Deloitte Washington National Tax Senior Manager Jonathan Cutler, a global information reporting expert, shared with Checkpoint his impressions of the IRS’ new form for reporting digital asset transactions.
On April 19, the IRS released the first draft of Form 1099-DA to coincide with proposed digital asset reporting regs that aim to clarify who is considered a “digital asset broker” under the Infrastructure Investment and Jobs Act (PL 117-58). The form is currently expected to be used beginning 2025.
The following Q&A reflects Checkpoint’s interview with Cutler and subsequently provided written comments. It has been edited for clarity.
Checkpoint: What were your first impressions when the form released? Were there any surprises on what types of information it asks for?
Jonathan Cutler: The most important point I would emphasize is the following language in the cover letter:
“This early draft release reflects the notice of proposed rulemaking that appeared in the Federal Register on August 29, 2023. This early draft release may change based on decisions made in response to comments received in response to that notice of proposed rulemaking.”
In other words, the draft Form 1099-DA that has now been published seems to reflect the IRS and Treasury’s point of view prior to receiving comments from digital asset industry members. A number of the fields included in the draft Form 1099-DA reflect rules in the proposed regulations on which many commentators chose to focus their feedback. For example, Lines 11a-d and 12a-d include digital asset and wallet information, a point which many of the public comment letters have suggested may raise privacy concerns.
As another example, a number of the lines are included for reporting of traditional securities on the Form 1099-DA because the securities are in tokenized form, a point which some commentators have suggested may create unnecessary efforts where the existing Form 1099-B reporting may otherwise suffice. In light of the cover letter language and subsequent public commentary, it will be interesting to see the final regulations and Form 1099-DA once published.
There are several points that were not anticipated from solely the language of the proposed regulations. For instance, we have historically not seen a free-text field for including an explanation of a missing recipient Taxpayer Identification Number (TIN) on any information return. It is also interesting to see a field where a filer must indicate their broker type. Existing brokers reporting on Forms 1099-B do not need to indicate a broker type, whereas this draft form seems to indicate that the IRS will be requesting broker classification indication on the forms.
It also appears that a list of codes for digital assets may be released in the future, requiring brokers to select digital asset codes for the asset sold and possibly for the asset received as proceeds where it is an exchange of digital asset for digital asset. Although the recipient instructions are included in the draft form, the draft payor instructions have not been released. Once released, we may have more insight into the 40+ fields on the form, a meaningful increase from the existing Form 1099-B.
CP: If a broker is unable to verify certain information about a recipient, a transaction, or asset, what is the recourse so all parties can be compliant? Does the form encourage more communication and transparency between brokers and customers?
JC: To the first question, the IRS has the same tools for enforcement for filers of Forms 1099-DA as they have for other information returns — penalties for late filings, failure to file, failure to furnish a copy to the customer, inaccurate reporting, late payment or failure to deposit withholding tax, as well as interest, and also the ability to audit brokers to confirm compliance and assess liability. Initially, we can expect that some of this enforcement on brokers may occur through the CP2100 (“B notice”) process and Notice 972CG penalty assessment process, but we could see expanded Forms 945 and 1099 audit activity related to the IRS’ publicly-stated perception of taxpayer noncompliance in the digital asset space.
With respect to the taxpayers, backup withholding applies to the gross proceeds from digital assets reportable on Forms 1099-DA, and the proposed rules expand the definition of proceeds to include digital assets among other types of proceeds. Generally, brokers must apply backup withholding when certified TINs — Social Security numbers and Employer Identification Numbers — or relevant exemptions are not established by customers, although B notices can result in backup withholding as well. Because a broker, as the party responsible to report, is the party responsible for the withholding. The IRS looks to the broker for fulfillment of the withholding liability, although it is ultimately intended to enforce compliance by the taxpayer that has sold the digital assets —withholding 24% of the gross proceeds of all transactions to motivate a taxpayer to file a return with the IRS.
To the second question, the Form 1099-DA has the benefit of providing the IRS and taxpayers with tax-relevant information on their digital asset trading activity. Furthermore, where a covered digital asset is sold and cost basis reporting is included on the form, a taxpayer can generally determine taxable gain or loss on each of their transactions using the Forms 1099-DA they receive from their brokers. This benefit quickly becomes a detriment where information is not reported accurately, especially where cost basis is included, and, as with traditional securities brokers, it is likely that communication between digital asset brokers and their customers will increase as a result.
Note that, under the proposed regulations, the scope of brokers required to include cost basis information is limited to brokers providing hosted wallet services, excluding a number of parties that may qualify as digital asset brokers from the obligation to report cost basis information.
CP: What is the best way for an entity who is not sure if they are considered a broker to verify whether they are required to complete and furnish the form? How clear are the definition-level distinctions between the broker types that appear on the form?
JC: As many public commentators noted, the definition of “broker” under the proposed regulations is broad and complex, and, in some cases, it is not a simple task to determine whether and under which categorization a business might fall for Form 1099-DA and related withholding purposes. To that end, we have been undertaking scoping exercises with our clients over the last nine months to determine applicability of the proposed rules and the resulting compliance obligations.
Although only in proposed form, these regulations indicate how IRS and Treasury are thinking about the digital asset ecosystem, and there are meaningful preparation and planning activities that digital asset businesses of all forms — centralized exchanges, non-fungible token platforms, wallet providers, and even decentralized exchange protocols — can undertake now to best prepare for final rule and form release.
CP: During the rulemaking hearing last November on proposed digital asset regs, several commenters said the IRS will be inundated with Forms 1099-DA, an estimated 8 billion annually. Now that the first draft of the form is released and based on what it asks for, is there still concern over volume?
JC: The same concern over volume is present, and the concern is arguably increased considering the number of fields and the free text inputs that might be required. However, under the new e-filing rules, the majority of forms are anticipated to be filed electronically, and we would expect brokers to consider using consolidated statements for furnishing copies to recipients just as is done with current securities broker reporting.
Modifications to the proposed broker and digital asset scope in the final rules could meaningfully impact the estimated volume of returns — treatment of stablecoins, for instance, could impact the total volume of forms.
CP: How has the industry reaction been since the form’s release? Because the draft is for 2025, will that leave enough time to prepare for the new reporting regime?
JC: Regarding the 2025 date on the form, it is difficult to discern whether this inclusion is meaningful or not because of the cover letter statement that the form is based on the proposed rules and may change based on final regulations.
Finally, regarding preparation time, many commentators noted the difficulty of complying on the proposed timelines because of system and technology builds, arrangement for internal or third-party support for form preparation, and general compliance readiness.
These comments came from businesses in all areas of the digital asset ecosystem, and each have unique challenges to overcome. A decentralized exchange or wallet provider may be building information reporting and withholding technology, processes, and teams from the ground up as this may be their first time dealing with these compliance responsibilities, whereas a centralized exchange or financial institution facilitating digital asset sales may be updating existing technology and procedures.
While starting fresh may be a significant effort, it also may be the case that attempting to update existing systems and processes for this unique rules is equally as challenging.
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