Following a public rulemaking hearing on proposed regs implementing digital asset broker provisions of the Infrastructure Investment & Jobs Act, TaxBit’s Vice President of Tax Solutions Erin Fennimore and Vice President of Government Relations Seth Wilks joined Checkpoint for a joint interview to provide their takeaways from the hearing and perspectives on common issues raised from the crypto community.
This interview has been edited for length and clarity.
Compliance vs. Government Overreach
Issue: Whether the proposed regs’ reporting requirements ask for too much from too many entities considered brokers.
Fennimore: “Information reporting is not a new concept. It exists to this level in terms of volume and operational aspects. It exists today equal to what these proposed regulations propose and the impact to the industry in many other regulations.”
There is a perception that the regs are taking things “a gigantic step back,” which begs the question of why there is information reporting in the first place. “We have it to close the tax gap, to help taxpayers when companies are going to enterprises or making payments. I’m a company — I’m making payments and that can be widespread payments, it can be broker payments, it could be payments for operating a business. All of those are already existing rules where that enterprise then has to issue information reporting returns to the ultimate recipient of those funds, and they do it in service of helping that taxpayer then accurately report their own income.”
Wilks: “We know anecdotally that compliance in this space has been fairly low. We know that when information returns are required, compliance jumps up to almost at an 85% level” whereas currently, it is estimated that digital asset compliance is at best 25%, possibly as low as 10%. “That’s a pretty huge gap between what people are doing and what they’re reporting. Information returns are meant to give better information to taxpayers to help them file, but it’s also to give the IRS tools to be able to know who is in compliance and who is not.”
On the flip side, it is also important for the IRS to “not be harassing people” who are already compliant. “I don’t believe that this space is just rampant with people who are trying to evade taxes. I think that the truth is it’s hard to calculate what your gains and losses are. If [taxpayers] had better information coming from the exchanges or protocols that they trade on … we would see significant level of compliance increase.” Most digital asset investors are “not purposely trying to evade. It’s just difficult and they end up giving up a little bit too quickly, I think.”
Issue: Whether the reporting requirements would lead to duplicative information when multiple brokers are involved.
Wilks: “What I’m hearing a lot is: what if you have multiple brokers involved, and will both brokers have to report? Let’s say you have a self-hosted wallet that is holding your private keys to your crypto and you use that wallet to then interact with a protocol. You swap out crypto A for crypto B — who is the broker in that transaction? [The] industry will argue that it’s not clear. Some might think that both the protocol and the wallet are brokers. That’s the scenario where you could have two forms being filed for the exact same transaction, which would be duplicative.”
TaxBit’s comment letter calls for a “last-in-line” analogy, “which is: the last broker in the chain of transaction that is facilitating that transaction would end up being the reporting broker. In this situation, it would likely be the protocol who would be the broker and required to report.”
Fennimore: The multiple-broker concept is also an existing concept not unique to crypto, although it is known on the “traditional equity side” who is the broker. “You have both sides of the conversation saying the existing rules can’t fit crypto. And then when they didn’t use existing rules for crypto, they’re like, ‘Wait a minute, we need those for crypto brokers!’ Again, when these regulations are in their infancy, there’s going to be a natural timeline of figuring out the right balance overall.”
Issue: Whether the regs favor centralized exchanges over “DeFi” and if there can be a one-size-fits-all approach.
Wilks: “I think you have to split these reporting groups or these brokers into two categories. It’s the centralized exchanges, and then the on-chain, or decentralized exchanges. I can imagine Treasury coming out and [providing] a timeline for centralized exchanges that probably looks very similar to what was already published in the proposed regulations. There’s a possibility that DeFi, self-hosted wallets and these other, newer brokers may have a little bit more time to implement” their systems to comply in a way that makes sense.
Fennimore: “Look at past regimes that impact enterprises that have never been impacted before. We have had this situation before. The original [Code Sec. 6045] regulations are a perfect example. You had things as recent as a handful of years ago with things called FATCA … entirely new regimes that impact enterprises that had to essentially update their overall procedures.”
“I think overall, the IRS knows that this has happened before. It’s why you see a phased-in approach. Phased-in timelines … give enterprises the ability to figure out the how they the how in terms of how they comply.”
Issue: Whether the final regs should carve out stablecoins and if not, what effect that will have on what the IRS receives.
Wilks: “Stablecoins … that are backed by fiat don’t fluctuate much … and the purpose of them is to be able to facilitate faster payment transactions. I look at my own credit card statement — if I’m buying everything through stablecoins, I’ve got 200 transactions every month. That’s 200 1099-DAs every month based on how the regs are written right now. Now, is that information helpful to the IRS because really, what it’s going to look like is a bunch of 1099s that show proceeds and cost basis are almost equal and my gain and loss on it is next to nothing. But whether it’s a zero gain or a very small gain, that still would have to be reported. I think that there is a real chance that Treasury could come out … maybe put a more narrow definition around payments, stablecoins, and exempt them from reporting because at the end of the day, the IRS doesn’t want more information that is not going to be helpful.”
Fennimore: “[The IRS] is not looking for more” information than what is necessary. “That’s why you already see exemptions across the entire landscape of information reporting. We’re still having that conversation of what is that right balance in this context with [1099-DAs]. And it’s happening with other returns as well that lower thresholds and the same conversation is happening” here, where the industry is “saying you’re going to get so much volume and unnecessary on unhelpful information with these other types of returns.”
Wilks: “With any new regulation, there’s always going to be initial pushback, because most industries try to limit the amount of regulation. Clear regulations will actually spur more growth in the space because you’ve got a lot of the traditional finance players who are waiting on the sidelines to get involved in crypto, but they’re not going to get involved without clear regulation. The more people who are getting involved, the more upside I think we all get to experience. Regulation I think can be a very good thing. I also think it’s just a maturity step for the industry. We certainly can debate the individual components, and I think we’ve had a healthy debate in the hearings and the comment letters … hopefully Treasury will consider all of those different opinions.”
Fennimore: “New compliance regimes are difficult. There is a transition period. Depending on how the final regulations land,” it would help “having some clear penalty relief so people understand that there is comfort and security, knowing the IRS understands how difficult the transitional time can be. It’s difficult, but it’s achievable. Just as we could innovate with an entirely new asset class, I think we can also figure out the tax compliance as well.”
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