Crypto Winter: Will smaller Crypto Exchanges be ready for new 1099 reporting?

By T. Chen, Tax & Accounting Senior Specialist Editor

Commentators have called the current situation regarding depressed cryptocurrency prices a Crypto Winter. That is another name for an extended period of trouble for the market. There has been speculation that during these times some smaller crypto exchanges may be on the brink of solvency distress (brink exchanges). In that type of situation, it would be reasonable for brink exchanges to focus on keeping the lights on for the set of days or weeks immediately in front of them. With that backdrop, my question is: Will brink exchanges continue preparations for compliance with the new IRS Form 1099 information reporting requirements for transfers of digital assets?

Those new information reporting requirements come from the Infrastructure Investment and Jobs Act (P.L. 117-58, 11/15/21) amendment to Code Sec. 6045 – Returns of Brokers. More specifically, the addition of new Subparagraph (c)(1)(D), which imposes a reporting obligation on:  any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person. I will refer to this subset of transaction reporting as Crypto Reporting. Without going into the technical definition, almost all cryptocurrencies will be considered digital assets for this purpose. Thus, most brink exchanges should end up with Crypto Reporting obligations.

The new Crypto Reporting starts up for transactions performed in 2023, with the resulting statements and returns to be furnished and filed in early 2024. Again, this comes under Code Sec. 6045, which classifies digital assets as specified securities. Currently, all of that reporting is performed through the use of IRS Form 1099-B.  Looking at the “boxes” on the version for 2022 transactions, it seems likely that a drastic overhaul of the form will be needed to accommodate the addition of digital asset transactions. In fact, it will not be shocking if the IRS creates an entirely separate Form 1099 for Crypto Reporting.

Regardless of those form details, you might be asking whether this is something brink exchanges really need to be concerned about right now. It is true that any Crypto Reporting won’t be due until February of 2024 at the earliest. However, brink exchanges will have to be tabulating transactions starting on Jan. 1, 2023. Furthermore, some mandatory reportable details (e.g., tax basis) may need to be drawn from data for activity from well before 2023, which also could require capabilities for cooperation with other crypto exchanges.

I have not seen the inner workings of a crypto exchange, but I did work for one of the largest payment card processing companies in the U.S. during the ramp up for the first 1099-K reporting under Code Sec. 6050W. Inserting the necessary tools into an existing transaction processing platform in order to be able to properly assemble data for Crypto Reporting will likely require fundamental changes to the platform. Those kinds of changes rarely can be launched on short notice. Thus, prudent brink exchanges should have kicked off preparations for compliance with Crypto Reporting right after Nov. 15, 2021. If so, they would now be in the middle of a capital investment program. If a brink exchange is having solvency concerns, Crypto Reporting may drop out of immediate focus. However, pausing and then trying to do something massive in a hurry could require efforts that would be exponentially more costly. Thus, once more I ask, will brink exchanges be ready? It is very hard to imagine.

My mention of platform upgrading only relates to the front end of Crypto Reporting. There also is a back end that brink exchanges need to be ready to handle. That is, statements (the 1099s) need to be printed and mailed, or hoops need to be jumped through for electronic delivery. Then, returns (with the 1099 information) need to be filed with the IRS. For most, that filing will need to be done through the IRS FIRE system, an electronic filing channel separate from those used for other kinds of tax returns (and the latest word is that this is being replaced by an XML-based system on Jan. 1, 2023).

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