The Crypto Tax Reporting Plan in the Infrastructure Bill is Good Policy.
In a move that caught the cryptocurrency industry off-guard, negotiators involved in the infrastructure deal added a bipartisan tax provision aimed at cryptocurrency exchanges. The new provisions significantly expand the definition of “brokers” who are subject to tax reporting requirements and would help pay for the infrastructure deal’s $1 trillion price tag.
If the crypto industry is to be believed, the end is nigh. “This is not a drill,” one prominent crypto lawyer warned, concluding that the new legislation “will do far more harm than good to US interests.” CoinDesk, a leading crypto publication, described crypto allies’ mission to “roll back the most dangerous provisions” of the infrastructure bill.
In reality, this is the sound of an industry rushing to try and save an unwarranted, accidental tax preference that it had gotten used to enjoying. This tax preference also enables tax cheats to, well, cheat.
Facilitators of financial transactions — exchanges, brokers, dealers — are subject to tax reporting requirements that enable the IRS to match the data it receives from taxpayers with the data it receives from financial institutions. There is plenty of research (summarized here) suggesting that such third-party reporting is an efficient instrument in fighting tax evasion.
To a significant extent, cryptoassets are not captured by these reporting laws. This is not the result of some well-conceived policy design — it is just happenstance. Cryptoassets were introduced into the world economy well after most of these reporting requirements were created. Drafters of the reporting requirements did not envision cryptoassets, so the definitional provisions in reporting laws arguably do not include facilitators of cryptoassets transactions. There is no rational justification, however, that explains why cryptoassets should be treated any differently than other financial assets when it comes to tax reporting requirements.
Thus, to date, cryptoassets have operated in an environment that is almost free of third-party tax reporting. Unsurprisingly, there is plenty of anecdotal evidence suggesting that tax evasion using cryptoassets is common. Earlier this year, for example, IRS Commissioner Charles Rettig suggested that massive amounts of cryptocurrency gains escape taxation due their ability to remain “off radar.” The J5 — a multinational task force of tax authorities — has identified cryptocurrencies as a main area of focus in fighting tax evasion.
If the blockchain industry has an interest in making cryptoassets mainstream, then its sounding of the alarm is perplexing. Tax-compliant investors should welcome this legislation. Among other things, this legislation would put 1099s in investors’ hands, making it much easier for them to comply with tax laws. The only investors who should be worried are those who do not comply.
The main cost of the law will be borne by cryptoassets’ trade facilitators such as centralized exchanges, custodian services, or others who help facilitate exchanges through decentralized platforms. Like with any other law, this will take some getting used to. There will be uncertainties. Mistakes will be made. But after some growing pains, legislative fixes, and the inevitable regulatory guidance that will follow, most uncertainties will be ironed out.
Overall, however, facilitators of crypto trades should welcome this new regime in spite of the added compliance costs. The new reporting requirements should help to introduce cryptoassets into the mainstream. I would expect many investors who refrained from investing in this class of assets to be encouraged by the increased certainty, and join the ride. I would expect investors who sat on their cryptoassets due to tax uncertainty to start spending more of their assets, as tax certainty increases. In fact, there is a certain level of hypocrisy with some in the blockchain community who, on the one hand, advocate for cryptoassets to go mainstream but, on the other, decry the imposition of standard, mainstream regulation.
Finally, even with this new legislation, cryptoassets will still enjoy significant tax preferences over other financial assets. Multiple anti-abuse laws, aimed at curtailing creative tax engineering, simply do not apply to cryptoassets — again, for the simple fact that the laws were drafted before cryptoassets had been introduced.
For example, with cryptoassets, you can probably “harvest losses” through wash sales; you cannot do so with stock or bonds. You can also short cryptoassets that you already own, constructively selling them without triggering tax; you cannot do so with stock. Tax advisers are well aware of this and urge their clients to use such strategies that, while perceived as abusive by Congress, happen to be legal due to the chronology of legal drafting.
The crypto measure in the bipartisan infrastructure bill should only be the opening shot. Cryptoassets still enjoy unjustified preferential tax treatment under the internal revenue code. If the cryptocurrency industry aims to “mainstream” cryptoassets, mainstream tax treatment should be part of the deal.