Read time: 9 minutes, 45 seconds

Hey, Crypto Tax Pros!

Welcome to another edition of Chain Reactions, where we analyze only the most relevant developments in cryptocurrency taxation and regulation.

And we do it in 5 minutes or less (because let’s face it, decoding crypto is already like solving a Rubik’s cube blindfolded).

This week, we’re covering:

📊 Crypto Broker Regs: 5 key tax reporting changes explained
🏛️ SEC and CFTC clash over crypto classification as securities or commodities
💼 Navigating CP2000 notices for BlockFi and other crypto transactions

Let’s dive in!

Crypto Broker Regs Rundown: 5 Key Tax Reporting Changes

The U.S. Treasury has just dropped a bombshell in the crypto world, and it will shake up how we handle digital asset reporting.

This week, the Treasury and IRS released the final regulations for crypto broker reporting, introducing significant changes that will impact taxpayers, brokers, and even crypto tax software companies. These new rules aim to close the tax gap and ensure compliance, but they’re not without their challenges.

Let’s dive into the details of these regulations and explore their far-reaching implications.

A shiny Bitcoin token lying on top of detailed US tax forms. The forms are filled out with intricate details, including numbers, text, and official labels. The top of the tax form has bolded numbers and letters saying '1099-DA Digital Asset Proceeds From Broker Transactions.' The Bitcoin token is prominently placed in the center, catching the light and showcasing its metallic texture. The tax forms should be crisp and clearly identifiable as US tax documents, with a mix of typed and handwritten information.

The 5 Major Changes

First, a quick disclaimer: this isn’t an exhaustive list of all tax reporting changes, but what changed from the proposed rules issued in August 2023.

A lot has changed since then. The IRS proposal received an eye-watering 124,000 responses to the proposed rules before the comment period closed, highlighting the intense interest and concern within the industry. Stakeholders, including lobbyists and advocacy groups like Coin Center and the Blockchain Association, voiced significant apprehension about the proposed regulations.

The final rules, as we’ll see, reflect a mix of victories and concessions for the crypto industry:

1. Rules Delayed for Non-Custodial Providers (DeFi)

The initial proposal introduced a new broker category called “digital asset middleman,” potentially encompassing a wide range of non-custodial providers like front ends, software wallets, RPC nodes, block builders, L2 sequencers, and liquidity providers. However, the final regulations have put this on hold - for now.

While the Treasury and IRS “do not agree that non-custodial industry participants should not be treated as brokers,” they’ve decided to “reserve” on this definition. They plan to issue separate rules for non-custodial providers “expeditiously,” so DeFi platforms should stay alert.

2. Stablecoin Reporting Adjustments

Good news for stablecoin users - the reporting requirements have been eased. Initially, all stablecoin dispositions required 1099s, but the final regulations allow for an alternative reporting method to simplify tax administration.

Now, exchanges of qualifying stablecoins for non-stablecoin digital assets are not reported. Exchanges for other assets or services are only reported if they exceed $10,000 annually. Qualifying stablecoins include those designed to track fiat currencies, with mechanisms to prevent significant depegs or redemption requirements.

3. Information Reported

Brokers now have a more explicit reporting timeline. They must report gross proceeds for digital asset transactions effected after 2024 and the basis for transactions effected after 2025.

Interestingly, reporting transaction time, ID, and the customer’s blockchain address is no longer required on forms. However, brokers must retain transaction IDs and blockchain addresses for seven years, ensuring a balance between simplified reporting and maintaining necessary records.

4. Excluded Transactions

The regulations carve out exceptions for specific activities, reducing unnecessary reporting burdens. Excluded transactions include:

Wrapping/unwrapping
Liquidity provision
Consensus layer and liquid staking
Lending with an obligation to return identical assets
Short selling
Notional principal contracts

This targeted approach aims to streamline reporting by focusing on transactions most relevant for tax purposes.

5. Multiple Lots Identification

Here’s where it gets tricky. Taxpayers must now specify which units of a digital asset they are selling using the specific identification method, which must be done by the sale date. If not specified, brokers will default to the “first-in, first-out” (FIFO) method.

Standing orders for pre-deciding units to sell are allowed, providing some flexibility. Brokers can use customer-provided acquisition information if deemed reliable, potentially easing the burden on both parties.

Impact on Crypto Brokers, Investors, Tax Pros, and Software Providers

These new regulations will have far-reaching effects across the crypto ecosystem. Let’s break down the impact on key stakeholders:

Crypto Brokers

Brokers face significant operational challenges in implementing these new rules. They must overhaul their systems to comply with the wallet-by-wallet reporting requirement, which includes implementing new processes to accurately track and report each transaction by wallet. This can be technologically and financially burdensome.

Collecting and verifying detailed customer information adds another layer of complexity, raising concerns about data privacy and security. Brokers must now balance compliance requirements with protecting sensitive user data.

Investors

For investors, the new regulations introduce both benefits and challenges. On one hand, the streamlined reporting for stablecoins and excluded transactions may simplify tax reporting for certain activities. However, the specific identification requirement for digital asset sales could complicate record-keeping for active traders.

Investors will need to be more diligent in tracking their digital asset purchases and sales, especially if they want to optimize their tax liability through specific identification. The default FIFO method could lead to higher taxable gains, as the earliest acquired assets (often at a lower cost basis) are sold first.

Tax Pros

Tax professionals will need to stay on top of these new regulations to effectively serve their crypto clients. The complexities around cost basis reporting, wallet-by-wallet rules, and the specific identification method will require a deeper understanding of both crypto operations and tax law.

Expect to see an increased demand for tax resolution services, especially as these new rules may lead to more CP2000 notices from the IRS. Tax pros should consider investing in specialized training and tools to navigate these complexities efficiently.

Software Providers

Crypto tax software companies face perhaps the most significant challenge in adapting to these new regulations. Many current software solutions use a Universal basis allocation method, which won’t comply with the new wallet-by-wallet and FIFO requirements.

To meet the transition requirements, software providers will need to:

Provide correct ending cost basis calculations under the universal method
Set up and apply an allocation of unused basis by wallets/accounts method
Produce reports showing each coin’s ending tax lots allocated to each wallet/account after the allocation

This is a substantial undertaking, and it’s questionable how many providers will be able to implement these changes accurately by the end of the year, given the January 1, 2025 effective date.

All in all, while these new regulations aim to bring clarity and close the tax gap in crypto transactions, they introduce significant complexities for all stakeholders. Brokers, investors, tax professionals, and software providers will need to adapt quickly to ensure compliance and minimize disruption.

Attention Tax Pros: Unlock the Crypto Tax Niche Without the Hassle!

Are your clients diving into crypto, but you’re not equipped to handle their complex tax situations? Don’t turn away business – join our exclusive Crypto Tax Alliance Program!

🤝 Partner with crypto tax experts
🔒 Keep your clients (we guarantee it!)
💰 Earn referral commissions
🚀 Expand your service offerings without the learning curve

Here’s how it works:

Schedule a free Discovery Call with our co-founders
Sign our Alliance Partner Agreement (we’re serious about protecting your clients)
Join our elite Crypto Tax Alliance Network (at no cost!)
Start referring crypto clients and watch your practice grow

Ready to revolutionize your practice? Click here to schedule your free Discovery Call and learn how you can tap into the booming crypto tax market – without the headache!

Schedule my free discovery call!

Treasury Trove of Resources

Hand-picked resources to help you dive deeper into our main story, learn crypto without confusion, and master crypto tax:

TaxBit’s Guide to Digital Asset Broker Regulations (10 min read) Comprehensive breakdown of the new crypto broker regulations, offering valuable insights for tax professionals and crypto businesses.
Journal of Accountancy: IRS Issues Final Regs on Reporting Requirements for Digital Assets (5 min read) Detailed analysis of the IRS’s final regulations on digital asset reporting, essential for accountants and tax practitioners serving crypto clients.
CPA Practice Advisor: IRS Finalizes Rules for Crypto Tax Reporting (3 min read) Concise overview of the finalized crypto tax reporting rules, helping CPAs quickly understand the key changes and implications for their practice.

Crypto Tax Pro Tip Of The Week

We recently signed up two new clients who received a CP2000 regarding their BlockFi transactions.

The response deadline is one week from now.

We will represent him before the IRS and do his crypto account reconciliation. The IRS has likely sent CP2000 to many others regarding their BlockFi or other crypto-related transactions. If you or your clients ever used BlockFi, you may get a CP2000 from the IRS.

In my recent LinkedIn post, I explain what the CP2000 is and steps to take if you get one.

P.S.: We are very experienced in handling IRS notices regarding crypto transactions and would love to help crypto taxpayers who need assistance with their IRS notices.

Curated Crypto News

Want to stay on the cutting edge?

Here's what else is happening in crypto tax, policy, and markets that you should know about:

Want to stay on the cutting edge?

Here's what else is happening in crypto you should know about:

🕵🏻‍♂️ SEC drops key stablecoin investigation in win for crypto industry: According to Fortune, SEC Chair Gary Gensler stated that BUSD, the Binance-branded stablecoin, is not a security. This is a big deal because it provides clarity on the regulatory status of a major stablecoin and potentially sets a precedent for similar assets. We think this means we might see increased adoption and development of stablecoins, as well as more nuanced regulatory approaches to different types of cryptocurrencies.

🙅‍♂️ CFTC Chair Declares 70-80% of Crypto Assets Are Not Securities: According to BeInCrypto, CFTC Chair Rostin Behnam stated that most cryptocurrencies, including Bitcoin and Ether, are likely commodities rather than securities. This is a big deal because it challenges the SEC’s broad approach to regulating cryptocurrencies and could lead to a shift in regulatory oversight. We think this means we might see a more balanced regulatory framework emerging, with clearer distinctions between different types of digital assets.

👩‍⚖️ House fails to override veto of anti-SAB 121 bill : According to Blockworks, the U.S. House of Representatives failed to override President Biden’s veto of a bill that would have nullified the SEC’s crypto custody accounting guidance (SAB 121). This is a big deal because it maintains the current regulatory stance on how banks and financial institutions must account for customers’ crypto holdings. We think this means we’ll continue to see cautious approaches from traditional financial institutions when it comes to offering crypto custody services, potentially slowing mainstream adoption in the short term.