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Hey Crypto Tax Pros!

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

This week’s roundup focuses on the significant implications of the new draft tax form 1099-DA, touching upon how these changes will reshape the landscape for all involved:

📑 5 Revealing Inclusions In the Draft Form 1099-DA: Unpack the significant elements of the draft Form 1099-DA and their potential implications on digital asset reporting.
👩🏻‍💼 What Form 1099-DA Means For Brokers, Taxpayers, and Tax Professionals: Explore how the new reporting requirements will affect different stakeholders within the cryptocurrency landscape.
“Bitcoin Jesus” Indicted For Tax Fraud: Learn about the recent indictment of a prominent crypto figure and its impact on the perception of tax compliance in the crypto community.

Let’s dive in!

Is The New 1099-DA Form a Compliance Nightmare? Here’s Our Honest Review

The latest draft of Form 1099-DA complicates cryptocurrency taxation more than it helps.

Why is this draft form causing such a stir amongst tax professionals, taxpayers, and digital asset brokers?

It started in August of 2023.

Last year, the Department of Treasury and the Internal Revenue Service proposed regulations that would broaden the definition of a digital asset broker to include blockchain software developers and DeFi protocols. The proposed regs drew over 100,000 comment letters expressing concerns over overextending the definition of a “broker,” increased taxpayer confusion, and taxpayer privacy and security.

There was a major uproar over the proposed changes, then the comment period, and then—radio silence from the IRS.

Until last week when they published a draft Form 1099-DA.

From looking at the draft, it appears that the industry’s comments went unheeded.

This is just a draft!

Before we get any further in our review, we need to emphasize a critical point:

This is just a draft Form 1099-DA. The final Form could (and should) look vastly different, especially because the proposed broker reporting regulations still aren’t finalized. The instructions to the firm even specify this:

”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.”

Some experts like Miles Fuller, senior director of government solutions at TaxBit and a former attorney at the IRS, suggest that we shouldn’t read into the new Form:

“They’re just making a form that aligns to what they described (in the proposed regulations),” he said. “They aren’t trying to announce some policy shift in the form.”

Despite its tentative nature, this draft form provides a glimpse into potential future requirements, underscoring the importance of staying informed and prepared.

Now, let’s dive deeper into the specifics—here are five critical aspects of the draft Form 1099-DA that could reshape digital asset reporting.

5 Revealing Inclusions in Form 1099-DA

While this Form is only a draft subject to change, it could signal how the IRS will approach digital asset broker information reporting.

So, grab a copy of the Draft 1099-DA, and let’s unpack the five revealing inclusions in Form 1099-DA.

1. “Unhosted wallets” included as a broker type

Under the “Broker type involved in transaction” section, “Unhosted Wallet Provider” is listed as an option.

"Broker type involved" on Draft Form 1099-DA

An unhosted wallet is a crypto wallet that is not hosted on a crypto platform like an exchange. For example, a Ledger hardware wallet is an unhosted wallet.

This means that, despite the industry explaining to the IRS why “unhosted wallets” aren’t brokers, the agency intends to include them in the definition anyway. This could be due to the reason that some unhosted wallets, such as Ledger, can be used to do trades, usually through a DeFi platform such as Uniswap. But that could potentially lead to duplicated 1099 reporting for the same transactions, for example, both by the wallet and by the DeFi platform.

2. Boxes 1a, 1b: Codes for digital assets?

The inclusion of these boxes suggests the IRS expects brokers to categorize digital assets based on some formal registry.

No such registry currently exists, so we’ll see how this plays out. Will the IRS create this registry? Will they be able to keep up with the 5,300 new tokens launching per day?

3. Boxes 11 - 12: Sales and transfer-related information

The Form collects the typical information you’d expect, such as date and time acquired/sold (1d/1e), proceeds (1f), and cost basis (1g).

However, the Form includes other boxes you wouldn’t expect, such as information about digital asset sales and transfers, including wallet addresses and transaction IDs:

Sales-related information:

Box 11a: Sale transaction ID (TxID)
Box 11b: Digital asset address
Box 11c: Number of units

Transfer-related information:

Box 12a: Transfer-in TxID number
Box 12b: Transfer-in digital asset address
Box 12c: Number of units transferred

4. Box 1i: Are crypto wash sales no longer allowed?

Box 1i reads, “Wash sale loss disallowed.”

This does not imply that all crypto transactions now fall under wash sale regulations. This box is specifically applicable to digital assets that double as stocks or securities already governed by wash sale rules, such as certain tokenized equities.

Additional instructions on what assets meet these requirements are needed.

5. Box 5: Non-deductible losses due to “reportable change in control or capital structure”

Box 5 requires brokers to report a loss as non-deductible due to a “reportable change in control or capital structure,” referencing Form 8949 and Schedule D Instructions.

However, these instructions lack specific directions on how to apply these rules to events involving cryptocurrencies and digital assets. It leaves brokers to determine the appropriate actions on their own, with an additional directive that they should inform investors of any losses through a separate statement.

What Form 1099-DA Means For Brokers, Taxpayers, and Tax Professionals

The IRS wants brokers to re-create block explorers on paper.

At least, that’s effectively the agency’s aim if the draft Form 1099-DA remains unchanged.

As a result, brokers, taxpayers, and tax professionals will all face new challenges and responsibilities under the draft Form 1099-DA.

What the 1099-DA Means for Brokers

For brokers, the introduction of the draft tax form 1099-DA signifies a significant shift.

This will require a comprehensive update to how transaction data is managed and reported. Due to the need for detailed records such as transfer-in addresses and sale addresses, brokers face a significant data-gathering challenge. Even major platforms like Coinbase struggle with current forms; smaller DeFi platforms may find this overwhelming.

Brokers such as major centralized exchanges should now consider implementing robust systems capable of handling these specific requirements.

Pending the finalization of the broker reporting rules, enhanced KYC processes may also become necessary for decentralized exchanges and wallets to ensure compliance and accurate reporting.

Ultimately, these demanding requirements may prove too burdensome for many crypto platforms, potentially driving them to offshore jurisdictions and, ironically, decreasing overall tax compliance.

What the 1099-DA Means for Taxpayers

Taxpayers would face new rules if the draft tax form 1099-DA remains unchanged, impacting how digital wallets and transactions are managed:

KYC Requirements for Unhosted Wallets: Classifying “unhosted wallets” as brokers means users must complete Know Your Customer (KYC) processes before using wallets like Ledger, Trezor, and Metamask, or engaging with DeFi protocols. This aims to increase transparency but may limit ease of use.
Privacy Concerns: With brokers required to collect and report detailed transaction data, privacy risks escalate. Each broker could become a target for data breaches, making personal information vulnerable.
Increase in Reporting Volumes and Complexity: The new classification could lead to taxpayers receiving thousands, or even millions, of 1099-DAs. This would significantly complicate tax filings for individuals engaged in frequent crypto transactions and, therefore, increase costs.
Shift Towards Centralized Platforms: Faced with these complexities, many users might prefer the relative simplicity of centralized platforms like Coinbase. This shift could reduce the tax reporting burden but may also move away from the decentralized nature of cryptocurrencies.

To prepare, you should review your current wallet setups and consider the privacy implications of these changes. Staying informed about what constitutes a broker under the new rules will help you navigate these requirements more effectively. Consider consulting with a crypto tax advisor to ensure compliance without compromising your data security.

What the 1099-DA Means for Tax Professionals

While business grows for tax professionals, it’s primarily because the new 1099-DA form complicates tax filing for average taxpayers.

New duties for tax professionals include extensive reconciliation of diverse data sources, including 1099 forms, crypto tax software, and block explorers to ensure accurate reporting. This process is meticulous and time-consuming, requiring a high level of detail and familiarity with both traditional and crypto-specific tax practices.

This may also lead to more CP2000 notices from the IRS and a growing demand for tax resolution services. These are challenging to resolve and can be thankless, yet they are increasingly common with the complexities introduced by crypto transactions.

To manage, we recommend leveraging advanced tax software and specialized training in crypto taxation. Understanding the nuances of forms like 1099-DA will be crucial. Tax professionals should also consider streamlining their workflow to handle these cases more efficiently, possibly by investing in newer technologies or hiring specialized staff.

As the potential implementation of Form 1099-DA approaches, tax professionals must prepare for significant changes in the management and reporting of digital assets. This shift could redefine the landscape of cryptocurrency taxation, challenging our existing frameworks for digital asset accountability and compliance.

Treasury Trove of Resources

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

EY: Draft Form 1099-DA Unanswered Questions Explore the complexities and unresolved issues surrounding the new draft Form 1099-DA as outlined by tax professionals.
Forbes: What Crypto CPAs Should Know About Form 1099-DA A detailed guide on what crypto CPAs need to know about the new Form 1099-DA, enhancing their readiness for upcoming tax changes.
Journal of Accountancy: Draft of Form 1099-DA for Reporting Digital Asset Transactions Understand the implications of the newly released draft of Form 1099-DA for reporting digital asset transactions.
Crypto Tax Outsourcing: We constantly get calls from other CPA firms that don’t have the capacity or desire to prepare their clients’ crypto taxes but still want to help by sending them to an experienced crypto tax professional. If this sounds like you, we’d love to chat about how we can help!

Feel free to schedule a free strategic partner consultation Zoom call on our calendar HERE.

Crypto Tax Pro Tip Of The Week

This week, we posted on LinkedIn about how our firm managed to finish tax season early this year. Check out the post below!

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:

⛏️ Crypto Mining Block Rewards Tax Legislation: According to Cointelegraph, new legislation has been proposed that could change how crypto mining block rewards are taxed. This is a big deal because it directly impacts miners’ profits and their operational strategies. We think this means that we may see a shift in how mining operations are structured, potentially driving innovation in more tax-efficient mining practices.

🚷 “Bitcoin Jesus” Indicted for Tax Fraud: According to CoinDesk, Roger Ver, a prominent crypto advocate commonly known as “Bitcoin Jesus,” has been indicted for tax fraud. This is significant because it highlights the ongoing scrutiny crypto individuals face under U.S. tax laws. We think this means increased caution and perhaps even hesitancy regarding tax compliance within the crypto community.

🥸 Elizabeth Warren’s Fake Letter on Crypto Tax: According to Cointelegraph, a fake letter allegedly from Elizabeth Warren proposing extreme measures on crypto taxation circulated online. This is a big deal because it stirs significant confusion and misinformation in the community and emphasizes the need for verified information before reacting.