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On November 15th, Beijing time, the U.S. Internal Revenue Service (IRS) held a highly anticipated hearing to discuss expanding the taxation scope of cryptocurrency assets. The hearing covered various key issues, including user privacy, the scope of cryptographic entities required to report transaction information, inclusion of stablecoins, application of proposed regulations to participants in decentralized finance (DeFi), and reporting of wallet addresses.
The rapid development of DeFi has made it a focus of regulatory attention. According to Barclays Bank research, the cryptocurrency tax gap is at least $500 billion. The lack of clear definitions for DeFi projects, no taxable history, no experience with on-chain transactions, and other entities posing as DeFi entities have increased regulatory challenges. Therefore, the IRS is attempting to ensure tax transparency and integrity by incorporating them into the regulatory framework.
The primary focus of the hearing revolved around the definition of "broker." According to proposed regulations drafted in August, the definition of a broker could potentially be expanded to include "digital intermediaries that directly or indirectly affect the sale of digital assets." The expanded definition would directly include DeFi, non-custodial wallets, and wallet developers within the broker's scope. Brokers would be responsible for:
- Taxpayer's name, address, and taxpayer identification number.
- Name, type, quantity, date, and time of the sale of digital assets.
- Total proceeds received by the seller from the sale (including exchange and on-chain proceeds).
- Total proceeds paid to the broker as transaction fees.
- Wallet address where the seller transferred digital assets.
- On-chain transactions related to the sale or transfer into accounts, transaction identifiers, or hashes associated with the sale.
In essence, the IRS requires decentralized projects like Uniswap, Sushi, Metamask, and others to perform KYC on all users, including tracking transactions on exchanges and on-chain, identifying wallet addresses, and having detailed knowledge of users' on-chain transaction movements and profits.
Although this hearing has faced public criticism, there are several issues in the current market that warrant consideration: the significant growth in trading volume on decentralized exchanges, the difficulty in tracking funds transferred in non-custodial wallets, and the increase in illegal activities due to private wallets lacking third-party reporting. Many experts believe that expanding the tax scope is inevitable, and the formal introduction of the legislation is expected by 2025.
What impact will expanding the tax scope have?
**For Users:**
In addition to reducing income, users will face complex data processing and paperwork. The 2021 Infrastructure Investment and Jobs Act in the United States previously directed the IRS to implement new rules for cryptocurrency brokers. If the tax scope is expanded, digital brokers must report the tax cost basis, and the complexity of the cost basis will pose additional challenges for brokers, taxpayers, and the IRS. Taxpayers have two choices when calculating the cost basis:
1. First in, First out (FIFO, default): Assumes selling the Bitcoin purchased at $1,000 and $2,000 when selling at $4,000, FIFO would assume selling the $1,000 portion of Bitcoin.
2. Specific identification: Allows taxpayers to choose which digital assets to sell, minimizing tax burden selectively, but requires clear identification and tracking of each transaction.
With specific identification, taxpayers need to delve into not only exchange but also on-chain transaction records dating back several years and mark specific bitcoins they intend to sell from their inventory, even if delegated to brokers. Simple FIFO may result in additional taxation because the United States has two tax rates: short-term and long-term. Short-term rates, holding less than a year, incur progressive tax rates directly, while long-term rates, holding more than a year, even at the highest tax bracket, only require a 20% payment, compared to 37% for short-term.
The IRS acknowledges that collecting cryptocurrency taxes will bring massive paperwork, and the vast amount of on-chain data may increase 1099-DA forms for 13 to 16 million taxpayers by 8 billion. Currently, brokers do not have the capability to support specific transaction identification, and users must rely on systematic learning of basic tax knowledge and use on-chain data tools to track and record digital asset transactions, transfers, and holdings for targeted tax reporting.
**For the Industry:**
Taxation requires complete transaction records for calculating cost basis, capital gains, fair market value, etc. However, tracking asset changes in exchanges, wallets, and decentralized protocol transactions is a complex task, and the IRS finds it challenging to directly produce tax reports. According to relevant organizations, tax reports for over millions of cryptocurrency investors are inaccurate.
In the future, businesses or tax authorities will rely on a more intelligent, automated tax reporting system based on on-chain and centralized data, similar to TurboTax and H&R Block. This system will integrate on-chain records, including buys, sells, airdrops, forks, minting, swapping, gifting, etc., leading to a significant amount of public information being disclosed, shaking the industry's ideal of "decentralization."
**Public Opposition:**
Tens of thousands of people expressed opposition to this hearing. Most believe that such excessive regulation will violate personal privacy and undermine individual freedom. This concern reflects the public's worries about excessive government intervention, suggesting that regulations should protect citizens' basic rights while maintaining social order. Congress has attempted similar definitions for intermediaries, including "any decentralized exchange or peer-to-peer market," but was ultimately rejected. Now, the IRS is reinterpreting the definition of "broker" using language similar to the concept of intermediaries, exceeding statutory definitions. As a result, the public questions whether this action potentially violates administrative law.
In the author's view, taxing DeFi is not realistic. Over 95% of projects in the market have not generated positive cash flow, and they are in a very early and fragile stage. Taxation would impose additional burdens on DeFi projects. Expanding the tax scope (to non-custodial wallets) will also exert tremendous pressure on the market. After Biden increased capital gains tax for the wealthy in 2021, Bitcoin experienced a steep decline. If a new tax system is implemented, expanding the scope to on-chain assets will lead to more users engaging in tax-loss transactions, selling for profit before formally paying taxes to reduce tax liability.
Taxation still has a long way to go, involving multiple government agencies, and there are many ambiguous areas at present: whether stablecoin transactions need to be reported, how to confirm non-financial assets, etc. The VP of Tax at Coinbase stated during the hearing that "reporting taxes on transactions with no gains or losses (including stablecoins) would result in a large but low-value reporting." A senior advisor to the Blockchain Association also commented that the proposal is too broad, forcing decentralized projects to choose between 1. abandoning decentralized technology or 2. staying away from the United States. |
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Post time 20-11-2023 09:22:17