Getting ready for the IRS’s new digital asset reporting regulations

The Internal Revenue Service is currently drafting proposed regulations on digital asset reporting requirements, but their final direction remains uncertain.

The Tax Reporting Conference, held each year in May, shed some light on digital asset reporting on the new Form 1099-DA, as well as the proposed regulations. Jessalyn Dean, vice president of tax information reporting at cryptocurrency tax and accounting software developer Ledgible, noted that the IRS is currently working on the Crypto Asset Reporting Framework, which would coordinate the U.S.’s collection and exchange of tax information on non-U.S. people to foreign tax authorities. 

She pointed out that the IRS’s John Sweeney, special counsel in the Office of Associate Chief Counsel, speaking at the conference, noted that changes will have to be made to future iterations of the 1099 and 1042-S regulations in order to collect the information that is needed to exchange tax data with foreign tax authorities — for example, account balances, which are not currently collected under U.S. regulations. 

“The rumor is that we should have the final regulations by the end of the year,” said Dean. “My sense is that they’re waiting because they want to coordinate them with the international reporting under CARF, because Sweeney said that his team is working on the CARF regulations.” 

Jordan Vonderhaar/Bloomberg

“We don’t have an exact date because, among other things, the IRS has to consider all public comments,” she added. “And there are more than 120,000 public comments. That makes it hard for us or other CPAs to locate the more technical letters.”

Sweeney noted that due to the work on the CARF, the IRS intends to draft coordinating regulations between the CARF and U.S. Form 1099 and Form 1042-S reporting in order to reduce duplicate reporting for U.S. and non-U.S. crypto and digital asset providers. 

“When asked by an audience member about issues of character and source of blockchain events for purposes of Form 1042-S [“Foreign Person’s U.S. Source Income Subject to Withholding”] withholding and reporting on non-U.S. persons, Sweeney noted that it is on the radar of his unit but did not further elaborate on its priority in the guidance queue,” remarked Dean.

The IRS has adopted a phased-in approach to different components, with gross proceeds reporting coming first, cost basis reporting coming second, and cost basis transfers reporting coming third, according to Dean: “In the second phase, only custodial brokers that held the asset from original acquisition through to its sale will be required to report cost basis. This significantly limits the amount of cost basis reporting in the first years of implementation.”

Among the highlights of the proposed regulations, according to Dean:

• Broker definition: In most cases, the IRS has reduced the scope of the definition from the original proposal in the Infrastructure Act. In broadening the definition, they have expanded what it means to “effect a sale,” which goes outside the traditional view of brokers in the financial services industry. As such, miners, validators, staking pool operators and those not operating a trade or business will typically be out of scope, while decentralized exchanges and decentralized autonomous organizations could be in scope if they have control or influence over the protocol to make changes in it. As expected, centralized exchanges remain in scope as a broker.
• Digital asset definition: In scope are crypto currencies, non-fungible tokens, stablecoins, tokenized real estate, tokenized securities and commodities overseen by the Commodity Futures Trading Commission (even if not approved by them). Out of scope are closed loop tokens used in video games, tokenized inventories and central bank digital currency.
• Wash sales. Though the IRS gave no commentary on this topic in the background of the proposed regulations, the proposed edits to the regulations show that digital assets will be out of scope, for now, of wash sale loss adjustments, but the lack of commentary leaves open the possibility of future intention to add wash sales rules for digital assets.

The new proposed Form 1099-DA for digital assets, as expected, has a look and feel similar to Form 1099-B for reporting sales of traditional financial products, with most of the boxes lining up with the required information listed in the proposed regulations from August 2023, according to Dean. 
“The inclusion of a ‘wash sale loss disallowed’ Box 11 does not mean that crypto is subject to wash sale rules,” Dean said. “It is included for purposes of digital assets that are also stock or securities already subject to wash sale rules — such as certain tokenized equities.”

“Box 11d is included to indicate that a sale is not recorded on the distributed ledger,” she continued. “This is necessary because very often digital asset addresses or transaction IDs cannot be provided because transactions occurred within internal record-keeping systems.”