IRS seeks to clarify digital assets, curtail tax evasion on new 1099

Brokers and brokerages trading digital assets would be required to report the proceeds of the transactions to the IRS through a new type of Form 1099 under a rule proposed by the agency.

The regulations submitted Aug. 25 by the IRS and the Treasury Department could reduce tax evasion by Bitcoin, Ethereum and other cryptocurrency investors while giving financial advisors and their clients more easily understandable documentation of their holdings beyond the current self-reporting of digital assets, according to experts. The new rules would define what kind of investment platforms, exchanges, wallet providers and "real estate reporting persons" are considered brokers for tax purposes. The implementation date would be in early 2025.

Coming only days before a court ruling in favor of a potential Bitcoin ETF in a legal fight with the Securities and Exchange Commission and weeks after FINRA's approval of the Digital Assets Council of Financial Professionals' certification, the IRS proposal joined other educational and regulatory efforts aimed at resolving ongoing legal and practical questions surrounding crypto.

"These new rules will prove problematic to tax evaders, and, unfortunately, there is a certain small segment, a remnant of the early Bitcoiners from 2010 who engaged in Bitcoin at least in part because of the anonymity and the ability to avoid reporting transactions on their tax returns," Ric Edelman, the founder of the Digital Assets Council, said in an interview. "Tax evaders will not be favorable to these new reporting requirements, but that is exactly why these rules are sorely needed and are long overdue."

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Indeed, some "crypto purists" will be upset by the potential rules bringing greater official legitimacy to digital assets, said Tyrone Ross, the founder of financial technology firm Turnqey Labs and registered investment advisory firm 401 Financial. With current systems for tracking purchases, sales, exchanges and realized or unrealized losses carrying "land mines everywhere" that many clients "just simply don't understand," the IRS proposal could offer much greater simplicity through the newly required 1099 forms, Ross said in an interview.

"I think that's a big deal," Ross said. "I think that's huge, especially for the tax and wealth management space, because this has been a pain point for a very long time."

Under the rule, the IRS would require brokers to submit a new Form 1099-DA to the agency listing the gross proceeds of digital transactions and provide customers with payee statements. The proposal also would codify rules for calculating gains and losses and basis determinations of asset values, set guidelines for backup withholding of future tax payments and create "many useful definitions" surrounding digital assets, according to a press release.

The agency asked for written comments from the industry and the public about the proposal to be submitted by Oct. 30, with a public hearing slated for Nov. 7. 

"These proposed regulations are designed to help end confusion involving digital assets and provide clear information and reporting certainty for taxpayers, tax professionals and others," IRS Commissioner Danny Werfel said in a statement. "A key part of this effort fits in with the larger IRS compliance focus on wealthy taxpayers. We need to make sure digital assets are not used to hide taxable income, and the proposed regulations are designed to provide a clearer line of sight into activities by high-income people as well as others using them. We want to make sure everyone pays what they owe under the tax laws, and our research and experience demonstrate that third-party reporting improves compliance."

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For Edelman, who admitted that he was still reading through the more than 300-page rule, the only disappointment with the potential regulations stems from the fact "that it took this long" for the federal government to propose them, he said. The package represents "a tacit acknowledgement by the government that crypto is here to stay and that tens of millions of Americans already own it," he said.

The new forms represent "the most thrilling aspect" of the proposal, according to Edelman, who expressed relief that the agency chose a 1099 instead of the "incredibly complicated" Schedule K-1 reporting method.

"The one thing we need beyond anything else is clarity," he said. "The IRS is going to be treating crypto and crypto exchanges the way they treat brokerage firms and stock and bond investments. … Everyone is familiar with 1099s. They are very simple documents that are typically a third of a page in many cases."

Other regulatory questions on crypto investors' radars include how the SEC's safeguarding and custody rule proposal could affect them and what new rules might be coming for decentralized platforms operating through blockchains, according to Ross. For advisors, the IRS proposal signals the need to speak with clients investing in crypto in order to "make sure that they have just been acknowledging that they're owning it," he said.

"There are probably clients who haven't been reporting properly," Ross said. "They should keep an eye on it, because I don't think this is where it's going to end."