The Senate released 2,702 pages of the latest version of the bipartisan infrastructure bill early Sunday evening. Notably, there is a lack of funding for increased enforcement of the IRS, but in particular it includes increased information reporting for cryptocurrency exchanges or “brokers” of cryptocurrency transactions. Increased information reporting necessarily entails increased penalties for information reporting. And these special penalties for reporting information are incredibly severe.
PARIS, FRANCE – JANUARY 15: In this photo illustration a digital visual representation … [+]
New reporting requirements
The pending bill does not create any new reporting requirements for individuals, does not create any new penalties for individuals, or imposes any new obligations on individual cryptocurrency holders. Instead, the proposed law, if passed, would require that the exchange of cryptocurrencies – defined as “any person who (in return for payment) for the regular provision of services that carries out digital asset transfers on behalf of another person” – is responsible, Submit informational feedback reporting the transaction. While the form has not yet been created – the law that requires filing has not even been passed – the form would likely be produced shortly. The proposed legislation would go into effect in 2023, giving exchanges a year and a half to prepare to meet the requirements.
While the words “cryptocurrency,” “virtual currency,” “Bitcoin” or the like never appear on the nearly 3,000 pages of the bill, a digital asset is defined as “any digital representation of value that is recorded on a cryptographically secured distributed ledger or ledger similar technology as stated by the Secretary. ”The definition is intended to include cryptocurrency and any other representation of value that may develop in the future.
What is information reporting?
Reporting information is not the same as filing a tax return. Tax returns are reports of how much income is being made, how much tax is due, and how much tax has been paid. All US persons earning an income above a certain amount * must file tax returns. If a tax return is a cake, the ingredients in that cake are made up by information reporting. Employers have information requirements, such as the requirement to submit Form W-2 reporting their employees’ wages and withheld taxes. Banks have information obligations and must report how much interest is earned and paid out to the account holders. If the proposed legislation is passed in the latest version of the Senate Infrastructure Act, crypto exchanges will have increased information requirements.
How is information reporting used?
The IRS “compares” information with the taxpayer’s tax returns. For every W-2, 1099, and 1098-T you receive, the IRS will also receive a copy. When the IRS receives a tax return, a computer checks that all of the W-2, 1099, and 1098-T received by the IRS are on the taxpayer’s tax return for the same tax identification number and number. Errors in matching usually lead to “matching errors” in IRS audits.
For items such as stocks that are taxed only at a profit, reporting mismatches in reporting information can create real problems. I previously wrote about how if a taxpayer fails to file a tax return, the IRS will prepare a return or SFR replacement. Imagine buying 10 shares of Amazon for $ 3,000 per share and selling them for $ 3,327 per share. Your profit is $ 3,270 (327 * 10) and your tax is calculated based on that profit, not the total sale of 10 shares for $ 33,327. The purchase price of the shares is your base. But for taxpayers who never file a tax return, the IRS has no information about the purchase price of the stock or the taxpayer’s base. If a tax return is not filed, the IRS calculates the capital gain as the total sale price, or $ 33,327, as information reports are required when assets are sold but not acquired.
Does this proposed rule affect crypto investors or just exchanges?
The proposed legislation, if passed, would have a significant impact on investors and stock exchanges. Exchanges must make significant efforts to comply with reporting requirements. Investors, on the other hand, do not have to “do” anything. But under the new law, any information the IRS would normally get if an investor sells a stock in Amazon is now sent to the IRS when an investor sells a Bitcoin, Ethereum, or something similar. There is a lot to be clarified: what happens to crypto that is stored in cold stores, wallets not on exchanges, so-called “self custody”. The proposed legislation does not deal with this “self-custody” cryptocurrency as it is comparable to cash under a mattress. It is difficult to develop an information reporting system that includes such an asset, and even more difficult. However, individual cryptocurrency owners and investors still need to be careful as it is even more likely that the IRS will be made aware of their transactions and expect them to be reported on a tax return.
What are the penalties?
The penalties for reporting information are the heaviest and most expensive in the Internal Revenue Code. As a tax attorney, I can say that clearly without hesitation. They are costly both in terms of the penalty imposed and the extremely difficult way to challenge them in court. The proposed law says nothing specifically about sanctions, except that section 6724 of the Internal Revenue Code will be amended to include digital assets in the definition of what constitutes a criminal information return.
Failure to submit a required information return will result in a multi-part penalty. Pursuant to Section 6721, the IRS may impose a penalty for failing to submit a required information return to the IRS. Pursuant to Section 6722, the IRS may impose a penalty for failure to provide a proper disclosure statement to a payee. The fine is $ 250 for each return “faulty” and cannot exceed $ 3,000,000 in any one year.
Think back to the example of a W-2. An employer who is requested to file a W-2 will be subject to both Section 6721 for failure to file that W-2 with the IRS and Section 6722 for failure to provide the W-2 to the employee Punishment proven. In my experience, the IRS always suggests evaluating both penalties, never one or the other. To put it in perspective, Coinbase, the first major cryptocurrency exchange to go public, has over 56 million customers. That’s $ 250 for each customer who would have to but not receive the form.
Worse still, these penalties are increased dramatically if the IRS determines that a required reporter has been “willfully disregarded”. Penalties imposed under the general rule are capped at $ 3,000,000 per reporter per tax year (for a combined cap of $ 6,000,000 per year under 6721 and 6722), but the penalty is is not capped when the IRS determines that the rules have not been followed due to deliberate disregard. And in my experience, in defending these criminal information reporting cases, the IRS almost always defended the first line of deliberate disregard, even in cases where taxpayers hired professionals to help them identify and fulfill their information obligations.
Put everything together
If the proposed legislation is enacted as it is drafted, cryptocurrency exchanges will have to work hard to ensure they meet strict information reporting requirements to avoid information reporting penalties. And cryptocurrency holders need to be even more vigilant to ensure that their cryptocurrency transactions are properly reported.
** For those readers who want to dig deeper into the technical requirements, I wrote a more detailed and technical article here last year on information reporting requirements and penalties.
*** I recently announced a series of “Top 10 Crypto Tax Mistakes to Avoid” and was unable to publish the series right away. It is imminent.