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Crypto Industry Says Tax-Reporting Plan Hits Wrong Players (1)

Aug. 2, 2021, 7:19 PMUpdated: Aug. 2, 2021, 8:54 PM

The cryptocurrency industry is warning that proposed reporting requirements included in the bipartisan infrastructure deal are so broad that they could penalize some participants for failing to give the Internal Revenue Service information they don’t have.

The legislative package, which includes $550 billion in new infrastructure spending, would a requirement on cryptocurrency “brokers” to report information on transactions involving digital assets, including cost-basis data. The Joint Committee on Taxation estimates it will raise about $28 billion over a decade by prodding people to pay what they owe from those trades.

Coinbase and Kraken are among the U.S. exchanges that would be impacted.

The latest text would define a broker as essentially anyone who is paid a fee to regularly facilitate transfers of cryptocurrency between third parties. The definition potentially takes in individuals involved in activities, such as mining or staking, that help verify and support cryptocurrency transactions even though they don’t have access to the data that brokers would need to report, said Lisa Zarlenga, a partner at Steptoe & Johnson LLP who advises clients on blockchain and cryptocurrency issues.

“It’s hands-down the single greatest legislative threat that we’ve seen gain momentum,” Kristin Smith, executive director of the Blockchain Association, said on Bloomberg QuickTake Monday.

She said her group will be pushing for amendments to the bill prior to its passage in the Senate. If unsuccessful, the association will have a another shot when the House takes up the measure. The Senate hopes to pass the measure this week.

Senate Banking Committee ranking member Pat Toomey (R-Pa.) called the current cryptocurrency text “unworkable” in a statement Monday, adding that he plans to offer an amendment to fix the “overly broad” definition of a broker.

“Congress should not rush forward with this hastily-designed tax reporting regime for cryptocurrency, especially without a full understanding of the consequences,” he said.

Broker Definition

Decentralized exchanges could also fit into the current definition, even though lawmakers opted to remove a direct reference to the exchanges that was included in prior drafts.

“In my opinion, decentralized exchanges would still be inside the definition although the enforcement of broker laws there is questionable,” said Shehan Chandrasekera, head of tax strategy for CoinTracker, a company that helps people manage and calculate taxes from their cryptocurrency transactions. He previously noted that often those exchanges don’t collect user information—such as Social Security numbers, names, or addresses—that would be necessary to meet the new reporting requirements.

It would be difficult to apply the reporting requirements to decentralized exchanges because, by nature, there isn’t a single company or entity behind them to put the procedures in place, said Dan Hannum, chief operating officer at crypto tax software firm Zenledger.

Basis Reporting

The proposed legislation would treat digital assets as “covered securities,” meaning brokers would have to report the original purchase price of assets used to calculate capital gains or losses.

But reporting accurate cost-basis information could be difficult—even for large, centralized exchanges.

“Exchanges will not be able to capture cost basis information accurately when someone transfers crypto from their hard wallet or a decentralized exchange that doesn’t share nor track cost basis information,” Chandrasekera said. A hardware wallet is a physical device that stores a person’s private keys for accessing their digital assets.

That means the information returns won’t be complete, which could confuse taxpayers, he said.

Reporting cost-basis in certain situations “becomes really, really, really hard, if not near-impossible for these brokers,” Hannum agreed.

Time to Adapt

The proposed legislation would treat digital assets as covered securities beginning in 2023, with reporting starting a year later.

That means brokers will have to adapt their systems to track basis information by that first deadline, Zarlenga said.

The proposed legislation would require exchanges to share basis information with each other when users transfer assets from one exchange to another. It would also require reporting when assets are transferred from a broker to a non-broker.

Current technology makes it difficult for exchanges to know if they’re dealing with another broker or a non-broker so that will be something the industry will have to work on if the proposal is enacted in its current form, Zarlenga said.

“If this passes, it’s going to take some time for the technology to catch up to the law,” she said.

—With assistance from Colin Wilhelm, Kaustuv Basu, and Maria Luiza Rabello.

(Adds statement from Senate Banking Committee ranking member Pat Toomey beginning in seventh paragraph. )

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Bernie Kohn at bkohn@bloomberglaw.com

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