow, crypto users may end up pushing the industry to increase its tax compliance support.

For the more well-known cryptocurrency exchanges, gathering and submitting a Form 1099 for their customers makes sense. Many people buy and sell their coins through these platforms, triggering a realization event. The exchanges can relatively easily log capital gains or losses, and several already do report information to the IRS.

But what happens when people take their cryptocurrencies off those exchanges and move them to a personal-or non-custodial-cryptocurrency wallet? There are still tax implications for making purchases and peer-to-peer trades from these wallets, but it is less clear who can or should report them.

To cover that grey area, some legislators want to make other parts of the cryptocurrency blockchain ecosystem, besides the exchanges, responsible for providing the IRS with relevant information on transactions and trades. This led industry advocates to raise concerns that some players in this realm might be required to give the IRS customer information they don't have. But the IRS might not need a broader definition of "broker" to solve a big chunk of the compliance problem.

In the Sept. 2 episode of TPC's webcast The Prescription, tax lawyer and former Treasury staffer Lisa Zarlenga said the Senate bill also would require exchanges to notify the IRS when customers move assets from their platform to a non-brokerage account. Those concerned about tax avoidance-or tax evasion-in the crypto space should rest a bit easier knowing that the IRS would receive the names and other account information on cryptocurrency traders who move their assets to a non-custodial wallet.

It's not a perfect solution for the IRS, but it might not have to be. Despite some stereotypes, it turns out that crypto investors look a lot like other investors.

A recent study published by the CESifo Network -a research group based in Munich, Germany-used data from the US Survey of Consumer Payment Choice to better understand whether cryptocurrency investors differ from those who stick to more traditional assets. They found that investors in the cryptocurrency space didn't show any propensity to distrust fiat currencies or traditional banking and financial services.

"From a policy angle, one of the main takeaways is that as the goals of investors are the same as those for other asset classes, so should be the regulation," the report says.

This isn't to suggest that lawmakers and Treasury should ignore industry concerns about regulations that are incompatible with the actual technology. But it does suggest that cryptocurrency investors want to stay in compliance with tax laws and may expect the cryptocurrency industry to provide more services that make tax compliance easier. For example, having exchanges report these transactions could be a useful convenience at tax time, just as reporting of stock transactions by securities broker/dealers makes tax filing easier and less time-consuming.

If the proposed customer information reporting rule becomes law, the demand for compliance help from the industry will only increase, and the messy debate over the actual definition of "broker" might not be what actually moves the needle.

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