Regulation
Cryptocurrency broker reporting regulations should avoid the risk of mismatch
The IRS’ April 19 release of the draft Form 1099-DA, which will be used to report certain sales and exchanges of digital assets starting January 1, 2025, may indicate that the IRS is close to finalizing the regulations proposals that extend the reporting of tax code information rules Section 6045 to cryptocurrencies and other digital asset transactions.
The broad definition of “intermediary” in the proposed rule creates the possibility that multiple intermediaries may have to issue information returns to the same taxpayer for the same transaction. This will create confusion and place an unfair burden on taxpayers.
The proposed regulations significantly expand the definition of “broker” under Section 6045 to include most participants involved in a transaction in which digital assets are sold or exchanged for services or other assets.
Under the proposed rule, each broker will be required to report information relating to the client and the transaction with respect to which he or she was the broker on Form 1099-DA. However, the draft form does not reflect comments urging the IRS to limit the scope of the term “broker” and limit the types of transactions subject to reporting.
On the draft Form 1099-DA, the “broker type” box lists non-hosted wallet providers, digital asset payment processors, kiosk operators, and “others” as reportable brokers. This description is consistent with the IRS’s expansive approach to the definition of “broker” in the proposed rule and may signal that the IRS does not intend to narrow the definition in the final rule.
If the IRS does not narrow the deadline, at least two problems are likely to arise under the proposed reporting system.
First, the current proposal likely requires multiple intermediaries facilitating a single transaction to each issue a Form 1099-DA. However, not all intermediaries may have access to the same information needed to correctly complete the form.
As a result, taxpayers would receive duplicate reports for the same transactions, as well as possibly inconsistent reports. Such reporting could cause a taxpayer to inadvertently report each Form 1099-DA received as separate income items, causing the taxpayer to overreport income and pay taxes.
Second, even when a taxpayer can reconcile all 1099-DA forms received and report the transaction only once, the IRS may flag a taxpayer’s return for review due to discrepancies that may arise because intermediaries report the same transaction with different information. This would cause a perceived mismatch between the information received from the IRS and taxpayers’ returns.
To avoid these risks, the final regulations should adopt a rule designed to maximize the likelihood that a single Form 1099-DA will be issued to a person engaged in the sale or exchange of a digital asset.
If so, the IRS would be less burdened by multiple or conflicting reports relating to a single transaction, and taxpayers would not risk reporting the same income or loss multiple times. The reporting problem does not exist in traditional financial markets because the IRS adopted the “multiple broker” rule. This rule limits reporting of securities sales to only the broker closest to the client, which prevents multiple brokers from issuing duplicate 1099 codes for a given transaction.
To address the problem of duplicative and potentially inconsistent reporting of digital assets, the New York State Bar Association has proposed creating a Qualified Digital Asset Reporting Person, or QDARP. This would be a third-party service provider that would enter into an agreement with the IRS and assume all reporting obligations to the IRS and accept regular audits.
The QDARP would be responsible for collecting and verifying information on taxpayers transacting in the digital assets market. It would also receive, aggregate and reconcile information from various digital asset intermediaries or other brokers that may relate to a particular sale or other disposition of digital assets.
Any aspiring broker would have the option, under the QDARP system, to take responsibility for reporting themselves or to offload their reporting obligations to QDARP through an agreement in which they would provide QDARP with all necessary information. The convenience of the QDARP system would likely be attractive to many market participants looking for ways to alleviate certain tax compliance burdens.
A QDARP would resemble other tax compliance systems the IRS has relied on. For purposes of withholding and reporting on fixed, determinable, annual, or periodic income paid to non-U.S. persons, the IRS permits payers of such income to rely on the services of a qualified intermediary to satisfy their reporting and withholding obligations.
Likewise, the IRS allows employers to fulfill their payroll withholding and reporting obligations by contracting with a certified professional employer organization.
If QDARP or a similar concept is not adopted in the final rule, taxpayers should consider working with digital asset transaction aggregators. These third-party companies compile and reconcile digital asset transactions so taxpayers can more accurately report basis, gains and losses.
While such tools will likely help taxpayers accurately report earnings from digital assets, they will not prevent the IRS from potentially challenging such returns due to discrepancies with the 1099-DA forms provided by brokers.
The ability of taxpayers and the digital asset industry to comply with the new reporting policy will depend on the IRS’ willingness to implement comments on the proposed regulations, particularly those related to clarifying the types of brokers subject to reporting.
This article does not necessarily reflect the views of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
About the author
Devon Bodoh is a partner in the tax department of Weil, Gotshal & Manges and is based in Miami and Washington, DC
Theo Agbi is an associate in the tax department of Weil, Gotshal & Manges and is based in Miami.
Carlos Parra is an associate in the tax department of Weil, Gotshal & Manges and is based in Miami.
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