Interpretation of the IRS New Regulations: Cryptocurrency and Stablecoin Transactions Must Be Reported for Taxation, Which May Encourage Users to Shift to DEX

Author: Aiying compliance

In recent years, digital assets have sparked a wave in the financial markets. From cryptocurrencies like Bitcoin and Ethereum to stablecoins like USDT, and NFTs (non-fungible tokens), these new types of assets have not only attracted a large number of investors but also triggered global technological innovations and regulatory discussions.

However, the rapid rise of digital assets has also brought numerous issues. Due to their anonymity and cross-border liquidity, tax authorities have encountered unprecedented difficulties in tracking and reporting these transactions. Often, tax opacity and compliance issues have left regulators in a quandary. Coupled with the tight fiscal situation in the U.S. in recent years, after imposing a $4.6 billion fine on Binance, although a U.S. federal judge dismissed part of the SEC's lawsuit against Binance and Zhao Changpeng, other allegations such as ICO issuance, continuous sales of BNB, BNB Vault, staking services, unregistered and fraud claims have recently been allowed to continue litigation and further fines. However, the support from just one company is certainly a drop in the bucket for the current U.S. fiscal situation. Therefore, to generate more revenue, the U.S. Congress passed the Infrastructure Investment and Jobs Act in 2021, which includes amendments to the Internal Revenue Code, particularly regarding reporting requirements for digital asset transactions. Under this act, the U.S. Department of the Treasury and the IRS have drafted and released new regulations for reporting digital asset transactions. These regulations require financial institutions and brokers to report detailed information about digital asset transactions, including gross proceeds and adjusted basis.

Aiying has summarized the entire report into three main parts, allowing you to clearly understand the key points of this revised legislation:

1. Definition of Digital Assets

1. Scope of Definition

In this new regulation, "digital assets" are broadly defined as a representation of value recorded on a cryptographic distributed ledger (such as blockchain). Specifically, it includes but is not limited to the following types:

• Cryptocurrencies: Such as Bitcoin, Ethereum, etc., these are currently the most widely recognized digital assets, primarily used for payments and investments.

• Stablecoins: Such as USDT, USDC, these currencies are usually pegged to fiat currencies (like the U.S. dollar) and are designed to maintain stable value for trading and payments.

• Non-fungible tokens (NFTs): Such as digital artworks and collectibles, these tokens represent unique assets, and each NFT is one of a kind, widely used in fields like art, music, and gaming.

The regulations have not finalized rules regarding unhosted wallets and related unhosted software. The IRS has indicated that these tools may be considered brokers, with specific regulations to be determined later.

Furthermore, the regulations stipulate that the definition of digital assets is not limited to the types mentioned above; any assets recorded using similar technology may fall into this category. This means that regardless of whether these assets are traded on-chain or off-chain, as long as they involve a digital representation of value, they must be reported (with exceptions noted below).

2. Reporting Requirements

1. Main Requirements

The new regulations require brokers and financial institutions to report detailed information for each digital asset transaction. Specifically, they need to report how much money was earned from each transaction (gross proceeds) and how much was initially spent to purchase it (adjusted basis).

2. Reporting Content

To comply with the regulations, brokers and financial institutions need to report the following information:

• Transaction Date: The specific date the transaction occurred.

• Transaction Amount: The total amount of the transaction, i.e., how much you sold for.

• Asset Type: The type of digital asset involved in the transaction, such as Bitcoin, Ethereum, USDT, NFT, etc.

• Adjusted Basis: The price you initially paid for these digital assets, minus some adjusted amounts, to calculate net gains or losses.

• Counterparty Information: Relevant information about both parties in the transaction to ensure transparency and traceability.

3. Exemptions

• Stablecoins and NFTs

There are some special provisions and reporting methods for stablecoins and NFTs.

• Stablecoins: Stablecoins like USDT and USDC are usually pegged to fiat currencies like the U.S. dollar, maintaining stable value. The regulations require that transactions involving stablecoins also need to be reported, but to ease the burden on brokers, certain types of stablecoin transactions may have simplified reporting methods. For example, for frequent small transactions, an aggregated reporting method may be used instead of detailed reporting for each transaction.

• NFTs: Non-fungible tokens (NFTs) represent unique digital assets, such as digital artworks and collectibles. Most NFT transactions also need to be reported, but the regulations also consider certain low-value NFT transactions, which may have simplified reporting requirements or exemptions. For instance, if you are merely buying and selling low-value digital collectibles, you may not need to report as detailed as for high-value transactions.

• Closed-loop Assets

"Closed-loop assets" refer to virtual assets that can only be used within a specific system and cannot be exchanged for fiat currency. Here are some related exceptions:

• In-game Currency: If a certain virtual currency can only be used within a specific game or platform and cannot be exchanged for fiat currency like the U.S. dollar, then this virtual currency may not fall within the reporting scope. For example, gold coins earned in a game that can only be used within that game do not need to be reported.

• Internal Company Points: Similarly, points issued by a company that can only be used internally within the company do not need to be reported as digital assets. If these points cannot be exchanged for external fiat currency and can only be consumed within the company, they do not fall within the definition of digital assets.

• Overall, the revised legislation aims to make digital asset transactions transparent, ensuring everyone pays taxes. While there is a desire to collect revenue, the regulations also consider the convenience of tax compliance, such as exempting some small transactions from reporting to avoid overwhelming individuals.

3. Implementation Date of the Regulations

1. Effective Date

The new digital asset transaction reporting regulations will take effect 60 days after their official publication in the Federal Register. Therefore, the specific effective date depends on when this regulation is published in the Federal Register. Additionally, some provisions in the regulations may have different effective dates, depending on the specific stipulations of each provision. The act is divided into three phases for trial:

• After December 31, 2023: This is the initial date when the regulations officially take effect, indicating that from this point onward, all relevant reports and declarations must comply with the new requirements.

• Operational Compliance by 2025: This means that starting in 2025, all affected institutions must fully comply with operational compliance requirements, including system updates, employee training, and comprehensive implementation of reporting processes.

• Basis Tracking by 2026: Starting in 2026, tracking and reporting of transaction basis (original purchase price and related adjustments) will be required. This may involve more specific and stricter tracking requirements to ensure that all tax basis information for transactions is accurately recorded and reported.

2. Preparatory Work

To ensure smooth compliance with the relevant requirements once the regulations officially take effect, relevant practitioners and institutions need to prepare in advance as follows:

• Update Systems and Processes: Ensure that your trading platform and backend systems can record and report all necessary information, such as transaction dates, amounts, asset types, etc. If necessary, existing systems may need to be updated or upgraded.

• Train Employees: Ensure that all relevant employees understand the specific requirements of the new regulations and the reporting processes. This includes training both front-end and back-end personnel to know what information needs to be collected and submitted.

• Review and Adjust Policies: Review existing compliance policies and procedures to ensure they meet the requirements of the new regulations. If necessary, adjust internal policies to better implement the new reporting standards.

• Communicate with Clients: Inform clients about the changes in the new regulations and tell them what information they need to provide to ensure they understand their new obligations.

• Establish a Compliance Team: If not already in place, consider forming a dedicated compliance team responsible for overseeing and managing all reporting matters related to digital asset transactions, ensuring that all transactions comply with the new regulations to avoid legal issues.

• Test Reporting Processes: Before the regulations officially take effect, conduct simulated tests to ensure that all systems and processes run smoothly. This includes trial runs of the reporting process to check whether the required information can be accurately captured and reported.

Through these preparatory efforts, relevant practitioners and institutions can be well-prepared before the new regulations take effect, ensuring compliance with all new reporting requirements after implementation. This not only helps avoid legal risks but also ensures that businesses remain compliant and competitive in the new regulatory environment.

Aiying Summary

Overall, these new digital asset transaction reporting regulations will have a significant impact on the financial market and tax compliance. They will make investors more cautious during transactions, prompt trading platforms to upgrade systems and processes, and increase market transparency, but they will also raise compliance costs.

Among them, the act's definition of "digital assets" is overly broad. Almost every NFT transaction and stablecoin transaction needs to be reported, and even operations like exchanging USDC for U.S. dollars need to be reported to the IRS, even if it’s just a few cents of gain or loss. Such policies may discourage people from trading on exchanges and push them towards DeFi, thus backfiring.