‘A Nightmare for Taxpayers’ - The Treasury Department’s Recent Guidance on Crypto Explained

On August 25, 2023, the Treasury Department issued proposed guidance which clarified that centralized exchanges, decentralized exchanges, payment processors, and even online wallets, will soon be required to report gains and losses to the IRS through Form 1099-DA. 

The Treasury Department claims that these new regulations will make it easier for investors to report their taxes. However, many in the industry say that these rules will make it significantly more difficult for investors to pay their taxes and cause issues for decentralized protocols. 

"The Treasury Department’s latest guidance is likely to cause more problems than it solves and was clearly put together by individuals with limited knowledge of the inner workings of the decentralized ecosystem," said CoinLedger CEO David Kemmerer. "It’s likely that this new guidance will make tax season a nightmare for both taxpayers and crypto-related businesses."

What does this mean for crypto investors like me?

It’s important to keep in mind that the Treasury Department’s proposed guidance will not increase taxes on cryptocurrency for investors. This guidance simply provides clarity on crypto tax rules put into place by the Build Back Better Act. 

Starting in the 2025 tax year, cryptocurrency brokers will issue Form 1099-DA to customers and the IRS. This form will contain a record of your gains and losses from digital assets. 

Currently, stock brokers like E*Trade are subject to similar tax reporting requirements. However, cryptocurrency’s unique properties will likely lead to some unique tax reporting challenges when it comes to wallet-to-wallet transfers. 

What’s the problem with the new guidance? 

Let’s walk through what these changes mean for the cryptocurrency ecosystem. 

The trouble with calculating gains and losses 

While Form 1099-DA was designed specifically for digital assets, it’s unlikely that it will solve the issues associated with cryptocurrency tax reporting. Consider the following scenario. 

In this case, David should have $5,000 of capital gain. 

However, Gemini is unlikely to know David’s original cost basis for buying cryptocurrency. As a result, the exchange may report his cost basis on his 1099-DA as ‘unknown’. If David hasn’t kept records of his cryptocurrency transactions, he could be liable for the full $15,000 of capital gain. 

The example above is relatively simple. However, some investors have thousands of transactions in a year across decentralized and centralized exchanges. In cases like these, trying to track down the original cost basis of your assets can be incredibly difficult. 

Handicapping decentralized finance 

The Treasury Department’s proposed guidance says that some decentralized finance protocols will be considered ‘brokers’ — though it’s not clear which protocols will fit the requirements. In any case, it’s likely that these new reporting requirements will change decentralized finance forever. 

Currently, most decentralized exchanges do not require Know Your Customer (KYC) information. For example, you don’t need to give your name and Social Security number to get started using Uniswap. 

Starting in 2026, decentralized exchanges may be required to start collecting customer information to comply with broker requirements. It’s possible that decentralized exchanges that don’t comply with these regulations will no longer be able to legally operate in the United States. 

In addition, decentralized exchanges like Uniswap — unlike centralized exchanges like Coinbase — are owned and controlled by users. As a result, decentralized exchanges don’t have large teams that can help them stay compliant with tax regulations and send out tax forms to users and the IRS.

In the future, it’s likely that it will be significantly more difficult to start a new decentralized exchange. Even brand new exchanges may be required to collect customer information and comply with tax regulations!

In conclusion

While these 1099 reporting requirements won’t be enforced until 2025, these proposed rules may cause lasting changes in the cryptocurrency ecosystem for years to come. 

It’s important to remember that the Treasury Department and the IRS do encourage written feedback from taxpayers and stakeholders. Written comments on the proposed guidance will be accepted until October 20th. In addition, public hearings on the Treasury Department guidance are scheduled on November 7th and 8th.