U.S. Department of the Treasury, IRS Release Proposed Regulations on Sales and Exchanges of Digital Assets by Brokers

On August 25, 2023, the Internal Revenue Service (IRS) and the U.S. Department of the Treasury (USDT) jointly announced an upcoming consultation on a set of proposed regulations to define how digital asset transactions are to be treated for tax purposes. The proposed regulations thereby address two primary aspects of digital asset taxation: information reporting requirements and the determination of essential financial components, including the amount realized, basis, and backup withholding to derive precise and accurate tax obligations. It is important to note in this context that the scope of the proposed regulations is limited to federal tax laws, meaning they do not introduce changes to other legal frameworks, such as federal securities laws or the Commodity Exchange Act. It may also be noteworthy that in the design of the proposed rules, the regulators sought to align the requirements of in-scope brokers with the requirements of securities brokers so as to ensure homogenety and convergence in obligations.
#### Reporting obligations for „brokers“
(1) Definition of brokers subject to reporting requirements
A central focus of the proposed regulations is the reporting obligations imposed on brokers who „facilitate the exchange of digital assets for various forms of consideration, including cash, broker services, or specific types of property“. This category of brokers would encompass a wide range of entities, including digital asset trading platforms, payment processors, wallet providers, and even those who redeem digital assets they have created.
In this context, the regulators propose to alter the definition of „broker“ to bring these „brokers“ under the remit of the regulation. Specifically, the IRS und USDT intend to maintain the existing definition of a broker as someone ready to „effect“ sales made by others, but would revise the definition of „effect“ to include anyone providing services that facilitate the sale of digital assets and who would typically know or be in a position to know the identity of the parties involved. Hence, the definition would also include real estate brokers receiving digital payments for sold properties.
(2) Explicit exclusions from the broker definition
Despite the broad definition of brokers noted above, the proposed regulations would provide certain exclusions, notably for (legal) persons effecting digital asset transactions in accordance with the newly proposed definition, where the assets are used exclusively within closed ecosystems or for routine business tasks, such as tracking inventory or processing orders. For example, distributed ledger validation services like miners and stakes would be exempt, as long as they do not provide other functions or services that may qualify them as brokers. Sellers of hardware or licensing software would also be excluded when the sole function of the hardware or software is to enable individuals to control private keys for accessing digital assets on a distributed ledger.
Retailers that accept digital assets from customers as payment would not be considered to be „effecting“ the sale of digital assets unless they are otherwise involved as a dealer of digital assets. Similarly, non-fungible token (NFT) artists who create and sell NFTs representing their work would not be considered brokers in the context of NFT sales.
(3) Types of digital asset „sales“ subject to reporting:
The breadth of digital assets and their various use cases necessitate a clear definition of what constitutes a „sale“ for purposes of the „broker“ definition and the subsequent reporting requirements. The proposed regulations would provide such clarity by defining a sale to include the exchange of a digital asset for cash, stored-value cards (including gift cards), or a different digital asset. The definition would also cover transactions involving brokers and real estate transactions where digital assets are used as consideration. Payment transactions made by customers to payment card issuers using digital assets are also within the scope, as are contracts involving the future delivery of digital assets.
However, the proposed regulations would also exclude specific transactions from the definition of a sale. Notable exceptions include hard fork transactions „in which a customer receives new digital assets as part of a protocol change“, airdrops which include „simultaneous distribution of units of digital assets to the distributed ledger addresses of multiple taxpayers“, and transactions where digital assets are received for performing services.
The regulators thereby acknowledge that the definition may not encompass every possible digital asset transaction and invite comments on potential revisions to address other types of transactions not explicitly mentioned.
(4) Information to be reported:
The information required to be reported under the proposed regulations would closely resemble reporting for traditional securities on IRS Form 1099-B. The regulators thereby propose new Form 1099-DA to require reporting on customer information, digital asset specifics, sale date, and the amount of gross proceeds. Importantly, brokers must also report transaction IDs and digital asset addresses for digital assets previously transferred into a broker-hosted wallet („transferred-in digital asset“) to aid in verification.
As brokers handle a wide range of digital assets, the proposed regulations would also require them to specify whether the consideration received was cash, a different digital asset, other property, or services. This level of detail is crucial for accurate tax reporting and enforcement, so the regulators.
(5) Coordination with existing rules:
To ensure consistency and prevent duplication, the proposed regulations would introduce coordination rules. These rules would clarify whether a transaction should be reported under existing rules for securities, commodities, or real estate, or under the newly proposed digital asset regulations. For instance, if a transaction qualifies both as a security and a digital asset, it should be reported solely as a sale of a digital asset. This coordination mechanism would maintain clarity and avoid unnecessary redundancy in reporting.
#### Determination of gross proceeds for taxation purposes
The IRS and the USDT propose that gross proceeds for digital asset transactions are determined by the amount „realized“ in these transactions. Gross proceeds would thereby be defined as the sum of the total cash payments received, the fair market value of received property (including digital assets), and the fair market value of any services received in a transaction, minus allocable digital asset transaction costs.
When determining the fair market value in exchange transactions involving digital assets, brokers would have to consider the transaction’s date and time to derive such value. For services or other property received, brokers would be required to use a reasonable valuation method based on common standards.
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To conclude it may be worth noting that there would be no de minimis rule for reporting transactions. Consequently, the reporting requirements would apply to all applicable digital product sales, regardless of the value of the digital product sold.